Financial Accounting & Reporting Outlook: Lease Accounting In Focus for Lessee
We are now almost four years (at the time of writing) on from the publishing of the new lease accounting standard IFRS 16 and the FASB 842 and preparers will be turning their minds to actually reporting under the relevant standard – transition to compliance now completed or nearing completion.
One of the main objectives of the new standards was to ensure that for any lessee the reporting of all lease activity together with all liabilities under contracted lease agreements was transparent, quantifiable and comprehensive. This key aim resulted from the consultations prior to the final drafting of IFRS 16 when many interested parties “indicated that the existing disclosure requirements did not provide enough information to understand an entity’s leasing activities”. IFRS 16 was therefore published with both quantitative and qualitative disclosure requirements. The objective of the disclosure requirements is to give a basis for users of financial statements, users such as lenders, investors and lessors to assess the effect that leases have on the financial statements. Businesses are expected to focus on the disclosure objective, not on a fixed checklist and the new standard underlines this with significantly enhanced presentation and disclosure requirements for leases.
FASB says it all with Accounting Standards Codification (ASC) 842-20-50-1 and 842-30-50-1 which provides that “the objective of the disclosure requirements is to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.” The standard further indicates that “a lessee shall consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the various requirements. A lessee shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or by aggregating items that have different characteristics.”
With that objective in mind, significant judgment will be required to determine the level of disclosures necessary for an entity. However, as a guiding principle, the basis for conclusions indicates “if leasing is a significant part of an entity’s business activities, the disclosures would be more comprehensive than for an entity whose leasing activities are less significant….”.
As part of their transition to compliance with the new standards, businesses will have been making disclosures in more recent annual financial statements on progress, potential impact and policy changes and although the new standard does not provide specific quantitative or qualitative disaggregation requirements for those businesses where leasing is a significant portion of their business, disaggregation might be appropriate.
The objective of IFRS 16’s disclosures is for information to be provided in the notes that, together with information provided in the statement of financial position, statement of profit or loss and statement of cash flows, gives a basis for users to assess the effect that leases have. Paragraphs 52 to 60 of IFRS 16 set out detailed requirements for lessees to meet this objective and paragraphs 90 to 97 set out the detailed requirements for lessors. [IFRS 16:51, 89]
A lessee subject to the new standards is, for accounting periods on after beginning 1st January 2019, required to present right of use (”ROU”) assets resulting from finance leases separately from those ROU assets subject to operating type leases and separately from any other assets, either on the face of the balance sheet or in the footnotes. Likewise, any lease liabilities resulting from finance type leases must be reported distinctly from those arising from operating types leases and from other liabilities. Then consistent with how other amortizing assets such as property, plant and equipment are reported it is required that lessees report ROU assets as noncurrent in their balance sheet. But consistent with the way other financial liabilities are presented, any associated liabilities are subject to current and long-term presentation requirements in a classified balance sheet.
A lessee opting to report ROU assets and associated liabilities within other line items on the balance sheet rather than in separate captions is prohibited from reporting finance lease ROU assets or finance lease liabilities in the same caption as operating lease ROU assets and operating lease liabilities – a disclosure of which line items in the statement of financial position include the ROU assets and lease liabilities would be required.
Regarding finance leases, a lessee should present the interest expense on the lease liability and amortization of the ROU asset in a manner consistent with how the lessee reports other interest expense and depreciation or amortization expense in the income statement. For operating leases, the lessee must present both components together as lease expense within income from continuing operations, consistent with the presentation of other operating expenses. Lease expense should be classified within cost of sales; selling, general, and administrative expense; or another expense line item depending on the nature of the lease.
The cash flow classification of payments related to finance leases should be consistent with the classification of payments associated with other financial liabilities. Payments of principal should be presented as financing activities, while payments of interest would typically result in operating cash flow presentation. Payments related to operating leases, leases to which the lessee has applied the practical expedient for short term leases, and any variable lease payments for either operating or finance leases should all be classified as operating cash outflows (unless the payment represents a cost of bringing another asset to the condition and location necessary for its intended use, in which case it should be classified within investing activities). Additionally, the establishment of ROU assets and lease liabilities at inception of a lease (or that change because of lease modifications or reassessment events) should be disclosed as noncash investing and financing activities.
As we look to financial reporting periods under IFRS 16 we additionally need to consider :–
Scope – Applies to all leases, including subleases, except for:
- leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
- leases of biological assets held by a lessee (see IAS 41 Agriculture);
- service concession arrangements (see IFRIC 12 Service Concession Arrangements);
- licences of intellectual property granted by a lessor (see IFRS 15 Revenue from Contracts with Customers);
- and rights held by a lessee under licensing agreements for items such as films, videos, plays, manuscripts, patents and copyrights within the scope of IAS 38 Intangible Assets
Instead of applying the recognition requirements of IFRS 16 described below, a lessee may elect to account for lease payments as an expense on a straight-line basis over the lease term or another systematic basis for the following two types of leases: [IFRS 16:5, 6 & 8]
- leases with a lease term of 12 months or less and containing no purchase options – this election is made by class of underlying asset; and
- leases where the underlying asset has a low value when new (such as personal computers or small items of office furniture) – this election can be made on a lease-by-lease basis.
Identifying a lease
IFRS 16:9 is quite specific in stating outright that 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
IFRS 16:B9 goes on to explain that control is conveyed when the customer has both the right to direct the identified asset’s use and to obtain substantially all the economic benefits from that use. Typically, an asset is identified by being explicitly specified in a contract, but an asset can also be identified by being implicitly specified at the time it is made available for use by the customer.
Separating components of a contract
“Lessors shall allocate consideration in accordance with IFRS 15 Revenue from Contracts with Customers” where a leases of biological assets held by a contract that contains a lease component and additional lease and non-lease components exists. An example is where the lease of an asset such as a car or copier and the provision of a maintenance service – in such cases a lessee should allocate the consideration payable on the basis of the relative stand-alone prices, which shall be estimated if observable prices are not readily available. IFRS 16:13-15 allows as a practical expedient, for a lessee to elect, by class of underlying asset, not to separate non-lease components from lease components and instead account for all components as a lease.
Finally a lessee must consider its position with regard to some of the key definitions to be determined by them which will include but not be limited to implicit interest rate in the lease, lease term (with regard to extension and termination options and the likelihood that they will be exercised), incremental borrowing rate and disclosures.
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Disclaimer: this article contains general information about the new lease accounting standards only and should NOT be viewed in any way as professional advice or service. The Publisher will not be responsible for any losses or damages of any kind incurred by the reader whether directly or indirectly arising from the use of the information found within this article.