Leases – IFRS 16

Overview and Objective

IFRS 16 Leases establishes principles for the recognition, measurement, presentation, and disclosure of leases. The objective is to ensure that lessees provide relevant information that faithfully represents lease transactions, enabling users of financial statements to assess the effect of leases on the entity’s financial position, performance, and cash flows.

• Lease Definition: A lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.

• Key Parties: Lessee (obtains right to use asset), Lessor (provides right to use asset).

• Scope: IFRS 16 applies to most leases, with specific exclusions (e.g., leases for minerals, licensing agreements, biological assets).

Reporting Framework: IFRS vs IFRS for SMEs

IFRS 16 and Section 20 of IFRS for SMEs both prescribe accounting for leases, but there are notable differences:

Identifying a Lease

Definition and Criteria

IFRS 16 defines a lease as a contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The lessee must have both:

• The right to obtain substantially all economic benefits from the use of the asset

• The right to direct the use of the asset

If only part of the contract term conveys these rights, only that portion is considered a lease.

Steps to Determine Whether a Contract Contains a Lease

To assess if a contract contains a lease, follow a logical decision process:

• Is there an identified asset?

• Does the customer have the right to obtain substantially all economic benefits?

• Does the customer have the right to direct the use of the asset?

• If not, is the use predetermined or controlled by the supplier?

Example: If the supplier can substitute the asset at minimal cost, or the customer does not control the asset, the contract does not contain a lease.

Separating Components of a Contract

Contracts may contain both lease and non-lease components. Each lease component should be accounted for separately unless the lessee elects the practical expedient to combine them.

• Allocate consideration based on relative stand-alone prices.

• If observable prices are unavailable, estimate using observable information.

Example: If a contract includes leasing a bus and maintenance, allocate the total payment proportionally to each component based on their stand-alone prices.

Lease Term

The lease term is the non-cancellable period plus any extension or termination options that the lessee is reasonably certain to exercise or not exercise. Judgement is required to assess certainty.

• Includes rent-free periods

• Considers enforceability and penalties for termination

Example: If a lessee is reasonably certain to extend a lease, the lease term includes the extension period.

Recognition and Measurement: Lessee

Recognition Exemptions

Lessee may elect not to recognize assets and liabilities for:

• Short-term leases (12 months or less)

• Leases of low-value assets (e.g., tablets, small office furniture)

Lease payments for exempt leases are expensed on a straight-line or systematic basis.

Initial Recognition and Measurement

At commencement, the lessee recognizes:

• Right-of-use asset at cost, including:

  • Initial measurement of lease liability

  • Lease payments made before commencement

  • Initial direct costs

  • Estimated dismantling/restoration costs

• Lease liability at present value of unpaid lease payments, discounted using the interest rate implicit in the lease or the lessee’s incremental borrowing rate.

Formula:

Where r is the discount rate and n is the period.

Interest Rate Implicit in the Lease

The interest rate implicit in the lease is the rate that causes the present value of lease payments and unguaranteed residual value to equal the fair value of the asset plus initial direct costs.

Formula:

Subsequent Measurement

• Right-of-use asset: measured at cost less accumulated depreciation and impairment

• Lease liability: increased by interest, reduced by lease payments, adjusted for modifications

Depreciation is calculated over the useful life or lease term, whichever is shorter.

Reassessment of Lease Liability

If lease payments change (e.g., index/rate changes, residual value guarantee changes), remeasure the lease liability using the original discount rate. Adjust the right-of-use asset accordingly.

Presentation and Disclosure: Lessee

Disclosure Requirements

• Depreciation charge for right-of-use assets by class

• Interest expense on lease liabilities

• Expenses relating to variable payments not included in lease liability

• Income from subleasing right-of-use assets

• Total cash outflow for leases

• Additions to right-of-use assets

• Gains/losses from sale and leaseback transactions

• Carrying amount of right-of-use assets at period end

• Maturity analysis of lease liabilities

Additional qualitative and quantitative information about leasing activities must be disclosed.

Comprehensive Examples

Low-Value Assets – Recognition Exemption

When the recognition exemption is applied, lease payments are expensed on a straight-line basis. Prepaid or accrued expenses may arise if actual payments differ from equalized lease expense.

Amortisation Tables

Amortisation tables are used to split lease payments between capital and interest. The interest rate implicit in the lease is calculated using financial calculators or manually.

Example: The present value of minimum lease payments equals the fair value of the asset, so both asset and liability are recognized at R40,000.

Summary Table: Key Lease Accounting Steps

Key Terms and Definitions

• Right-of-use asset: Asset representing lessee’s right to use the underlying asset

• Lease liability: Obligation to make lease payments

• Interest rate implicit in the lease: Rate equating present value of payments and residual value to asset’s fair value

• Incremental borrowing rate: Rate lessee would pay to borrow funds for similar asset

• Residual value guarantee: Minimum value guaranteed to lessor at lease end

• Low-value asset: Asset with value less than $5,000 when new

Conclusion

IFRS 16 Leases requires lessees to recognize right-of-use assets and lease liabilities for most leases, with specific exemptions for short-term and low-value leases. Proper identification, measurement, and disclosure are essential for accurate financial reporting.