IFRS 16 summary

In this summary of IFRS 16, we will carry out a detailed analysis of this standard.

We will see the most relevant aspects of the accounting recognition of a right of use asset and the liability associated with a lease contract.

 

Summary IFRS 16 effective date

 
 

IFRS 16 became effective as of January 2019.

However, an entity may make an early application of this standard as long as the entity also applies IFRS 15.

Let’s remember that IFRS 15 entered into force in January 2018.

Lease Definition

 
 
 

Before the entry into force of IFRS 16, companies had been using IAS 17.

Both the repealed IAS 17 and the current IFRS 16 analyze leases from the point of view of the lessor and the lessee.

However, in IAS 17, an entity refers to operating and finance leases from the lessee’s point of view.

On the other hand, in IFRS 16, the term financial and operating is substituted by the right of use asset concept.

That is, the right to use an asset for a specific period.

In other words, a right-of-use asset concept refers to an asset recognized in the statement of financial position that shows the economic benefits of using an asset.

In contrast, under IAS 17, an entity only had the right to recognize financial leases in the statement of financial position while recognizing operating leases in profit and loss.

Under IFRS 16, all leases are recognized in the statement of financial position, except for short-term and low-value leases.

Finally, IFRS 16 does not present changes from the point of view of lessor.

In other words, reference is still made to operate and financial leases.

Summary Elements outside the scope of IFRS 16:

 
 
  • An entity shall apply IFRS 16 to all leases except leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources.
  • Leases of biological assets within the scope of IAS 41 Agriculture held by a lessee.
  • Licenses of intellectual property granted by a lessor within the scope of IFRS 15 Revenue from Contracts with Customers.
  • Rights held by a lessee under licensing agreements within the scope of IAS 38.
 

Short-term and low-value leases.

 
 

IFRS 16 establishes that an entity can recognize short-term leases in profit and loss.

A short-term lease is considered an agreement to use an asset with a term of less than one accounting period.

That is, a period that is usually 12 months.

This type of lease, as it is less than one accounting period, should not be discounted at present value.

In other words, in long-term leases, it is necessary to recognize the liability associated with this agreement at the present value of the payments agreed in the contract, as we will see later.

To analyze low-value leases, it is necessary to review paragraphs B5 and B6 of part B of IFRS 16.

There it is established that a low-value asset must meet two requirements:

1: the lessee can benefit from the use of the underlying asset on its own or together with other resources that are readily available to the lessee; and

2: the underlying asset is not highly dependent on or highly interrelated with other assets.

Example: An entity leases a low-value machine for five years.

An energy generator is necessary for this machine to work, which has a significant price.

As you can see from this example, the leased asset is not low value because although the leased asset does not have a significant price, the asset is associated with an asset with a representative price.

Recognition of low-value assets in profit and loss is optional.

In other words, if an entity decides to recognize a low-value asset as a right-of-use asset, it can do so.

Still, if it decides to recognize it in profit and loss, it must recognize the payments associated with this agreement throughout the useful life of the lease on a linear basis.

Identification of a lease

 
 

Captura de Pantalla 2022 08 04 a las 8.22.03 p. m.

The following map shows how to determine if an agreement contains a lease.

This diagram begins with the determination of an identifiable asset:

An asset is normally identified by being specified in a contract.

However, an asset may also be identified as being implicitly specified at the time the asset is available for use by the customer.

Right to obtain 100% of the benefits associated with the use of the asset:

 
 

Captura de Pantalla 2022 08 04 a las 8.24.37 p. m.

An entity may lease an asset for a specific period; however, for the asset to qualify as a lease, 100% of the benefits associated with using the asset must belong to the lessee.

In this aspect, there is an issue known as substantive substitution rights.

Substitution rights is the ability of a supplier to replace certain assets leased and benefit from this change.

Example: An entity leases a machine for 10 years.

The contract establishes that the supplier can substitute any machine for another with similar characteristics at any time.

This is the objective to lease this machine to another third party.

In this example, the agreement does not contain a lease because substitution rights exist and, therefore, the customer does not obtain 100% of the benefits associated with the asset.

Right to direct the use of the asset.

 
 

Captura de Pantalla 2022 08 04 a las 8.28.30 p. m.

If an entity can establish the existence of an identifiable asset in a lease and substitution rights do not exist, the entity must establish whether the entity has the right to direct the use of the asset.

Example: An entity leases a truck for 5 years, and there are no substitution rights.

The supplier cannot make any changes to the asset unless this change exclusively benefits the lessee.

However, the lessee can only use the asset for certain economic activities.

In this example, the arrangement does not contain a lease because the lessee does not have 100% right to direct the asset use.

Right to operate or design the asset.

 
 
 

Captura de Pantalla 2022 08 04 a las 8.31.55 p. m.

If an entity can determine that it obtains 100% of the benefits associated with the use of the asset, it can direct its use, and there are no substitution rights, it can conclude that a lease exists.

If at this point the entity is uncertain whether an arrangement contains a lease, it should establish whether the company can operate or design the asset.

What is a right-of-use asset:

 
 

Once an entity concludes that an arrangement contains a lease, it must recognize a right-of-use asset.

This asset represents the benefits associated with the use of an asset.

In other words, if an entity leases a building, it cannot recognize a property, plant, and equipment because this would mean that the entity controls the asset, and this is not so.

That is, the entity controls the right to use the asset; for this reason, it must recognize a right-of-use asset and not a fixed asset.

Initial recognition of a right-of-use asset and a contract liability.

 
 

The initial recognition of an asset with these characteristics will comprise the following elements.

  • The amount of the initial measurement of the lease liability.
  • Lease payments made before or after the commencement date of the agreement, less lease incentives received.
  • The initial direct costs incurred by the lessee.
  • Decommissioning costs.
  • As for the initial lease liability, this corresponds to the present value of the payments established in the contract.
 

That is, if an entity agrees with a third party to use an asset for 5 years with annual payments of 10,000 and a discount rate of 11%, an entity must calculate the present value of these payments over a period of 5 years with the discount rate set out in the contract.

If, for example, there are no directly attributable costs or decommissioning costs in a contract, we can say that the initial recognition of a right-of-use asset should coincide with the contractual liability.

But this is not always the case because the costs for dismantling, for example, do not affect the contract’s liability.

Leasing agreements and services associated with the agreement.

 
 

Within a lease contract, there may be a global fee that includes the right to use an asset and, together with that right, a complementary service.

For example, an entity leases a machine for 10 years and, together with the machine, a complementary service.

The contract establishes a global rate of 5,000 per year.

Under paragraph 13 of IFRS 16, an entity should separate the part corresponding to the rental payment and the part corresponding to the complementary service.

To determine the cost of this service, an entity can look at external prices as long as this service is not necessary for the machine to operate.

An entity could also look at paragraph 15 of this same standard as a practical solution and not separate the part that corresponds to the ancillary service from the part that corresponds to the rental.

Elements that may affect the lease liability

 
 
 

Paragraph 27 of IFRS 16 establishes a series of elements that could affect the liability of the contract; among these, we find the following:

  • Fixed payments.
  • Variable lease payments.
  • Amounts expected to be paid by the lessee as residual value guarantees.
  • The exercise price of a purchase option if the lessee is reasonably certain to exercise that option.
  • Payments for penalties derived from the termination of the lease.
 
 

Summary what are protective rights under IFRS 16?

 

Protective rights are clauses included in lease contracts to protect investors’ assets.

For example, an entity leases a warehouse for 8 years with annual payments of 2,000.

The contract includes a clause establishing that the lessee may not store elements that affect the investors’ assets, such as explosives or flammable liquids.

Protective rights may give the impression that the lessee does not have 100% rights to direct the asset use.

But this is not the case; they are clauses incorporated to protect the lessor assets.

Before continuing to read the post, put your knowledge into practice.

IFRS 16 - SUMMARY QUESTIONS

We want to introduce you to our IFRS course, which has a new methodology based on answers and questions using videos and training tests.

Subsequent measurement of a right-of-use asset and a contract liability.

 

Paragraph 40 of IFRS 16 states that an entity shall remeasure a lease liability if:

  • There is a change in the lease term, or there is a change in the assessment to purchase the underlying asset.
  • On the other hand, the measurement of an asset by right of use is framed in three categories.

Cost model

Fair value model of IAS 40

IAS 16 revaluation model

Cost model: Under the cost model, an entity will measure the right-of-use asset at cost, less accumulated depreciation, and less impairment losses.

In addition, this asset may also be adjusted for any remeasurement of the lease liability.

Fair value model of IAS 40: This model is used by companies that lease an asset and deliver that same asset as a sublease to a different third party.

And finally, in the revaluation model, an entity adjusts the cost of the asset to equal it to the fair value.

Modifications to a lease.

 
 

Under paragraph 44 of IFRS 16, an entity will modify a lease contract and account for a separate agreement if the following requirements are met.

  • The modification increases the scope of the lease by adding the right to use one or more underlying assets, and
  • The consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope and any appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.
 

Leases from the lessor’s point of view.

 
 

IFRS 16 presents practically no changes from the lessor’s point of view.

An entity that owns an asset may assign it under an operating or financial lease.

IFRS 16 - SUMMARY QUESTIONS

We want to introduce you to our IFRS course, which has a new methodology based on answers and questions using videos and training tests.

If you liked this content please share this post

Facebook
OTHER POSTS