IFRS 16 lease accounting is the International Financial Reporting Standard (IFRS) that regulates the recognition, measurement, presentation, and disclosure of leases. The International Accounting Standards Board (IASB) developed it and implemented it on January 1, 2019. IFRS 16 substitutes IAS 17 and does away with the difference between operating and finance leases for lessees. Under accounting for leases IFRS 16, lessees must recognize a right-of-use (ROU) asset and a lease liability for virtually all leases. This article discusses lessee lease classification, accounting for a right-of-use asset, lease disclosures, accounting for lease termination, and lease examples under IFRS 16.
What is IFRS 16 Lease Accounting?
IFRS 16 lease accounting will compel companies to put most leases on the balance sheet with an entry of a right-of-use asset and a lease liability. This will make the financial statements more representative of lease burdens and make the system more transparent.
In the case of early termination, under IFRS 16 accounting lease termination, a lessee shall derecognize the lease liability and the right-of-use (ROU) asset. A gain or a loss from termination is recognized in the income statement.
For lessees, IFRS 16 lease accounting removes the distinction between operating and finance leases. Requires a lessee to recognize, at the commencement of a lease, a liability to make lease payments and an asset representing the right to use the underlying asset during the lease term. Retains IAS 17 principles for lessors, thus simplifying lease accounting. Enhances the comparability of financial statements across industries.
IFRS 16 Lessee Lease Classification
Under IAS 17, lessees accounted for leases as either operating or finance leases. IFRS 16 eliminates this distinction and makes lessees account for all leases as finance leases, except for short-term leases (shorter than 12 months) and leases of low-value items such as laptops or office equipment. This simplifies financial disclosure by making all lease liabilities appear on the balance sheet.
At the beginning of a lease term, companies must report a right-of-use (ROU) asset and a lease liability for future payments. The ROU asset is amortized over the lease term and interest expense is recognized based on the lease liability. Therefore, the lease liability is altered every time a payment is made. This method also gives a clearer idea of a company’s financial position.
What is Considered a Lease Under IFRS 16?
According to IFRS 16, a lease is a contract allowing a lessee to control and utilize an asset in exchange for consideration over a specified period. The lessee will direct the use of the asset and for what purpose, and payments will be specified in a lease agreement. This ensures that the lease agreements do not go unrecognized in the financial statements.
There are exemptions in IFRS 16 for some leases. This excludes short-term leases of less than 12 months, low-value leases for possessions worth less than ₹4,00,000, and service contracts that do not give control of the asset. For instance, leasing a building for 10 years counts as a lease but not a contract for a cloud computing service.
IFRS 16 Right of Use Asset Accounting
A clear difference between ASC 842 and IFRS 16 is the amortization approach of the ROU (right-of-use) asset. ASC 842 determines the expense that reduces the ROU asset as a proportion of the aggregate operating expense based on the liability expenses accrued. Consequently, the expense amount recorded for the ROU asset differs in every period.
On the other hand, under IFRS 16, the ROU asset depreciates, similar to a finance lease under ASC 842. It methodically and rationally decreases the ROU asset, generally on a straight-line basis, over the useful life of the underlying asset or the lease term, whichever is shorter.
The first thing you must know about IAS 17 lease accounting is that the right-of-use (ROU) asset is king. It indicates the right to use the leased asset during the lease term. Use an initial measurement at the amount of lease liability. This includes direct initial costs incurred, preliminary rentals earned before commencement, and estimated restoration costs. Leases are not owned but depreciated over the lease term.
IFRS 16 Finance Lease Example
IFRS 16 mandates that companies recognize right-of-use assets and lease liabilities for finance leases. Lease payments should be separated into interest and principal components to reflect proper financial reporting. The following is an example of how a company accounts for a lease under IFRS 16.
A company leases equipment for 3 years at ₹16,50,000 per year, with a 5% discount rate.
| Year | Lease Payment (₹) | Interest Expense (₹) | Principal Reduction (₹) | Lease Liability (₹) |
| 1 | 16,50,000 | 2,06,250 | 14,43,750 | 26,93,750 |
| 2 | 16,50,000 | 1,34,688 | 15,15,312 | 11,78,438 |
| 3 | 16,50,000 | 58,922 | 15,91,078 | 0 |
This IFRS 16 lease example demonstrates how companies must disburse lease payments into interest and principal, keeping accounting standards and financial transparency in view.
IFRS 16 Disclosures
IFRS 16 lease accounting makes disclosures more extensive to improve transparency. Proper disclosure in this way ensures stakeholders realize the financial implication of IFRS 16 lease accounting.
Lessee Disclosures
To provide transparency about finances for IFRS 16 leases, lessees must disclose significant financial information. The entities should disclose the right-of-use assets, carrying amounts by asset class and lease liabilities, separating current and non-current assets. A lessee should also recognize and disclose interest on the lease liabilities, short-term and low-value lease expenses, and variable payments not contained in lease liabilities. These disclosures allow investors and stakeholders to analyze a company’s lease exposure and financial condition.
Lessor Disclosures
Lessors must also make transparent disclosures of lease income and risk exposures. They must disclose finance and operating leases separately to clarify the company’s earnings. Lessees ought to provide and disclose maturity analyses to demonstrate the financial risks of lease arrangements. In addition, selling profit or loss under lease releases is necessary. These disclosures enable investors and regulators to evaluate a lessor’s financial health and risk management practices.
Relevance to ACCA Syllabus
Lease Accounting is covered in the ACCA syllabus, with details available under Financial Reporting (FR) and Strategic Business Reporting (SBR). IFRS 16 (Leases), the standard replacing IAS 17, came to replace the old standard and requires lessees to recognize a right-of-use asset and a lease liability. This aids in financial statement presentation, lease classification, and compliance with IFRS.
Lease Accounting ACCA Questions
Q1: Under IF221IF6, does an operating lease have to be recognised on lessees’ financial statements?
A) Only in the income statement as an expense
B) As an asset, and as a liability on the balance sheet
C) On the liability side alone, with no asset recognition
As a footnote with a contingent liability in the financial statements.
Ans: B) P&l impact for the period.
Q2 Before IFRS 16 what were operating leases?
A) They were responded to as an asset and liability
B)They only were reported in net income as a rental expense
C) They were classified as financing leases
D) They were treated as off-balance-sheet liabilities
Ans: B) They considered only as a rent expense at income statement
Q3: What is the difference that IFRS 16 makes to a company’s financial ratios during the transition from operating leases under IAS 17?
A) It reduces debt-equity ratio
B) It has no impact on any of the finance ratios
C) It increases liabilities and reduces return on assets
D) It reduces the amount of total assets and total liabilities
Ans: C) It heightens liabilities and increases return on assets
Q4: What is a major exception of the IFRS 16, recognizing leases?
A) All leases of more than 1 year term
B) Leases of low-value assets
C) Rentals of prime business real estate
D) Leases with unlimited renewals
Ans: B) Leases of low-value assets
Q5: What is the progression of the lease liability on an entity’s balance sheet in accordance with IFRS 16?
A) Fixed — It stays the same throughout the lease term
B) It decreases when you make lease payments and record interest expense
C) It increases due to new lease payments
D) It is removed from the balance sheet once payments begin
Ans: B) It decreases as the lease payments are made and interest expense is recognised
Relevance to US CMA Syllabus
The US CMA syllabus places Lease Accounting under Financial Reporting and Corporate Finance. The CMA aspirants learn capital vs. operating leases, lease amortization schedules, and obligations under leases. Lease accounting aids in analysis of business finance planning and finance performance.
Lease Accounting US CMA Questions
Q1: What are the criteria to classify a lease as finance lease US GAAP?
A) The term of lease is for less than a year
B) Lessee can normally give the asset back to lessee whenever he requires to use it
C)This lease conveys a title or other qualification
D)Well, the lease renews automatically each year
Ans: C) Leases that transfer ownership or meets at least one other condition set
Q2 — What effect does the financial lease have on the financial leverage ratio of the company?
A) Removes long-term debts/leverage
B) It raises leverage since lease liabilities are included in total debt
(d) None since lease payments are an expense
D) Operating income is up, thus leverage is down
Ans: B) The net debt will need to be reduced with rising lease liabilities
Q3: Where are you recording the depreciation on a finance lease?
A)Many of them do not factor in depreciation on their finance leases
B)The lessee has a right-of-use asset and lease liability
C) Less check whether an deprecation is recorded for leased asset
Ans: b) Depreciation on right of use asset recognised by lessee
Q4: A finance lease/capital lease does not affect the balance sheet
A) The lease payment shall be recorded as operating cash outflow
(B) Fund outflow from financing is Principal repayments
C) All payments under the lease are an investment outflow
D) finance lease payments are liabilities that capture the cost of leasing a cart/capital asset over time
Ans: B) Financing cash outflows in financing cash outflows
Q5: The benefits to the lessee of a finance lease
A) Expense accounts of lease fee payments
B) On-Balance Sheet: The asset continues to be owned by the lessor
C) Obtaining an asset with no initial capital outlay
D. Leasing payments are off-balance sheet
Ans: C) Obtaining an asset with no initial capital outlay
Relevance to US CPA Syllabus
The US CPA syllabus includes Lease Accounting in Financial Accounting & Reporting (FAR) under ASC 842 (US GAAP). CPA candidates examine right-of-use assets, lease liabilities, and lease disclosures. Knowledge correctly ensures compliance with SEC regulations and proper financial reporting.
Lease Accounting US CPA Questions
Q1: What is the reporting requirement for lessees of operating lease assets and liabilities under ASC 842?
A) Off-balance-sheet items
B) Operating income
C) To be reflected on the balance sheet as right of use assets and lease liabilities
D) Only in the footnotes
Ans: C) Balance sheet as right-of-use assets and lease liabilities
Q2) Lease payments made under an operating lease are__________.
The amortisation expenses they are charged with
B) They affect interest expense and depreciation
C) They will be considered as straight-line expense on income statement
D) They have an immediate accounting impact as they reduce liabilities on the balance sheet
Ans: C) Charge as straight line expense in income statement
Q3: What is the impact of the new lease accounting on EBITDA for companies with operating leases?
A) It has a material impact on EBITDA
B) It increases EBITDA as you split lease expense into interest and depreciation
C) It has no impact on EBITDA
D) It reduces EBITDA and total revenue
Ans: B) Lease expense is split to interest & depreciationline through P&L, which sounds increases to EBITDA
Q4: Which financial ratio is most directly affected by changes in a company’s total assets?
A) Return on assets (ROA)
B) Gross profit margin
C) Dividend yield
D) Earnings per share (EPS)
Ans: A) Return on assets(ROA)
Q5: Who establishes US lease accounting standards?
A) FASB (Financial Accounting Standards Board)
B) Iternational Accounting Standards Board (IASB)
C.) SEC (Securities and Exchange Commission)
D) PCAOB (Public Company Accounting Oversight Board)
Ans: A) Financial Accounting Standards Board (FASB).
Relevance to CFA Syllabus
The CFA coursework covers Lease Accounting in Financial Reporting & analysis and Corporate Finance. The CFA equivallents are all about operating vs finance leases, the impact to your ratios as well as lease valuation. Expert knowledge of lease accounting is essential for investment analysis, credit risk assessment and financial modelling.
Lease Accounting CFA Questions
Q1: In lease accounting, finance leases affect financial statements in the following ways:
A) Higher operating expenses
B) Liabilities and assets increased
C) Financial ratios do not change
D) Decreased long-term debt
Ans: B) Liabilities and asset gearing up
Q2: Name one benefit to companies of operating leases.
A) They are not subject to lease liabilities recognition
B) They enable for automatic transfer of ownership
C) They offer tax advantages and depreciation costs
D) Always more expensive than finance leases
Q: The correct answer is: A) They are not required to recognize lease liabilities
Q3: Why do finance leases impact financial ratios differently than operating leases?
A) Increase in debt to equity ratio
The ROA increasesB)
C) Interest coverage ratio increases
D) No impact on leverage
Ans: A) Increases debt-equity ratio
Q4: What lease classification method produces a larger amount of net income in the early years?
A) Operating lease
B) Finance lease
C) Sales lease
D) Leveraged lease
Ans: A) Operating lease
Q5: What does a sale and leaseback transaction mean?
A) An asset is sold by a company and leased back from the buyer
B) The asset is not purchased by a company through an operating lease
C) The answer was: facilities; that is, a lease that turns into a loan
D) Short-term lease without contractual obligation
Ans: A) A company sells an asset and leases the asset back from the buyer
