Summary Leases capitalisation on the balance sheet
IFRS 16 includes a single accounting model for all leases by lessees.
The main implications of the new standard on current practice for lessees include:
- No more operating leases under IFRS 16 (subject to the exceptions described below)
- All leases (subject to the exceptions described below) will be capitalised on the balance sheet by recognising a ‘right-of-use’ asset and a lease liability for the present value of the obligation
- No rental expense! i.e. no more straight-line expenses for operating lease costs. All leases will incur a front-end loaded expense, comprising depreciation on the right-of-use asset, and interest on the lease liability
- When initially measuring the right-of-use asset and a lease liability, non-cancellable lease payments (including inflation-linked payments), as well as payments for option periods which the entity is reasonably certain to exercise, must be included in the present value calculation.
Lessees of retail premises paying contingent (turnover) rentals, and others required to make significant contingent rental payments, will be relieved to know that these will not be capitalised into the right-of-use asset, but will continue to be expensed in profit or loss.
Industries and assets most impacted Leases capitalisation on the balance sheet
IFRS 16 will result in higher debt levels and interest costs (particularly in the earlier years of a lease) for any entities operating in industries that currently have many operating leases of high value that are material to their balance sheets. For example:
- Retailers – their shops or mall space, particularly where leases include multiple renewal options (e.g. anchor tenants in a shopping mall),
- Mines and mining services companies, where there is a significant amount of expensive equipment held on operating leases,
- Airlines – millions, and in some cases, billions of dollars will be required to be capitalised on balance sheet for aircraft,
- Cruise ship operators – as for airlines above,
- Businesses with large fleets of motor vehicles, including cars and trucks.
Exceptions Leases capitalisation on the balance sheet
Lessees can choose not to apply the IFRS 16 requirements to the following types of leases:
- Short-term leases – leases for a period of 12 months or less from commencement date, including any extension options,
- ‘Small ticket’ or low value items – items which, when new, have a low value, e.g. laptops, tablets, computers, small items of furniture and equipment.
This low value item is applied to an item, not to a group of items, and applies to the ‘as new’ value, not a second hand value, meaning that vehicles are unlikely to meet the requirements for a small ticket item.
Lease payments for these assets will be recognised on a straight line basis over the lease term, or another systematic basis if more representative of the pattern of the lessee’s benefits.
No change to current practice – lessors Leases capitalisation on the balance sheet
There have been no changes in the requirements for accounting by lessors required by IAS 17 Leases (the old standard). This means that the distinction between operating and finance lease assets will remain.
Effective date Leases capitalisation on the balance sheet
IFRS 16 is operative for annual periods beginning on or after 1 January 2019 and can be adopted early if IFRS 15 Revenue from Contracts with Customers is adopted for the same accounting period.