Understanding IFRS 16: Leases
IFRS 16 introduced a single lessee accounting model, requiring most leases to be recognized on the balance sheet. This guide breaks down the core principles of the standard into simple, interactive components. Explore the key definitions, accounting treatments, and special cases.
Is It a Lease?
A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Use this decision flow to see if your contract qualifies.
Identified Asset?
Is the asset explicitly or implicitly specified in the contract? Does the supplier have a substantive right to substitute the asset?
Economic Benefits?
Does the customer have the right to obtain substantially all of the economic benefits from use of the asset?
Right to Direct Use?
Does the customer have the right to direct how and for what purpose the asset is used throughout the period of use?
Scope Exclusions: Remember, IFRS 16 does not apply to leases of intangible assets, exploration for natural resources, or biological assets.
The Lessee’s Perspective: A Major Shift
For lessees (the entity using the asset), IFRS 16 changes everything. Almost all leases are now brought onto the balance sheet, which increases transparency but also impacts key financial metrics. This section illustrates the “before” and “after” picture.
Balance Sheet Impact
Previously, operating leases were off-balance sheet. IFRS 16 requires the recognition of a ‘Right-of-Use’ (RoU) asset and a corresponding lease liability. Click the button to see the change.
- RoU Asset: Represents the lessee’s right to use the leased asset.
- Lease Liability: The obligation to make lease payments.
Exemptions: This rule doesn’t apply to short-term leases (12 months or less) and leases of low-value assets.
The Lessor’s Perspective: Business as Usual
For lessors (the entity providing the asset), the accounting remains largely consistent with the previous standard, IAS 17. The primary task is to classify the lease as either a finance lease or an operating lease.
Finance Lease
A lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset.
- The lessor derecognises the underlying asset.
- Recognises a lease receivable at an amount equal to the net investment in the lease.
- Recognises finance income over the lease term.
Special Cases: Sale and Leaseback
This transaction occurs when an entity sells an asset and immediately leases it back from the new owner. The accounting treatment depends on whether the transfer of the asset qualifies as a sale under IFRS 15.
Seller-Lessee
Sells the asset and leases it back.
Buyer-Lessor
Buys the asset and leases it out.
If the transfer is a sale, the seller-lessee measures the RoU asset arising from the leaseback at the proportion of the previous carrying amount that relates to the right of use retained. The buyer-lessor accounts for the purchase of the asset and for the lease in accordance with the lessor accounting model.
Enhanced Disclosures
IFRS 16 requires extensive disclosures to give investors a complete picture of an entity’s leasing activities.
For Lessees
- Depreciation charge for RoU assets.
- Interest expense on lease liabilities.
- A maturity analysis of lease liabilities.
- Information about the nature of their leases.
For Lessors
- Selling profit or loss.
- Finance income on the net investment.
- Income from operating leases.
- Information about risks and rewards of their leases.