IFRS 16 Leases replaces IAS 17, and is effective periods beginning on or after 1 January 2019.

IFRS 16 Leases brings significant changes in accounting requirements for lease accounting, primarily for lessees. For lessees, there is a choice of full retrospective application or retrospective application without restatement of prior year comparatives. IFRS 16 removes the distinction between operating (“off-balance-sheet”) and finance (“on balance sheet”) leases for lessees.

Many of our clients have asked, “does IFRS 16 really affect us?”
Our response; “if your institution either financial or non-financial rents offices or equipment, IFRS 16 does affect your financial reporting.” However, how do you go about it?

At the commencement date, a lessee (a customer) recognizes a Right-of-Use asset and a lease liability (IFRS 16, paragraph 22). A right-of-use asset is an asset representing lessee’s right to use the leased asset during the lease term. Here, you compute the amount to be adjusted on the retained earnings for the previous year.

READ: Have you reviewed your leases and rented properties for IFRS 16 Compliance

If you choose not to adjust your retained earnings, follow the steps 1, 4.

  1. Identify the leases that existed as at 1 January 2016 and compute their Present Values (PV) based on your companies borrowing rate. The borrowing rate is the cost you would incur to acquire a similar asset under similar economic conditions. If you are financial institution, you can adopt the Central Bank Rate at the time of entering into the contract.
  2. Determine the remaining period of those leases from 1 January 2019 to end of the lease.
  3. Compute the PV (discount rate/12, remaining period as at 1 January 2019 in months, annual lease amount/12).
  4. Get total PV for all leases as at 1 January 2019 and that’s the balance you post as a transition to bring the balances on balance sheet.

Example 1: initial measurement of the right-of-use asset and a lease liability

Let’s work through a calculation example on the initial measurement of a lease based on the following assumptions:

  • Commencement date: 01/01/2001
  • Discount rate: 5%
  • Initial direct costs: US$20,000
  • Lease incentives: US$5,000
  • Upfront lease payment for year 20X1: $50,000

See all the calculations presented in this example in an EXCEL Sheet [download id=”20147″] available for download.

Entries to be made:

  1. Initial recognition

Dr. Right of Use asset

Cr. Lease liability

  1. Subsequent measurement of monthly

Dr. Depreciation (Depreciation is computed on a straight line using the remaining lease period)

Cr. Accumulated depreciation

  1. Compute the interest expense component based on the discount rate, monthly PV and remaining period.

Dr. Interest expense

Cr. Lease liability

  1. For transition; if there any outstanding prepayments, these should be derecognized and reduce the lease liability since the payments were already posted.

Dr. Lease liability

Cr. Prepayment account.

Download: [download id=”20147″]