The following post shows a series of illustrative examples related to IFRS 16.
An entity leases a building for 5 years with payments of 20,000 per year and an implicit interest rate of 9%.
¿ What is the carrying amount of the right-of-use asset and the lease liability at the end of year 4?
- The amount of the initial measurement of the lease liability
- Any lease payments made at or before the commencement date, less any lease incentives received.
- Any initial direct costs incurred by the lessee.
- Decommissioning Costs
And on the other hand, the liability associated with a lease is made up of the following elements:
The present value of the lease payments is established in the agreement using an implicit interest rate.
The following amortization table shows the initial calculation of the lease liability using a payment of 20,000 per year and an interest rate of 9%.
We want to introduce you to our IFRS course, which has a new methodology based on answers and questions using videos and training tests.
As can be seen, the present value of the lease liability is equal to 77,793.
This will be the initial cost of the right-of-use asset and the lease liability.
In this example, both the asset and the liability present the same amount on initial recognition.
However, this is not always the case because there are other elements such as decommissioning costs that could modify the initial cost of the right-of-use asset, as shown in example number 2.
The accounting recognition for years 1 to 4 are as follows:
The liability will be adjusted for subsequent years to show interest recognition and the lease liability payment.
Thus, the lease liability at the end of year 4 amounts to:
Liability balance year 4: 77,793 – 12,999 – 14,169 – 15,444 – 16,834 = 18,349.
The next step is to calculate the carrying amount of the right-of-use asset at the end of year 4.
Under paragraph 29 of IFRS 16, the subsequent measurement of a right-of-use asset will be made up of accumulated depreciation less impairment losses.
In addition, it will be necessary to adjust the asset for any new measurement of the lease liability, as we will see in example number 3 of this article.
Accumulated depreciation to year 4 amounts to (77,793 / 5) x 4 = 62,234.
Therefore, the carrying amount at the end of year 4 is equivalent to 77,793 – 62,234 = 15,559
Illustrative examples 2 : IFRS 16 decommissioning costs:
An entity agrees with a third party to lease a warehouse for 6 years.
The contract establishes a payment per year of 30,000 with an implicit interest rate of 10%.
For the warehouse to meet the entity’s needs, it will be necessary to make a series of modifications to the asset.
Once the lease agreement ends, the entity must deliver the asset to the lessor under the same conditions established at the beginning of the contract.
The entity estimates that at the end of year 6, it will have to disburse 9,000 to restore the asset.
A rate of 9% is estimated to calculate the dismantling provision.
According to the information above, what are lease liability value, the right-of-use asset, and the decommissioning provision at the end of year 1?
The amortization table of the lease liability and the decommissioning provision is shown below.
The accounting recognition for year 1 is as follows:
The initial recognition of the right-of-use asset is made up of:
Present value of lease payments: 130,658.
Decommissioning costs: 5,366.
Total cost for the right of use asset: 136,024.
The lease liability at the end of year 1 amounts to: Initial balance of liability + adjustment to liability = 130,658 – 16,934 = 113,724.
Decommission provision = opening balance + adjustment to provision = 5,366 + 483 = 5,849.
The carrying amount of right-of-use asset at the end of year one amounts to:
Initial cost, right of use asset: 136,024.
Accumulated depreciation: 22,671 (136,024 / 6).
Carrying amount, right of use asset: 113,353.
Illustrative examples 3 : IFRS 16 changes in the term of a lease:
An entity agrees with another company to lease an asset.
The contract establishes payments per year of 25,000 per year for five years.
Besides, the agreement set an implicit interest rate of 8% is
At the end of year 1, both entities extend the lease to agree to 7 years.
A new payment per year of 35,000 is agreed upon.
¿ What is the carrying amount of the right-of-use asset and the lease liability at the end of year 2?
In the same way that in previous examples, it is necessary to calculate the amortization table of the lease liability.
Now, we must calculate the liability balance and the right-of-use asset at the end of year 1.
Liability carrying amount: 99,818 – 17,015 = 82,803.
Right-of-use asset: 99,818.
Accumulated depreciation: 19,964 (99,818 / 5).
Carrying amount asset: 79,854.
Now it is necessary to calculate the new amortization table due to the contract extension to 7 years.
In this table, it is necessary to bring to the present value 35,000 at 6 years; because one year has already passed.
In this new amortization table, the balance at the beginning of year 2 amounts to 161,801.
And balance at the end of year 1, in the amortization table before the extension of the agreement, amounts to 82,803.
Therefore, adjusting the liability for the difference generated will be necessary.
That is, by 78,998.
The accounting recognition is as follows:
As established in the exercise, it is necessary to determine the carrying amount at the end of year 2 of the right of use asset and the liability for the lease.
For this, we know that the carrying amount at the end of year 1 is equal to:
Asset cost = Final carrying amount year 1 + agreement extension adjustment.
Asset cost = 79,854 + 78,998 = 158,852.
Depreciation expense year 2 = 158,852 / 6 (remaining useful life) = 26,475.
The accounting recognition of the right-of-use asset and the agreement liability for year 2 is as follows:
Finally, the balance of the lease liability at the end of year 2 amounts to 139,745 = (161,801 – 22,055)
And the carrying amount of the right-of-use asset at the end of year 2 is equal to 132,377 = (158,852 – 26,475)