IFRS 16 “Leases”, the new standard on lease contracts, will replace the old IAS 17 “Leases” for reporting periods beginning on or after 1 January 2019.
This will have a significant impact on our clients who report under IFRS with material operating leases. Examples of such leases include, but are not limited to, long-term rental of your business premises, long-term hire of plant and equipment and lease of business computer equipment.
Under the new standard, most leases (see exceptions below) will now need to be recognised on the balance sheet and treated as a finance lease.
A right-of-use asset and a lease liability at present value of lease payments should be recognised on the balance sheet.
The lease liability is calculated as all the lease payments not paid at the commencement date discounted by the interest implicit in the lease or the incremental borrowing rate i.e. the rate you would have to pay to borrow the funds for a similar asset over a similar term and with similar security.
If your company has the right to obtain substantially all economic benefits and has the right to direct the use of the asset, it is considered a “right-of-use” asset.
IFRS 16 offer a choice for implementation of the standard.
- Full retrospective approach: Restating opening balances of the earliest period presented in the financial statements. For periods beginning on 1 January 2019 this would mean the transition date is 1 January 2018.
- Modified retrospective approach: Make an equity adjustment on 1 January 2019. Comparative figures remain the same as presented.
We will apply the modified retrospective approach in the worked example below.
Company S leases a floor of a building for £100,000 per annum. The lease commenced on 1 January 2015 and has a term of 10 years. Lease payments are payable annually in advance. There is no rate implicit in the lease, no direct costs or lease incentives. Company S incremental borrowing rate is 5% per annum.
It is the year ended 31 December 2019.
Restatement of opening balances 1 January 2019
n = no. of years
|Present Value of lease payments|
Lease liability b/f
(C = A*5%)
Decrease in lease liability
(D = B – C)
Lease liability c/f
(E = A – D)
We need to recognise lease asset (future economic benefit of the rental premises) and the lease liability (what the company owes for the future benefit of the rental premises). To do this we use the value calculated from the present value of the lease payments.
1. Dr Right-of-Use Asset 810,782
Cr Lease liability 810,782
We also need to reverse the lease payments before 1 January 2019 under IAS 17 from 2015 – 2018. No cash has actually been returned but this adjustment is simply to adjust equity correctly:
2. Dr Bank 400,000
Cr Retained earnings 400,000
3. Account for the lease payments before 1 January 2019 under IFRS 16 (there were four):
Dr Lease liability 277,835
Dr Retained earnings (interest) 122,165 (2015 – 2018 interest as above)
Cr Bank 400,000
4. Calculate the depreciation of the right-of-use asset before 1 January 2019 under IFRS 16.
Company S depreciates right-of-use assets at straight line over the lease term.
|Year||NBV b/f||Depreciation (Straight line over 10 years)||Accumulated Depreciation||NBV c/f|
Four years have already gone by, therefore journal is:
Dr Retained earnings 324,312 (81,078 x 4)
Cr Accumulated Depreciation ROU asset 324,312
All of these journals can be done at once as follows:
Dr Right-of-use asset £486,470 (PV of future lease payments – Accumulated Depreciation)
Dr Retained earnings £46,477 (Depreciation + 4 years of interest – 4 years of payments)
Cr Lease liability £532,947 (PV of lease liability – 4 years of payments + 4 years of interest
Current year movements under IFRS 16
Now we have transitioned to IFRS 16, we need to make our postings for the year to 31 December 2019. Journals are as follows:
1. Recognition of interest, payment and reduction in lease liability.
Dr Lease liability £78,353
Dr Interest expense £21,647
Cr Bank £100,000
2. Recognition of current year depreciation and accumulated depreciation
Dr Depreciation £81,078
Cr Accumulated Depreciation ROU asset £81,078
Right-of-use assets should be presented separately from other assets on the balance sheet or disclosed separately in the notes.
Likewise, lease liabilities are either presented separately from other liabilities on the balance sheet or disclosed separately in the notes.
Profit & Loss
Interest on the lease and depreciation expense should be recognised separately.
Principal payments on the lease liability are presented in financing activities.
No assets or liabilities are required for short-term leases (leases of 12 months or less) or for leases of low-value assets (e.g. lease of a laptop).
Specific advice should be obtained before taking action, or refraining from taking action, in relation to the above. If you would like advice or further information, please speak to your usual Shipleys contact.