Applying IFRS - A closer look at IFRS 16 Leases Updated December 2020

Applying IFRS

A cl

oser look at

IFRS 16 Leases

Updated December 2020

December 2020  Applying IFRS - A closer look at IFRS 16 Leases 
Contents 
Overview    4 
 Objective and scope of IFRS 16  5 
1  Objective of IFRS 16  5 
2  Scope of IFRS 16  5 
3  Recognition exemptions  6 
 What is a lease?  7 
1  Determining whether an arrangement contains a lease  7 
2  Identifying and separating lease and non-lease components of a 
contract and allocating contract consideration  27 
3  Contract combinations  36 
 Key concepts  37 
1  Inception of a contract  37 
2  Commencement date of the lease  37 
3  Lessee involvement with the underlying asset before the 
commencement date  38 
4  Lease term and purchase options  39 
5  Lease payments  47 
6  Discount rates  55 
7  Initial direct costs  58 
8 Economic life  60 
9  Fair value  60 
 Lessee accounting  61 
1  Initial recognition  61 
2  Initial measurement  64 
3  Subsequent measurement  66 
4  Remeasurement of lease liabilities  71 
5  Lease modifications  73 
6  Other lessee matters  80 
7  Presentation  81 
8  Disclosure  83 
 Lessor accounting  89 
1  Lease classification  89 
2  Key concepts applied by lessor  91 
3 Finance leases  92 
4  Operating leases  102 
5  Lease modifications  104 
6  Other lessor matters  109 
7  Presentation  109 
8  Disclosure  110 
 Subleases  112 

December 2020  Applying IFRS - A closer look at IFRS 16 Leases 
1  Definition  112 
2  Intermediate lessor accounting  112 
3  Sub-lessee accounting  115 
4  Presentation  115 
5  Disclosure  115 
 Sale and leaseback transactions  116 
1  Determining whether the transfer of an asset is a sale  116 
2  Transactions in which the transfer of an asset is a sale  119 
3 Transactions in which the transfer of an asset is not a sale  126 
4  Disclosure  127 
 Business combinations  128 
1  Acquiree in a business combination is a lessee  128 
2  Acquiree in a business combination is a lessor  129 
 Effective date and transition  130 
1  Effective date  130 
2  Transition  130 
3  Lessee transition  131 
4  Lessors  141 
5  Other considerations  142 
6  Disclosure  143 
Appendix A: IFRS 16 Defined terms  145 
Appendix B: Key differences between IFRS 16 and IAS 17  148 
Appendix C: Key differences between IFRS 16 and ASC 842  155 
Appendix D: Summary of lease reassessment and remeasurement 
requirements  162 
 
   

3 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

What you need to know

• IFRS 16 Leases requires lessees to put most leases on their balance

sheets.

• Lessees apply a single accounting model for all leases, with certain

exemptions.

• For lessors, the accounting is substantially unchanged from the accounting

under IAS 17 Leases.

• IFRS 16 is effective for annual periods beginning on or after

1 January 2019, with limited early application permitted.

4 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Overview

IFRS 16

Leases

requires lessees to recognise assets and liabilities for most

leases. The International Accounting Standards Board (IASB or the Board)

issued the standard after joint deliberations with the Financial Accounting

Standards Board (FASB), which issued a similar standard (ASC 842 Leases).

However, there are significant differences between the IASB and FASB

standards (e.g., lessees classify leases as finance or operating leases under

the FASB standard). These differences will result in certain transactions

being accounted for differently under IFRS and US GAAP. Appendix C of this

publication summarises the key differences between IFRS 16 and ASC 842.

IFRS 16 replaces IAS 17

Leases.

It requires lessees to recognise most leases on

their balance sheets and provides enhanced disclosure requirements. The IASB

believes this will result in a more faithful representation of lessees’ assets and

liabilities and greater transparency of lessees’ financial obligations and leasing

activities.

Under IFRS 16, leases are accounted for based on a ‘right-of-use model’.

The model reflects that, at the commencement date, a lessee has a financial

obligation to make lease payments to the lessor for its right to use the

underlying asset during the lease term. The lessor conveys that right to

use the underlying asset at lease commencement, which is the time when

it makes the underlying asset available for use by the lessee.

Entities will need to focus on whether an arrangement contains a lease

or a service agreement because there are significant differences in the

accounting. Although IFRS 16 changes how the definition of a lease is applied,

we believe that the assessment of whether a contract contains a lease will be

straightforward in most arrangements. However, judgement may be required

in applying the definition of a lease to certain arrangements, particularly those

that include significant services.

Lessor accounting under IFRS 16 is substantially unchanged from the accounting

under IAS 17. Lessors continue to classify all leases as operating or finance

leases.

IFRS 16 is effective for annual periods beginning on or after 1 January 2019.

Early application is permitted, provided the new revenue standard, IFRS 15

Revenue from Contracts with Customers

, has been applied, or is applied at

the same date as IFRS 16.

This publication discusses how IFRS 16 is applied and is intended to help

companies consider the effects of adopting and applying it. We encourage

preparers and users of financial statements to read this publication carefully and

consider the potential effects of the new standard.

The views we express in this publication represent our perspectives as of

December 2019. We may identify additional issues as we continue to analyse the

standard and entities interpret it, and our views may evolve during that process.

IFRS 16 requires lessees

to recognise most

leases on their balance

sheets.

5 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

1. Objective and scope of IFRS 16

1.1 Objective of IFRS 16

IFRS 16 sets out the principles for the recognition, measurement, presentation

and disclosure of leases. The objective is to ensure that lessees and lessors

provide relevant information in a manner that faithfully represents those

transactions. This information gives a basis for users of financial statements

to assess the effect that leases have on the financial position, financial

performance and cash flows of an entity.

IFRS 16 requires an entity to consider the terms and conditions of contracts and

all relevant facts and circumstances, and to apply the standard consistently to

contracts with similar characteristics and in similar circumstances.

1.2 Scope of IFRS 16

Extract from IFRS 16

3 An entity shall apply this Standard to all leases, including leases of right-of-

use assets in a sublease, except for:

(a)

leases to explore for or use minerals, oil, natural gas and similar non-

regenerative resources;

(b)

leases of biological assets within the scope of IAS 41

Agriculture

held

by a lessee;

(c)

service concession arrangements within the scope of IFRIC 12

Service

Concession Arrangements

(d)

licences of intellectual property granted by a lessor within the scope of

IFRS 15

Revenue from Contracts with Customers

; and

(e)

rights held by a lessee under licensing agreements within the scope of

IAS 38

Intangible Assets

for such items as motion picture films, video

recordings, plays, manuscripts, patents and copyrights.

4 A lessee may, but is not required to, apply this Standard to leases of

intangible assets other than those described in paragraph 3(e).

IFRS 16 applies to all leases, including leases of right-of-use assets in a sublease,

except for the following:

•

Leases to explore for, or use, minerals, oil, natural gas and similar non-

regenerative resources

•

Leases of biological assets within the scope of IAS 41

Agriculture

held by

a lessee

•

Service concession arrangements within the scope of IFRIC 12

Service

Concession Arrangements.

Entities should evaluate the applicability of

IFRIC 12 before evaluating whether an arrangement contains a lease.

•

Licences of intellectual property granted by a lessor within the scope of

IFRS 15

•

Rights held by a lessee under licensing agreements within the scope of

IAS 38

Intangible Assets

for such items as motion picture films, video

recordings, plays, manuscripts, patents and copyrights

6 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

A lessee is not required to apply IFRS 16 to leases of intangible assets not

covered by the exceptions above. However, a lessee could choose to account

for leases of such intangible assets under IFRS 16.

There are differing views about whether a licence of software is excluded from

the scope of IFRS 16 based on interpretations of paragraph 3(e) of IFRS 16. If

an entity determines that a licence of software is not excluded from the scope

of IFRS 16, paragraph 4 of IFRS 16 permits, but does not require, an entity to

account for the licence of software as a lease.

If a cloud computing arrangement contains a lease of an asset other than

a licence of software (or the entity has determined that a licence of software

is not excluded from the scope of IFRS 16 and has elected to account for leases

of intangible assets under IFRS 16), an entity should apply the provisions of

IFRS 16 to the cloud computing arrangement. This includes identifying and

separating lease and non-lease components and allocating contract

consideration, which is discussed at 3.2 below.

1.3 Recognition exemptions

IFRS 16 allows a lessee to elect not to apply the recognition requirements to:

Short-term leases; and

Leases for which the underlying asset is of low value.

These recognition exemptions are discussed further in section 4.1

7 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2. What is a lease?

A lease is a contract (i.e., an agreement between two or more parties that

creates enforceable rights and obligations), or part of a contract, that conveys

the right to control the use of an identified asset for a period of time in exchange

for consideration.

IFRS 16 requires an entity to determine whether a contract is a lease or contains

a lease at the inception of the contract. The assessment of whether a contract

is or contains a lease will be straightforward in most arrangements. However,

judgement may be required in applying the definition of a lease to certain

arrangements. For example, in contracts that include significant services, we

believe that determining whether the contract conveys the right to direct the

use of an identified asset may be challenging. We discuss this further below.

2.1 Determining whether an arrangement contains a lease

Extract from IFRS 16

Appendix A

Defined terms

Lease

A contract, or part of a contract, that conveys the right to use an asset

(the underlying asset) for a period of time in exchange for consideration.

Contract

An agreement between two or more parties that creates enforceable rights

and obligations.

Period of use

The total period of time that an asset is used to fulfil a contract with

a customer (including any non-consecutive periods of time).

9 At inception of a contract, an entity shall assess whether the contract

is, or contains, a lease. A contract is, or contains, a lease if the contract

conveys the right to control the use of an identified asset for a period of

time in exchange for consideration. Paragraphs B9–B31 set out guidance

on the assessment of whether a contract is, or contains, a lease.

B9 To assess whether a contract conveys the right to control the use of

an identified asset (see paragraphs B13–B20) for a period of time, an entity

shall assess whether, throughout the

period of use

, the customer has both of

the following:

(a) the right to obtain substantially all of the economic benefits from use

of the identified asset (as described in paragraphs B21–B23); and

(b) the right to direct the use of the identified asset (as described in

paragraphs B24–B30).

B10 If the customer has the right to control the use of an identified asset for

only a portion of the term of the contract, the contract contains a lease for

that portion of the term.

8 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 (cont’d)

B11 A contract to receive goods or services may be entered into by a joint

arrangement, or on behalf of a joint arrangement, as defined in IFRS 11

Joint

Arrangements

. In this case, the joint arrangement is considered to be the

customer in the contract. Accordingly, in assessing whether such a contract

contains a lease, an entity shall assess whether the joint arrangement has

the right to control the use of an identified asset throughout the period of use.

B12 An entity shall assess whether a contract contains a lease for each

potential separate lease component. Refer to paragraph B32 for guidance

on separate lease components.

2.1.1 Joint arrangements

Entities often enter into joint arrangements with other entities for certain

activities (e.g., exploration of oil and gas fields, development of pharmaceutical

products).

A contract for the use of an asset by a joint arrangement might be entered into

in a number of different ways, including:

•

Directly by the joint arrangement, if the joint arrangement has its own legal

identity

•

By each of the parties to the joint arrangement (i.e., the lead operator and

the other parties, commonly referred to as the non-operators) individually

signing the same arrangement

•

By one or more of the parties to the joint arrangement on behalf of the joint

arrangement. Generally, this would be evidenced in the contract and the

parties to the joint arrangement would have similar rights and obligations as

they would if they individually signed the arrangement. In these situations,

the facts and circumstances, as well as the legal position of each entity, need

to be evaluated carefully

•

By the lead operator of the joint arrangement in its own name, i.e., as

principal. This may occur when the lead operator leases equipment which

it then uses in fulfilling its obligations as the lead operator of the joint

arrangement and/or across a range of unrelated activities, including

other joint arrangements with unrelated activities, such as with other

joint operating parties

A contract to receive goods or services may be entered into by a joint

arrangement or on behalf of a joint arrangement, as defined by IFRS 11

Joint

Arrangements

. In this case, the joint arrangement is considered to be the

customer in the contract. Accordingly, in determining whether such a contract

contains a lease, an assessment needs to be made as to which party (e.g., the

joint arrangement or the lead operator) has the right to control the use of an

identified asset throughout the period of use.

If the parties to the joint arrangement collectively have the right to control

the use of an identified asset throughout the period of use as a result of their

collective control of the operation, the joint arrangement is the customer to

the contract that may contain a lease. It would be inappropriate to conclude that

the contract does not contain a lease on the grounds that each of the parties to

the joint arrangement either has rights to a non-physically distinct portion of

an underlying asset and, therefore, does not have the right to substantially all

9 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

of the economic benefits from the use of that underlying asset or does not

unilaterally direct its use. Determining if the parties to the joint arrangement

collectively have the right to control the use of an identified asset throughout

the period of use would require a careful analysis of the rights and obligations

of each party.

In the first three scenarios above, if it has been determined that a contract is,

or contains, a lease, each of the parties to the joint arrangement (i.e., the joint

operators comprising the lead operator and the non-operators) will account for

their respective interests in the joint arrangement (including any leases) under

paragraphs 20-23 of IFRS 11. Therefore, they will account for their individual

share of any right-of-use assets and lease liabilities, and associated depreciation

and interest.

In the fourth scenario (i.e., where the lead operator enters the arrangement in

its own name), the lead operator will need to assess whether the arrangement is,

or contains, a lease. If the lead operator controls the use of the identified asset,

it would recognise the entire right-of-use asset and lease liability on its balance

sheet. This would be the case even if it is entitled to bill the non-operator parties

their proportionate share of the costs under the joint operating agreement

(JOA).

If the lead operator determines that it is the lessee, it would also evaluate

whether it has entered into a sublease with the joint arrangement (as the

customer to the sublease). For example, the lead operator may enter into

a five-year equipment lease with a supplier, but may then enter into a two-year

arrangement with one of its joint arrangements, thereby yielding control of the

right to use the equipment to the joint arrangement during the two-year period.

In many cases, the lead operator will not meet the requirements to recognise

a sublease because the arrangement does not create legally enforceable rights

and obligations that convey the right to control the use of the asset to the joint

arrangement. However, the conclusion as to whether the joint arrangement is a

customer, i.e., the lessee in a contract with a lead operator, by virtue of the JOA,

would be impacted by the individual facts and circumstances.

If there is a sublease with the lead operator, IFRS 11 would require the non-

operators to recognise their respective share of the joint arrangement’s right-of-

use asset and lease liability and the lead operator would have to account for its

sublease to the joint arrangement separately. However, if no sublease existed,

the non-operators would recognise joint interest payables when incurred for

their share of the costs incurred by the lead operator in respect of the leased

asset.

In limited cases, the lead operator and non-operators will enter into a contract

directly with the supplier, in which the lead operator and non-operators are

proportionately liable for their share of the arrangement. In this case, the parties

with interests in the joint operation would recognise their proportionate share of

the leased asset, liability and lease expense in accordance with IFRS 11.

There has been considerable debate as to how the term “on behalf of the

joint arrangement” should be interpreted and applied in practice. The IFRS

Interpretations Committee (the Committee) discussed a question (in September

2018) relating to lease arrangements in a joint operation (JO) under IFRS 16.

The question asked was how a lead operator (the party responsible for

undertaking the operations on behalf of the other joint operators) of a JO,

which is not structured through a separate vehicle, recognises a lease liability.

10 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

The question specifically focused on situations where the lead operator, as the

sole signatory, enters into a lease contract with a third-party supplier (lessor)

for an item of property, plant and equipment that will be operated jointly as part

of the JO’s activities. The lead operator has the right to recover a share of the

lease costs from the other joint operators in accordance with the contractual and

other arrangements governing the JO.

The Committee concluded, in the agenda decision published in March 2019, that

in accordance with IFRS 11, a joint operator identifies and recognises both:

(a) liabilities it incurs in relation to its interest in the JO; and

(b) its share of any liabilities incurred jointly with other parties to the joint

arrangement.

The Committee observed that identifying the liabilities that a joint operator

incurs and those incurred jointly, requires an assessment of the terms and

conditions in all contractual arrangements that relate to the JO, including

consideration of the laws pertaining to those agreements. The Committee

further observed, in accordance with IFRS 11, the liabilities a joint operator

recognises include those for which it has primary responsibility. Therefore, as

sole signatory and where a lead operator has primary responsibility for a lease,

the lead operator recognises 100% of the lease liability.

The Committee also highlighted the importance of disclosing information

about joint operations that is sufficient for a user of financial statements to

understand the activities of the joint operation and a joint operator’s interest

in that operation. Therefore, the Committee concluded that the principles and

requirements in IFRS standards provide an adequate basis for the lead operator

to identify and recognise its liabilities in relation to its interest in a JO and did not

to add this matter to its standard-setting agenda.

2.1.2 Identified asset

Extract from IFRS 16

B13 An asset is typically identified by being explicitly specified in a contract.

However, an asset can also be identified by being implicitly specified at the

time that the asset is made available for use by the customer.

B20 A capacity portion of an asset is an identified asset if it is physically

distinct (for example, a floor of a building). A capacity or other portion of an

asset that is not physically distinct (for example, a capacity portion of a fibre

optic cable) is not an identified asset, unless it represents substantially all of

the capacity of the asset and thereby provides the customer with the right

to obtain substantially all of the economic benefits from use of the asset.

An arrangement only contains a lease if there is an identified asset. Under

IFRS 16, an identified asset can be either implicitly or explicitly specified

in a contract.

11 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 1 — Implicitly specified asset

Customer X enters into a five-year contract with Supplier Y for the use

of rolling stock specifically designed for Customer X. The rolling stock is

designed to transport materials used in Customer X’s production process

and is not suitable for use by other customers. The rolling stock is not

explicitly specified in the contract, but Supplier Y owns only one rolling stock

that is suitable for Customer X’s use. If the rolling stock does not operate

properly, the contract requires Supplier Y to repair or replace the rolling

stock. Assume that Supplier Y does not have a substantive substitution

right. Refer to section 2.1.3

Substantive substitution rights

Analysis

: The rolling stock is an identified asset. While the rolling stock is

not explicitly specified in the contract (e.g., by serial number), it is implicitly

specified because Supplier Y must use it to fulfil the contract.

Illustration 2 — Identified asset – implicitly specified at the time the asset is

made available for use by the customer

Customer X enters into a five-year contract with Supplier Y for the use of

a car. The specification of the car is specified in the contract (brand, type,

colour, options etc.). At inception of the contract the car is not yet built.

Analysis

: The car is an identified asset. Although the car cannot be identified

at inception of the contract, it is apparent that it will be identifiable at the

commencement of the lease. The car is identified by being implicitly specified

at the time that it is made available for use by the customer (i.e., at the

commencement date).

A capacity portion of an asset is an identified asset if it is physically distinct (e.g.,

a floor of a building). A capacity or other portion of an asset that is not physically

distinct (e.g., a capacity portion of a fibre optic cable) is not an identified asset

unless it represents substantially all of the capacity of the asset and thereby

provides the customer with the right to obtain substantially all of the economic

benefits from use of the asset.

How we see it

• Some contracts involve a dedicated cable that is part of the larger network

infrastructure (e.g., unbundled network element arrangements for the ‘last

mile’ to a customer location, ‘special access’ arrangements for a dedicated

connection between two locations). IFRS 16 does not specify or provide

examples that clarify that these arrangements are identified assets.

However, the FASB’s standard ASC 842 includes an additional example

that is similar to a dedicated cable (i.e., a segment of a pipeline that

connects a single customer to a larger pipeline). The example clarifies

that such segments of a larger pipeline are identified assets. As the IASB

has stated that both it and the FASB have reached the same conclusions

on the definition of a lease, we believe that, under IFRS 16, the last mile of

a network that connects a single customer to a larger network may be an

identified asset. However, such arrangements may, or may not, meet the

definition of a lease. Entities will need to be sensitive to this matter in both

these and other similar arrangements.

An identified asset can

be a physically distinct

portion of a larger

asset.

12 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 3 — Identified asset – physically distinct portion of a larger asset

Customer X enters into a 12-year contract with Supplier Y for the right to

use three fibres within a fibre optic cable between New York and London.

The contract identifies three of the cable’s 20 fibres for use by Customer X.

The three fibres are dedicated solely to Customer X’s data for the duration

of the contract term. Assume that Supplier Y does not have a substantive

substitution right (refer to section 2.1.3

Substantive substitution rights

Analysis:

The three fibres are identified assets because they are physically

distinct and explicitly specified in the contract.

Illustration 4 — Identified asset – capacity portion of an asset

Scenario A

Customer X enters into a five-year contract with Supplier Y for the right

to transport oil from Country A to Country B through Supplier Y’s pipeline.

The contract provides that Customer X will have the right to use of 95% of

the pipeline’s capacity throughout the term of the arrangement.

Analysis

: The capacity portion of the pipeline is an identified asset. While

95% of the pipeline’s capacity is not physically distinct from the remaining

capacity of the pipeline, it represents substantially all of the capacity of

the entire pipeline and thereby provides Customer X with the right to

obtain substantially all of the economic benefits from use of the pipeline.

Scenario B

Assume the same facts as in Scenario A, except that Customer X has the right

to use 60% of the pipeline’s capacity throughout the term of the arrangement.

Analysis

: The capacity portion of the pipeline is not an identified asset

because 60% of the pipeline’s capacity is less than substantially all of

the capacity of the pipeline. Customer X does not have the right to

obtain substantially all of the economic benefits from use of the pipeline.

Land easements or rights of way are rights to use, access or cross another

entity’s land for a specified purpose. For example, a land easement might be

obtained for the right to construct and operate a pipeline or other assets (e.g.,

railway line, utility pipes or telecommunication lines) over, under or through

an existing area of land or body of water while allowing the landowner continued

use of the land for other purposes (e.g., farming), as long as the landowner does

not interfere with the rights conveyed in the land easement. A land easement

may be perpetual or for a specified term. It may provide for exclusive or non-

exclusive use of the land and may be prepaid or paid over a defined term.

Perpetual easements are outside the scope of IFRS 16, as the definition of

a lease requires the contract to be for a period of time. Therefore, entities

must carefully evaluate easement contracts to determine whether the contract

is perpetual or for a period of time. Examples of contracts that may appear

perpetual but are term-based include:

•

Very long-term contracts (e.g., the FASB indicated in the Basis for

Conclusions (BC113) to ASC 842 that very long-term leases of land

(e.g., 999 years) are in the scope of ASC 842)

13 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

•

Contracts with a stated non-cancellable lease term that “automatically

renews” if the lessee pays a periodic renewal fee. This is an in-substance

fixed term contract with optional renewal periods

•

Contracts that define the period of use as the period over which the assets

are used (e.g., as long as natural gas flows through a gathering system) is

a fixed term contract (i.e., terminated when production ceases) rather than

a perpetual contract because the gas reserves will ultimately be depleted

When determining whether a contract for a land easement or right of way

is a lease, entities will need to assess whether there is an identified asset and

whether the customer obtains substantially all of the economic benefits of the

identified asset and has the right to direct the use of that asset throughout the

period of use.

In June 2019, the IFRS Interpretations Committee discussed a contract for

subsurface rights. In the contract described, a pipeline operator obtains the

right to place an oil pipeline in underground space for 20 years in exchange for

consideration. The contract specifies the exact location and dimensions (path,

width and depth) of the underground space within which the pipeline will be

placed. The landowner retains the right to use the surface of the land above

the pipeline, but it has no right to access or otherwise change the use of

the specified underground space throughout the 20-year period of use. The

customer has the right to perform inspection, repairs and maintenance work

(including replacing damaged sections of the pipeline when necessary).

The Committee noted the following in the agenda decision:

•

Paragraph 3 of IFRS 16 requires an entity to apply IFRS 16 to all leases,

with limited exceptions. In the contract described in the request, none of

the exceptions in paragraphs 3 and 4 of IFRS 16 apply (see 1.2 above). In

particular, the Committee noted that the underground space is tangible.

Accordingly, if the contract contains a lease, IFRS 16 applies to that lease.

If the contract does not contain a lease, the entity would then consider which

other IFRS standard applies.

•

Applying paragraph B9 of IFRS 16, to meet the definition of a lease, the

customer must have both:

• the right to obtain substantially all the economic benefits from use of an

identified asset throughout the period of use; and

• the right to direct the use of the identified asset throughout the period of

use.

•

The specified underground space is physically distinct from the remainder

of the land. The contract’s specifications include the path, width and depth

of the pipeline, thereby defining a physically distinct underground space.

The space being underground does not in itself affect whether it is an

identified asset — the specified underground space is physically distinct in

the same way that a specified area of space on the land’s surface would be

physically distinct. As the landowner does not have the right to substitute

the underground space throughout the period of use, the Committee

concluded that the specified underground space is an identified asset as

described in paragraphs B13–B20.

14 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

•

The customer has the right to obtain substantially all the economic benefits

from use of the specified underground space throughout the 20-year period

of use. The customer has exclusive use of the specified underground space

throughout that period of use.

•

The customer has the right to direct the use of the specified underground

space throughout the 20-year period of use because the customer has the

right to operate the asset throughout the period of use without the supplier

having the right to change those operating instructions. How and for what

purpose the specified underground space will be used (i.e., to locate the

pipeline with specified dimensions through which oil will be transported)

is predetermined in the contract. The customer has the right to operate

the specified underground space by having the right to perform inspection,

repairs and maintenance work. The customer makes all the decisions about

the use of the specified underground space that can be made during the 20-

year period of use.

Consequently, the Committee concluded that the contract described in the

request contains a lease as defined in IFRS 16. The customer would therefore

apply IFRS 16 in accounting for that lease.

2.1.3 Substantive substitution rights

Extract from IFRS 16

B14 Even if an asset is specified, a customer does not have the right to use

an identified asset if the supplier has the substantive right to substitute the

asset throughout the period of use. A supplier’s right to substitute an asset

is substantive only if both of the following conditions exist:

(a) the supplier has the practical ability to substitute alternative assets

throughout the period of use (for example, the customer cannot prevent

the supplier from substituting the asset and alternative assets are readily

available to the supplier or could be sourced by the supplier within

a reasonable period of time); and

(b) the supplier would benefit economically from the exercise of its right to

substitute the asset (ie the economic benefits associated with substituting

the asset are expected to exceed the costs associated with substituting

the asset).

B15 If the supplier has a right or an obligation to substitute the asset only

on or after either a particular date or the occurrence of a specified event,

the supplier’s substitution right is not substantive because the supplier does

not have the practical ability to substitute alternative assets throughout the

period of use.

B16 An entity’s evaluation of whether a supplier’s substitution right is

substantive is based on facts and circumstances at inception of the contract

and shall exclude consideration of future events that, at inception of the

contract, are not considered likely to occur. Examples of future events that,

at inception of the contract, would not be considered likely to occur and,

thus, should be excluded from the evaluation include:

(a) an agreement by a future customer to pay an above market rate for use

of the asset;

15 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 (cont’d)

(b) the introduction of new technology that is not substantially developed at

inception of the contract;

performance of the asset, and the use or performance considered likely

at inception of the contract; and

(d) a substantial difference between the market price of the asset during

the period of use, and the market price considered likely at inception of

the contract.

B17 If the asset is located at the customer’s premises or elsewhere, the costs

associated with substitution are generally higher than when located at the

supplier’s premises and, therefore, are more likely to exceed the benefits

associated with substituting the asset.

B18 The supplier’s right or obligation to substitute the asset for repairs and

maintenance, if the asset is not operating properly or if a technical upgrade

becomes available does not preclude the customer from having the right to

use an identified asset.

B19 If the customer cannot readily determine whether the supplier has

a substantive substitution right, the customer shall presume that any

substitution right is not substantive.

Even if an asset is specified, a customer does not have the right to use an

identified asset if, at inception of the contract, a supplier has the substantive

right to substitute the asset throughout the period of use (i.e., the total period

of time that an asset is used to fulfil a contract with a customer, including the

sum of any non-consecutive periods of time). A supplier’s right to substitute

an asset is substantive when both of the following conditions are met:

•

The supplier has the practical ability to substitute alternative assets

throughout the period of use (e.g., the customer cannot prevent the supplier

from substituting an asset and alternative assets are readily available to

the supplier or could be sourced by the supplier within a reasonable period

of time).

•

The supplier would benefit economically from the exercise of its right to

substitute the asset (i.e., the economic benefits associated with substituting

the asset are expected to exceed the costs associated with substituting the

asset).

The IASB indicated in the Basis for Conclusions (BC113) that the conditions

above are intended to differentiate between substitution rights that result in

a supplier controlling the use of an asset, rather than the customer, and rights

that do not change the substance or character of the contract.

If the supplier has a right or an obligation to substitute the asset only on or after

either a particular date, or the occurrence of a specified event, the supplier’s

substitution right is not substantive because the supplier does not have the

practical ability to substitute alternative assets throughout the period of use.

An entity’s evaluation of whether a supplier’s substitution right is substantive

is based on facts and circumstances at inception of the contract. At inception

of the contract, an entity should not consider future events that are not likely

16 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

to occur. IFRS 16 provides the following examples of circumstances that,

at inception of the contract, are not likely to occur and, thus, are excluded

from the evaluation of whether a supplier’s substitution right is substantive

throughout the period of use:

•

An agreement by a future customer to pay an above market rate for use of

the asset

•

The introduction of new technology that is not substantially developed at

inception of the contract

•

A substantial difference between the customer’s use of the asset, or the

performance of the asset, and the use or performance considered likely at

inception of the contract

•

A substantial difference between the market price of the asset during the

period of use, and the market price considered likely at inception of the

contract

The requirement that a substitution right must benefit the supplier economically

in order to be substantive is a new concept. The IASB indicated in the Basis for

Conclusions (BC113) that, in many cases, it will be clear that the supplier will not

benefit from the exercise of a substitution right because of the costs associated

with substituting an asset. The physical location of the asset may affect the costs

associated with substituting the asset. For example, if an asset is located at the

customer’s premises, the cost associated with substituting it is generally higher

than the cost of substituting a similar asset located at the supplier’s premises.

However, simply because a supplier concludes that the cost of substitution is not

significant does not automatically mean that it would economically benefit from

the right of substitution.

IFRS 16 further clarifies that a customer should presume that a supplier’s

substitution right is not substantive when the customer cannot readily determine

whether the supplier has a substantive substitution right. This requirement is

intended to clarify that a customer is not expected to exert undue effort to

provide evidence that a substitution right is not substantive. We believe that the

Board did not include a similar provision for suppliers, because they should have

sufficient information to make a determination of whether a substitution right is

substantive.

Contract terms that allow or require a supplier to substitute alternative assets

only when the underlying asset is not operating properly (e.g., a normal

warranty provision) or when a technical upgrade becomes available do not

create a substantive substitution right.

17 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 5 — Substitution rights

Scenario A

Assume that an electronic data storage provider (supplier) provides services

through a centralised data centre, that involve the use of a specified server

(Server No. 9). The supplier maintains many identical servers in a single

accessible location and determines, at inception of the contract, that it is

permitted to and can easily substitute another server without the customer’s

consent throughout the period of use. Further, the supplier would benefit

economically from substituting an alternative asset, because doing this

would allow the supplier to optimise the performance of its network at only

a nominal cost. In addition, the supplier has made clear that it has negotiated

this right of substitution as an important right in the arrangement, and the

substitution right affected the pricing of the arrangement.

Analysis:

The customer does not have the right to use an identified asset

because, at the inception of the contract, the supplier has the practical

ability to substitute the server and would benefit economically from such

a substitution. However, if the customer could not readily determine whether

the supplier had a substantive substitution right (e.g., there is insufficient

transparency into the supplier’s operations), the customer would presume

the substitution right is not substantive and conclude that there is an

identified asset.

Scenario B

Assume the same facts as in Scenario A except that Server No. 9 is

customised, and the supplier does not have the practical ability to substitute

the customised asset throughout the period of use. Additionally, it is unclear

whether the supplier would benefit economically from sourcing a similar

alternative asset.

Analysis

: Because the supplier does not have the practical ability to substitute

the asset and there is no evidence of economic benefit to the supplier for

substituting the asset, the substitution right is non-substantive, and Server

No. 9 would be an identified asset. In this case, neither of the conditions of

a substitution right is met. As a reminder, both conditions must be met for

the supplier to have a substantive substitution right.

18 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2.1.4 Right to obtain substantially all of the economic benefits from use of

the identified asset

Extract from IFRS 16

B21 To control the use of an identified asset, a customer is required to have

the right to obtain substantially all of the economic benefits from use of the

asset throughout the period of use (for example, by having exclusive use of

the asset throughout that period). A customer can obtain economic benefits

from use of an asset directly or indirectly in many ways, such as by using,

holding or sub-leasing the asset. The economic benefits from use of an asset

include its primary output and by-products (including potential cash flows

derived from these items), and other economic benefits from using the asset

that could be realised from a commercial transaction with a third party.

B22 When assessing the right to obtain substantially all of the economic

benefits from use of an asset, an entity shall consider the economic benefits

that result from use of the asset within the defined scope of a customer’s right

to use the asset (see paragraph B30). For example:

(a)

if a contract limits the use of a motor vehicle to only one particular

territory during the period of use, an entity shall consider only the

economic benefits from use of the motor vehicle within that territory,

and not beyond.

(b)

if a contract specifies that a customer can drive a motor vehicle only up

to a particular number of miles during the period of use, an entity shall

consider only the economic benefits from use of the motor vehicle for

the permitted mileage, and not beyond.

B23 If a contract requires a customer to pay the supplier or another party

a portion of the cash flows derived from use of an asset as consideration,

those cash flows paid as consideration shall be considered to be part of

the economic benefits that the customer obtains from use of the asset. For

example, if the customer is required to pay the supplier a percentage of sales

from use of retail space as consideration for that use, that requirement does

not prevent the customer from having the right to obtain substantially all of

the economic benefits from use of the retail space. This is because the cash

flows arising from those sales are considered to be economic benefits that

the customer obtains from use of the retail space, a portion of which it then

pays to the supplier as consideration for the right to use that space.

To control the use of an identified asset, a customer is required to have the right

to obtain substantially all of the economic benefits from use of the identified

asset throughout the period of use (e.g., by having exclusive use of the asset

throughout that period). The term ‘substantially all’ is not defined in IFRS 16.

However, entities might consider the term similarly to how it is used in IAS 17

in the context of lease classification.

A customer can obtain economic benefits either directly or indirectly (e.g., by

using, holding or subleasing the asset). Economic benefits include the asset’s

primary outputs (i.e., goods or services) and any by-products (e.g., renewable

energy credits that are generated through the use of the asset), including

potential cash flows derived from these items. Economic benefits also include

benefits from using the asset that could be realised from a commercial

transaction with a third party (e.g., subleasing the asset). However, economic

benefits arising from construction or ownership of the identified asset (e.g., tax

A lease conveys the

right to control the use

of an identified asset

for a period of time

in exchange for

consideration.

19 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

benefits related to excess tax depreciation and investment tax credits) are not

considered economic benefits derived from the use of the asset. Therefore, they

are not considered when assessing whether a customer has the right to obtain

substantially all of the economic benefits.

When assessing whether the customer has the right to obtain substantially all

of the economic benefits from the use of an asset, an entity must consider the

economic benefits that result from use of the asset within the defined scope of

the customer’s right to use the asset. A right that solely protects the supplier’s

interest in the underlying asset (e.g., limits on the number of miles a customer

can drive a supplier’s vehicle) does not, in and of itself, prevent the customer

from obtaining substantially all of the economic benefits from use of the asset

and, therefore, are not considered when assessing whether a customer has

the right to obtain substantially all of the economic benefits.

If a contract requires a customer to pay the supplier or another party a

portion of the cash flows derived from the use of an asset as consideration

(e.g., a percentage of sales from the use of retail space), those cash flows are

considered to be economic benefits that the customer derives from the use

of the asset.

2.1.5 Right to direct the use of the identified asset

Extract from IFRS 16

B24 A customer has the right to direct the use of an identified asset

throughout the period of use only if either:

(a) the customer has the right to direct how and for what purpose the asset is

used throughout the period of use (as described in paragraphs B25–B30);

(b) the relevant decisions about how and for what purpose the asset is used

are predetermined and:

(i) the customer has the right to operate the asset (or to direct others

to operate the asset in a manner that it determines) throughout the

period of use, without the supplier having the right to change those

operating instructions; or

(ii) the customer designed the asset (or specific aspects of the asset) in

a way that predetermines how and for what purpose the asset will be

used throughout the period of use.

Requiring a customer to have the right to direct the use of an identified asset is

a change from IFRIC 4. A contract may have met IFRIC 4’s control criterion if, for

example, the customer obtained substantially all of the output of an underlying

asset and met certain price-per-unit-of-output criteria even though the customer

did not have the right to direct the use of the identified asset as contemplated by

IFRS 16. Under IFRS 16, such arrangements would no longer be considered leases.

A customer has the right to direct the use of an identified asset throughout the

period of use when either:

•

The customer has the right to direct how and for what purpose the asset is

used throughout the period of use.

•

The relevant decisions about how and for what purpose an asset is used

are predetermined and the customer either: (1) has the right to operate

20 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

the asset, or to direct others to operate the asset in a manner that it

determines, throughout the period of use, without the supplier having the

right to change those operating instructions; or (2) designed the asset, or

specific aspects of the asset, in a way that predetermines how and for what

purpose the asset will be used throughout the period of use.

2.1.5.1 The right to direct how and for what purpose an asset is used

throughout the period of use

Extract from IFRS 16

B25 A customer has the right to direct how and for what purpose the asset

is used if, within the scope of its right of use defined in the contract, it can

change how and for what purpose the asset is used throughout the period of

use. In making this assessment, an entity considers the decision-making rights

that are most relevant to changing how and for what purpose the asset is used

throughout the period of use. Decision-making rights are relevant when they

affect the economic benefits to be derived from use. The decision-making

rights that are most relevant are likely to be different for different contracts,

depending on the nature of the asset and the terms and conditions of the

contract.

B26 Examples of decision-making rights that, depending on the

circumstances, grant the right to change how and for what purpose the asset

is used, within the defined scope of the customer’s right of use, include:

(a) rights to change the type of output that is produced by the asset (for

example, to decide whether to use a shipping container to transport

goods or for storage, or to decide upon the mix of products sold from

retail space);

(b) rights to change when the output is produced (for example, to decide

when an item of machinery or a power plant will be used);

upon the destination of a truck or a ship, or to decide where an item of

equipment is used); and

(d) rights to change whether the output is produced, and the quantity of that

output (for example, to decide whether to produce energy from a power

plant and how much energy to produce from that power plant).

B27 Examples of decision-making rights that do not grant the right to change

how and for what purpose the asset is used include rights that are limited to

operating or maintaining the asset. Such rights can be held by the customer

or the supplier. Although rights such as those to operate or maintain an asset

are often essential to the efficient use of an asset, they are not rights to direct

how and for what purpose the asset is used and are often dependent on the

decisions about how and for what purpose the asset is used. However, rights

to operate an asset may grant the customer the right to direct the use of the

asset if the relevant decisions about how and for what purpose the asset is

used are predetermined (see paragraph B24(b)(i)).

A customer has the right to direct the use of an identified asset whenever it has

the right to direct how and for what purpose the asset is used throughout the

period of use (i.e., it can change how and for what purpose the asset is used

throughout the period of use). How and for what purpose an asset is used is

21 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

a single concept (i.e., ‘how’ an asset is used is not assessed separately from

‘for what purpose’ an asset is used).

When evaluating whether a customer has the right to change how and for what

purpose the asset is used throughout the period of use, the focus should be on

whether the customer has the decision-making rights that will most affect the

economic benefits that will be derived from the use of the asset. The decision-

making rights that are most relevant are likely to depend on the nature of the

asset and the terms and conditions of the contract.

The IASB indicated in the Basis for Conclusions (BC120) that decisions about

how and for what purpose an asset is used can be viewed as similar to the

decisions made by a board of directors. Decisions made by a board of directors

about the operating and financing activities of an entity are generally the most

relevant decisions rather than the actions of individuals in implementing those

decisions.

IFRS 16 provides the following examples of decision-making rights that grant

the right to change how and for what purpose an asset is used:

•

The right to change the type of output that is produced by the asset

(e.g., deciding whether to use a shipping container to transport goods

or for storage, deciding on the mix of products sold from a retail unit)

•

The right to change when the output is produced (e.g., deciding when

an item of machinery or a power plant will be used)

•

The right to change where the output is produced (e.g., deciding on the

destination of a truck or a ship, deciding where a piece of equipment is

used or deployed)

•

The right to change whether the output is produced and the quantity of that

output (e.g., deciding whether to produce energy from a power plant and

how much energy to produce from that power plant)

IFRS 16 also provides the following examples of decision-making rights that

do not grant the right to change how and for what purpose an asset is used:

•

Maintaining the asset

•

Operating the asset

Although the decisions about maintaining and operating the asset are often

essential to the efficient use of that asset, the right to make those decisions,

in and of itself, does not result in the right to change how and for what purpose

the asset is used throughout the period of use.

The customer does not need the right to operate the underlying asset to have

the right to direct its use. That is, the customer may direct the use of an asset

that is operated by the supplier’s personnel. However, as discussed below, the

right to operate an asset will often provide the customer the right to direct the

use of the asset if the relevant decisions about how and for what purpose the

asset is used are predetermined.

22 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

How we see it

We believe that the assessment of whether a contract is or contains a lease

will be straightforward in most arrangements. However, judgement may

be required in applying the definition of a lease to certain arrangements.

For example, in contracts that include significant services, we believe that

determining whether the contract conveys the right to direct the use of an

identified asset may be challenging.

2.1.5.2 The relevant decisions about how and for what purpose an asset is

used are predetermined

In some cases, it will not be clear whether the customer has the right to direct

the use of the identified asset. This could be the case when the most relevant

decisions about how and for what purpose an asset is used are predetermined

by contractual restrictions on the use of the asset (e.g., the decisions about the

use of the asset are agreed to by the customer and the supplier in negotiating

the contract, and those decisions cannot be changed). This could also be the

case when the most relevant decisions about how and for what purpose an

asset is used are, in effect, predetermined by the design of the asset. The IASB

indicated in the Basis for Conclusions (BC121) that it would expect decisions

about how and for what purpose an asset is used to be predetermined in few

cases. In such cases, a customer has the right to direct the use of an identified

asset throughout the period of use when the customer either:

•

Has the right to operate the asset, or direct others to operate the asset in

a manner it determines, throughout the period of use without the supplier

having the right to change those operating instructions

•

Designed the asset (or specific aspects of the asset) in a way that

predetermines how and for what purpose the asset will be used throughout

the period of use

Significant judgement may be required to assess whether a customer designed

the asset (or specific aspects of the asset) in a way that predetermines how

and for what purpose the asset will be used throughout the period of use.

See Example 9 in

IFRS 16 Leases Illustrative Examples

, for an example of

the evaluation of whether a customer designed the asset in a way that

predetermines how and for what purpose the asset will be used throughout

the period of use.

In January 2020, the IFRS Interpretations Committee issued an agenda decision

about whether the customer has the right to direct the use of a ship throughout

the five-year term of a contract. In the fact pattern described in the request:

There is an identified asset (the ship) applying paragraphs B13–B20 of

IFRS 16

The customer has the right to obtain substantially all of the economic

benefits from use of the ship throughout the five-year period of use applying

paragraphs B21–B23 of IFRS 16.

Many, but not all, decisions about how, and for what purpose, the ship is

used are predetermined in the contract. The customer has the right to

make the remaining decisions about how, and for what purpose, the ship

is used throughout the period of use (i.e., the order of the voyages to the

designated ports during the contract term). In the fact pattern described in

23 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

the request, the customer has determined that this decision-making right is

relevant because it affects the economic benefits to be derived from use of

the ship

The supplier operates and maintains the ship throughout the period of use

The Committee observed that, in the fact pattern described in the request,

because not all relevant decisions about how and for what purpose the ship is

used are predetermined, the customer considers paragraph B24(a) of IFRS 16

in assessing whether it has the right to direct the use of the ship.

Paragraph B24(a) specifies that a customer has the right to direct the use of an

identified asset throughout the period of use if it has ‘the right to direct how and

for what purpose the asset is used throughout the period of use (as described

in paragraphs B25–B30)’. To have the right to direct how and for what purpose

the asset is used, within the scope of its right of use defined in the contract,

the customer must be able to change how and for what purpose the asset is

used throughout the period of use (paragraph B25). In assessing whether that

is the case, an entity considers rights to make decisions during the period of use

that are most relevant to changing how and for what purpose the asset is used

throughout that period. Decision-making rights are relevant when they affect the

economic benefits to be derived from use (paragraph B25). An entity does not

consider decisions that are predetermined before the period of use unless the

conditions in paragraph B24(b)(ii) exist (paragraph B29).

The Committee observed that, in the fact pattern described in the request,

the customer has the right to direct how and for what purpose the ship is used

throughout the period of use. Within the scope of its right of use defined in the

contract, the customer can change how and for what purpose the ship is used

(i.e., the customer can change the order of the voyages to the designated ports

during the contract term). Despite many decisions about how and for what

purpose the ship is used being predetermined, such decisions define the scope

of the customer’s right of use. Therefore, in this fact pattern, the customer has

the right to make the decisions that are most relevant to changing how and for

what purpose the ship is used.

The Committee also observed that, although the operation and maintenance of

the ship are essential to its efficient use, the supplier’s decisions in this regard

do not give it the right to direct how and for what purpose the ship is used.

The Committee concluded that, in the fact pattern described in the request, the

customer has the right to direct the use of the ship throughout the period of use.

Consequently, the contract contains a lease. The Committee concluded that the

principles and requirements in IFRS 16 provide an adequate basis for an entity

to determine whether the contract described in the request contains a lease and,

therefore, decided not to add the matter to its standard-setting agenda.

24 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2.1.5.3 Specifying the output of an asset before the period of use

Extract from IFRS 16

B28 The relevant decisions about how and for what purpose the asset is

used can be predetermined in a number of ways. For example, the relevant

decisions can be predetermined by the design of the asset or by contractual

restrictions on the use of the asset.

B29 In assessing whether a customer has the right to direct the use of an

asset, an entity shall consider only rights to make decisions about the use of

the asset during the period of use, unless the customer designed the asset

(or specific aspects of the asset) as described in paragraph B24(b)(ii).

Consequently, unless the conditions in paragraph B24(b)(ii) exist, an entity

shall not consider decisions that are predetermined before the period of use.

For example, if a customer is able only to specify the output of an asset before

the period of use, the customer does not have the right to direct the use of

that asset. The ability to specify the output in a contract before the period of

use, without any other decision-making rights relating to the use of the asset,

gives a customer the same rights as any customer that purchases goods or

services.

If a customer can only specify the output from an asset before the beginning

of the period of use and cannot change that output throughout the period

of use, the customer does not have the right to direct the use of that asset

unless it designed the asset, or specific aspects of the asset, as contemplated

in paragraph B24(b)(ii) of IFRS 16. If the customer did not design the asset or

aspects of it, the customer’s ability to specify the output in a contract that does

not give it any other relevant decision-making rights relating to the use of the

asset (e.g., the ability to change when, whether and what output is produced)

gives the customer the same rights as any customer that purchases goods or

service

in an arrangement (i.e., a contract that does not contain a lease).

2.1.5.4 Protective rights

Extract from IFRS 16

B30 A contract may include terms and conditions designed to protect the

supplier’s interest in the asset or other assets, to protect its personnel, or

to ensure the supplier’s compliance with laws or regulations. These are

examples of protective rights. For example, a contract may (i) specify the

maximum amount of use of an asset or limit where or when the customer can

use the asset, (ii) require a customer to follow particular operating practices,

or (iii) require a customer to inform the supplier of changes in how an asset

will be used. Protective rights typically define the scope of the customer’s

right of use but do not, in isolation, prevent the customer from having the

right to direct the use of an asset.

A supplier’s protective rights, in isolation, do not prevent the customer from

having the right to direct the use of an identified asset. Protective rights typically

define the scope of the customer’s right to use the asset without removing the

customer’s right to direct the use of the asset. Protective rights are intended

to protect a supplier’s interests (e.g., interests in the asset, its personnel,

compliance with laws and regulations) and might take the form of a specified

maximum amount of asset use, a restriction on where an asset may be used or

a requirement to follow specific operating instructions.

25 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 6 — Right to direct the use of an asset

Customer X enters into a contract with Supplier Y to use a vehicle for a three-

year period. The vehicle is identified in the contract. Supplier Y cannot

substitute another vehicle unless the specified vehicle is not operational

(e.g., it breaks down).

Under the contract:

•

Customer X operates the vehicle (i.e., drives the vehicle) or directs others

to operate the vehicle (e.g., hires a driver).

•

Customer X decides how to use the vehicle (within contractual limitations,

discussed below). For example, throughout the period of use, Customer X

decides where the vehicle goes, as well as when or whether it is used

and what it is used for. Customer X can also change these decisions

throughout the period of use.

•

Supplier Y prohibits certain uses of the vehicle (e.g., moving it overseas)

and modifications to the vehicle to protect its interest in the asset.

Analysis

: Customer X has the right to direct the use of the identified vehicle

throughout the period of use. Customer X has the right to direct the use of

the vehicle because it has the right to change how the vehicle is used, when

or whether the vehicle is used, where the vehicle goes and what the vehicle

is used for.

Supplier Y’s limits on certain uses for the vehicle and modifications to it are

considered protective rights that define the scope of Customer X’s use of

the asset, but do not affect the assessment of whether Customer X directs

the use of the asset.

26 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2.1.6 Flowchart

The following flowchart is included in IFRS 16’s application guidance and depicts

the decision-making process for determining whether an arrangement is or

contains a lease:

Start

Is there an identified asset?

Consider paragraphs B13-B20.

(refer to section 1.2.2, Identified asset)

Does the customer have the right to obtain substantially all of

the economic benefits from use of the asset throughout the

period of use? Consider paragraphs B21-B23. (refer to

section 1.2.3.1, Right to obtain substantially all of the

economic benefits from the use of the identified asset)

Does the customer or the supplier have the right to direct how

and for what purpose the identified asset is used throughout

the period of use? Consider paragraphs B25-B30. (refer to

section 1.2.3.2, Right to direct the use of the identified asset)

Does the customer have the right to operate the asset

throughout the period of use without the supplier having the

right to change those operating instructions? (refer to section

1.2.3.2, Right to direct the use of the identified asset)

Did the customer design the asset (or specific aspects of the

asset) in a way that predetermines how and for what purpose

the asset will be used throughout the period of use? (refer to

section 1.2.3.2, Right to direct the use of the identified asset)

The contract contains

a lease

The contract does not

contain a lease

Yes

Neither; how and for what purpose the asset

will be used is predetermined

(refer to section 1.2.3.2, Right to direct the

use of the identified asset)

Yes

Supplier

Customer

Yes

27 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2.1.7 Reassessment of the contract

Extract from IFRS 16

11 An entity shall reassess whether a contract is, or contains, a lease only if

the terms and conditions of the contract are changed.

Under IFRS 16, an entity reassesses whether a contract is or contains a lease

only if the terms and conditions of the contract are changed. A change in the

terms and conditions of a contract does not include the exercise of an option

(e.g., renewal option) or failure to exercise an option that is included in the

contract.

Refer to Appendix D for a summary of lessee and lessor reassessment and

remeasurement requirements.

2.2 Identifying and separating lease and non-lease components

of a contract and allocating contract consideration

2.2.1 Identifying and separating lease components of a contract

Extract from IFRS 16

12 For a contract that is, or contains, a lease, an entity shall account for each

lease component within the contract as a lease separately from non-lease

components of the contract, unless the entity applies the practical expedient

in paragraph 15. Paragraphs B32–B33 set out guidance on separating

components of a contract.

B32 The right to use an underlying asset is a separate lease component if

both:

(a) the lessee can benefit from use of the underlying asset either on its own

or together with other resources that are readily available to the lessee.

Readily available resources are goods or services that are sold or leased

separately (by the lessor or other suppliers) or resources that the lessee

has already obtained (from the lessor or from other transactions or

events); and

(b) the underlying asset is neither highly dependent on, nor highly

interrelated with, the other underlying assets in the contract. For

example, the fact that a lessee could decide not to lease the underlying

asset without significantly affecting its rights to use other underlying

assets in the contract might indicate that the underlying asset is not highly

dependent on, or highly interrelated with, those other underlying assets.

B33 A contract may include an amount payable by the lessee for activities and

costs that do not transfer a good or service to the lessee. For example, a lessor

may include in the total amount payable a charge for administrative tasks,

or other costs it incurs associated with the lease, that do not transfer a good

or service to the lessee. Such amounts payable do not give rise to a separate

component of the contract, but are considered to be part of the total

consideration that is allocated to the separately identified components of

the contract.

16 Unless the practical expedient in paragraph 15 is applied, a lessee shall

account for non-lease components applying other applicable Standards.

B55 When a lease includes both land and buildings elements, a lessor shall

assess the classification of each element as a finance lease or an operating

lease separately applying paragraphs 62–66 and B53–B54. In determining

An entity reassesses

whether a contract

contains a lease only if

the terms and conditions of

the contract are changed.

28 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 (cont’d)

whether the land element is an operating lease or a finance lease, an

important consideration is that land normally has an indefinite economic life.

B56 Whenever necessary in order to classify and account for a lease of land

and buildings, a lessor shall allocate lease payments (including any lump-sum

upfront payments) between the land and the buildings elements in proportion

to the relative fair values of the leasehold interests in the land element and

buildings element of the lease at the inception date. If the lease payments

cannot be allocated reliably between these two elements, the entire lease is

classified as a finance lease, unless it is clear that both elements are operating

leases, in which case the entire lease is classified as an operating lease.

B57 For a lease of land and buildings in which the amount for the land element

is immaterial to the lease, a lessor may treat the land and buildings as a single

unit for the purpose of lease classification and classify it as a finance lease or

an operating lease applying paragraphs 62–66 and B53–B54. In such a case,

a lessor shall regard the economic life of the buildings as the economic life of

the entire underlying asset.

For contracts that contain the rights to use multiple assets (e.g., a building

and equipment, multiple pieces of equipment), the right to use each asset is

considered a separate lease component if both of the following criteria are met:

•

The lessee can benefit from the use of the asset either on its own or together

with other resources that are readily available to the lessee (i.e., goods or

services that are sold or leased separately, by the lessor or other suppliers,

or that the lessee has already obtained from the lessor or in other

transactions or events).

•

The underlying asset is neither highly dependent on, nor highly interrelated

with, the other underlying assets in the contract.

If one or both of these criteria are not met, the right to use multiple assets is

considered a single lease component.

Illustration 7 — Identifying and separating lease components

Scenario A

Assume that a lessee enters into a lease of an excavator and the related

accessories (e.g., excavator attachments) that are used for mining purposes.

The lessee is a local mining company that intends to use the excavator at

a copper mine.

Analysis:

From the perspective of the lessee, the contract contains one

lease component. The lessee would be unable to benefit from the use of

the excavator without also using the accessories. Therefore, the excavator

is dependent upon the accessories.

Scenario B

Assume the same facts as in Scenario A, except that the contract also

conveys the right to use an additional loading truck. This loading truck

could be deployed by the lessee for other uses (e.g., to transport iron

ores at another mine).

29 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 7 — Identifying and separating lease components (cont’d)

Analysis: From the perspective of the lessee, the contract contains two lease

components: a lease of the excavator (together with the accessories) and

a lease of the loading truck. Because the loading truck could be deployed

for other uses independent of the excavator, the lessee can benefit from

the loading truck on its own or together with other readily available resources.

The lessee can also benefit from the use of the excavator on its own or

together with other readily available resources.

For contracts that involve the right to use land and land improvements (e.g.,

buildings), IFRS 16 requires a lessor to classify (refer to section 5.1

Lease

classification

) and account for the right to use land as a separate lease

component, unless the accounting effect of doing so is immaterial to the lease.

For example, separation of the land may not be necessary when the amount

that would be recognised for the land lease component is immaterial to the

lease. If the lease payments cannot be allocated reliably between the land and

the buildings, the entire lease is classified as a finance lease, unless it is clear

that both elements are operating leases (i.e., the entire lease is classified as

an operating lease).

How we see it

An entity that leases an entire building (i.e., 100% of the building) is inherently

leasing the land underneath the building and would potentially account for

the land and the building as separate lease components. However, this would

not necessarily be the case when an entity only leases part of the building

(e.g., one floor of a multi-storey building).

2.2.2 Identifying and separating lease from non-lease components of

a contract

Many contracts contain a lease coupled with an agreement to purchase or sell

other goods or services (non-lease components). The non-lease components are

identified and accounted for separately from the lease component in accordance

with other standards (except when a lessee applies the practical expedient as

discussed in section 2.2.2.2

Practical expedient - lessees

). For example, the non-

lease components may be accounted for as executory arrangements by lessees

(customers) or as contracts subject to IFRS 15 by lessors (suppliers).

Some contracts contain items that do not relate to the transfer of goods or

services by the lessor to the lessee (e.g., fees or other administrative costs a

lessor charges a lessee). These items are not considered separate lease or non-

lease components, and lessees and lessors do not allocate consideration in the

contract to these items. Refer to section 2.2.3.2

Allocating the consideration in

the contract - lessees

on lessee allocation of consideration in the contract and

2.2.4.2

Allocating the consideration in the contract - lessors

on lessor allocation

of consideration in the contract.

However, if the lessor provides services (e.g., maintenance, supply of utilities)

or operates the underlying asset (e.g., vessel charter, aircraft wet lease), the

contract would generally contain non-lease components.

2.2.2.1 Lessee reimbursements

Under IFRS 16, payments for maintenance activities, including common area

maintenance (e.g., cleaning the common areas of a building, removing snow from

a car park for employees and customers) and other goods or services transferred

30 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

to the tenant (e.g., providing utilities or rubbish removal) are considered non-

lease components because they provide the lessee with a service.

In some leases, a lessee also may reimburse (or make certain payments on

behalf of) the lessor that relate to the leased asset for activities and costs that

do not transfer a good or service to the lessee (e.g., payments made for real

estate taxes that would be owed by the lessor regardless of whether it leased

the building and regardless of who the lessee is, payments made for insurance

that protects the lessor’s investment in the asset and the landlord will receive

the proceeds from any claim). Under IFRS 16, such costs are not separate

components of the contract because they do not represent payments for

goods or services and are considered to be part of the total consideration that

is allocated to the separately identified components of the contract (i.e., the

lease and non-lease components). Entities also need to evaluate whether such

payments are fixed (or in-substance fixed) lease payments or variable lease

payments. Refer to section 3.5

Lease Payments

Illustration 8 — Activities that are not components of a lease contract

Scenario A

A lessee enters into a three-year lease of equipment, with fixed annual

payments of CU12,000. The contract itemises the fixed annual payments

as follows: CU9,000 for rent, CU2,500 for maintenance and CU500 of

administrative tasks.

Analysis

: The contract contains two components - a lease component

(lease of equipment) and a non-lease component (maintenance). The amount

paid for administrative tasks does not transfer a good or service to the

lessee. Therefore, the total consideration in the contract of CU36,000 will be

allocated to the lease component (equipment) and the non-lease component

(maintenance).

Scenario B

Assume the fact pattern as in scenario A except that, in addition, the contract

requires the lessee to pay for the restoration of the equipment to its original

condition.

Analysis

: The contract still contains two components – a lease component

(lease of equipment) and a non-lease component (maintenance). Similar to

the amount paid for administrative tasks, the restoration does not transfer

a good or service to the lessee as it is only performed at the end of the lease

term. Therefore, the total consideration in the contract will be allocated to the

lease component (equipment) and the non-lease component (maintenance).

See 4.2.1 for further discussion on the inclusion of restoration costs to the

initial measurement of the right-of-use asset.

2.2.2.2 Practical expedient — lessees

Extract from IFRS 16

15 As a practical expedient, a lessee may elect, by class of underlying asset,

not to separate non-lease components from lease components, and instead

account for each lease component and any associated non-lease components

as a single lease component. A lessee shall not apply this practical expedient

to embedded derivatives that meet the criteria in paragraph 4.3.3 of

IFRS 9

Financial Instruments

31 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

IFRS 16 provides a practical expedient that permits lessees to make

an accounting policy election, by class of underlying asset, to account for

each separate lease component of a contract and any associated non-lease

components as a single lease component. IFRS 16 provides this expedient

to alleviate concerns that the costs and administrative burden of allocating

consideration to separate lease and non-lease components may not be justified

by the benefit of more precisely reflecting the right-of-use asset and the lease

liability. Furthermore, the Board expects the practical expedient to most often

be used when the non-lease components of a contract are not significant when

compared with the lease components of a contract. The practical expedient does

not allow lessees to account for multiple lease components of a contract (refer

to section 2.2.1

Identifying and separating lease components of a contract

) as

a single lease component. Refer to section 4

Lessee accounting

for a discussion

of measurement of right-of-use assets and lease liabilities.

Although it is not explicitly stated, we believe that non-lease components relate

to services contained within the lease contract. Paragraphs BC133 and BC135

of the Basis for Conclusions to IFRS 16 refer to non-lease components being

service components. Therefore, when a lease includes a component related

to the purchase of inventory or another asset such as property, plant and

equipment or an intangible asset, we believe an entity should separate these

asset components from other lease and non-lease components, even if it has

elected to apply the practical expedient to the class of underlying asset to which

the lease relates. For example, if a contract contains a lease as well as non-lease

components related to a service and the purchase of sheet metal to be used

in the construction of inventory, we believe the purchase of the sheet metal

should be accounted for as a component of inventory rather than together

with the lease component as the purchase of a physical good is not a ‘non-

lease component associated with that lease component’.

Lessees that make the policy election to account for each separate lease

component of a contract and any associated non-lease components as

a single lease component allocate all of the contract consideration to the lease

component. Therefore, the initial and subsequent measurement of the lease

liability and right-of-use asset is higher than if the policy election was not

applied.

2.2.3 Determining and allocating the consideration in the contract - lessees

2.2.3.1 Determining the consideration in the contract

IFRS 16 does not define ‘consideration’ in a lease contract, nor is ‘consideration’

defined in the IFRS Glossary. However, we believe that the consideration in

a lease contract for a lessee would include all the payments described in

section 3.5

Lease payments

as well as any fixed payments (e.g., monthly service

charges) or in substance fixed payments, variable payments that depend on an

index or a rate, initially measured using the index or rate at the commencement

date, less any incentives paid or payable to the lessee, other than those included

in lease payments.

Lessees can make

a policy election to

not separate non-lease

components from

lease components.

32 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2.2.3.2 Allocating the consideration in the contract – lessees

Extract from IFRS 16

13 For a contract that contains a lease component and one or more additional

lease or non-lease components, a lessee shall allocate the consideration in

the contract to each lease component on the basis of the relative stand-alone

price of the lease component and the aggregate stand-alone price of the non-

lease components.

14 The relative stand-alone price of lease and non-lease components shall be

determined on the basis of the price the lessor, or a similar supplier, would

charge an entity for that component, or a similar component, separately. If

an observable stand-alone price is not readily available, the lessee shall

estimate the stand-alone price, maximising the use of observable information.

Lessees that do not make an accounting policy election (by class of underlying

asset) to use the practical expedient (discussed in section 2.2.2.2

Practical

expedient — lessees

) to account for each separate lease component of a contract

and any associated non-lease components as a single lease component are

required to allocate the consideration in the contract to the lease and non-lease

components on a relative stand-alone price basis. Lessees are required to use

observable stand-alone prices (i.e., prices at which a customer would purchase

a component of a contract separately) when available. If observable stand-alone

prices are not readily available, lessees estimate stand-alone prices, maximising

the use of observable information. Although a contractually stated price may

be the stand-alone price for a good or service, it is not presumed to be for

accounting purposes.

Illustration 9 — Allocating contract consideration to lease and non-lease

components – lessees

A lessee enters into a lease of equipment. The contract stipulates the lessor

will perform maintenance of the leased equipment and receive consideration

for that maintenance service. The contract includes the following fixed prices

for the lease and non-lease component:

Lease

CU80,000

Maintenance

CU10,000

Total

CU90,000

Assume the stand-alone prices cannot be readily observed, so the lessee

makes estimates, maximising the use of observable information, of the lease

and non-lease components, as follows:

Lease

CU85,000

Maintenance

CU15,000

Total

CU100,000

Analysis:

The stand-alone price for the lease component represents 85% of

total estimated stand-alone prices. The lessee allocates the consideration in

the contract (CU90,000), as follows:

Illustration 9 — Allocating contract consideration to lease and non-lease

components – lessees

(cont’d)

Lease

CU76,500

(1)

Maintenance

CU13,500

(2)

Total

CU90,000

(1) 85% x CU90,000

(2) 15% x CU90,000

33 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2.2.4 Determining and allocating the consideration in the contract – lessors

2.2.4.1 Determining the consideration in the contract – lessors

As discussed in section 2.2.3.1

Determining the consideration in the contract

IFRS 16 does not define ‘consideration’ in a lease contract, nor is ‘consideration’

defined in the IFRS Glossary. However, we believe that the consideration in

a lease contract for a lessor would include the following:

•

Lease payments in section 3.5

Lease payments

•

Any other fixed payments (e.g., monthly service charges, non-lease

components such as maintenance) or in-substance fixed payments made

during the lease term, less any incentives paid or payable to the lessee

•

Any other variable payments that depend on an index or a rate made

during the lease term and initially measured using the index or rate at the

commencement date (refer to section 3.2

Commencement date of the lease)

•

Any other variable payment amounts that would be included in the

transaction price in accordance with the requirements on variable

consideration in IFRS 15 that specifically relate to either of the following:

• The lessor’s efforts to transfer one or more goods or services that are

not leases

• An outcome from transferring one or more goods or services that are

not leases

Variable consideration is described broadly in IFRS 15 and can take many forms.

Consideration can vary because of discounts, rebates, refunds, credits, price

concessions, incentives, performance bonuses, penalties or other similar items.

It is important for lessors to appropriately identify the different types of variable

consideration included in the contract because estimating variable consideration

requires lessors to apply a constraint to each type of variable consideration.

Refer to our publication

Applying IFRS: A closer look at IFRS 15, the revenue

recognition standard (updated October 2020)

for an in-depth discussion of

the forms of variable consideration, estimating variable consideration and

constraining estimates of variable consideration.

The publication is available on http://www.ey.com/ifrs.

34 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

2.2.4.2 Allocating the consideration in the contract - lessors

Extracts from IFRS 16

17 For a contract that contains a lease component and one or more additional

lease or non-lease components, a lessor shall allocate the consideration in the

contract applying paragraphs 73–90 of IFRS 15.

When applying IFRS 16, lessors are required to apply paragraphs 73 – 86 of

IFRS 15 to allocate the consideration in the contract between the lease and

non-lease components on a relative stand-alone selling price basis. In addition,

lessors are required to apply paragraphs 87-90 of IFRS 15 to allocate any

subsequent changes in the consideration of the contract between the lease

and non-lease components. The stand-alone selling price is the price at which

an entity would sell a promised good or service separately to a customer. When

stand-alone selling prices are not directly observable, the lessor must estimate

the stand-alone selling price. Paragraph 79 of IFRS 15 provides suitable methods

for estimating the stand-alone selling price.

Refer to our publication

Applying IFRS: A closer look at IFRS 15, the revenue

recognition standard (updated October 2020)

, for an in-depth discussion on

determining standalone selling prices under IFRS 15.

How we see it

We anticipate that personnel responsible for an entity’s revenue recognition

policies (including revenue recognition policies associated with arrangements

that include a lease) will need to obtain information from personnel beyond

those in the accounting or finance departments to estimate stand-alone

selling prices. That is, we expect them to need to gain information and an

understanding of an entity’s pricing decisions in order to determine estimated

stand-alone selling prices, especially when there are limited or no observable

inputs. This may be a change for some entities that do not today estimate

stand-alone selling prices.

2.2.5 Examples – Identifying and separating components of a contract and

determining and allocating the consideration in the contract

IFRS 16 provides the following example to illustrate how lessees identify and

separate lease and non-lease components of a contract and determine and

allocate the consideration in the contract.

Extract from IFRS 16 Illustrative Examples

Example 12—Lessee allocation of consideration to lease and non-lease

components of a contract

Lessor leases a bulldozer, a truck and a long-reach excavator to Lessee to

be used in Lessee’s mining operations for four years. Lessor also agrees

to maintain each item of equipment throughout the lease term. The total

consideration in the contract is CU600,000

(a)

, payable in annual instalments

of CU150,000, and a variable amount that depends on the hours of work

performed in maintaining the long-reach excavator. The variable payment

is capped at 2 per cent of the replacement cost of the long-reach excavator.

The consideration includes the cost of maintenance services for each item of

equipment.

Lessors allocate the

consideration in the

contract between the

lease and non-lease

components of the

contract on a relative

stand-alone selling price

basis.

35 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 Illustrative Examples (cont’d)

Lessee accounts for the non-lease components (maintenance services)

separately from each lease of equipment applying paragraph 12 of IFRS 16.

Lessee does not elect the practical expedient in paragraph 15 of IFRS 16.

Lessee considers the requirements in paragraph B32 of IFRS 16 and

concludes that the lease of the bulldozer, the lease of the truck and the lease

of the long-reach excavator are each separate lease components. This is

because:

(a) Lessee can benefit from use of each of the three items of equipment on

its own or together with other readily available resources (for example,

Lessee could readily lease or purchase an alternative truck or excavator

to use in its operations); and

(b) Although Lessee is leasing all three items of equipment for one purpose

(ie to engage in mining operations), the machines are neither highly

dependent on, nor highly interrelated with, each other. Lessee’s ability to

derive benefit from the lease of each item of equipment is not significantly

affected by its decision to lease, or not lease, the other equipment from

Lessor.

Consequently, Lessee concludes that there are three lease components

and three non-lease components (maintenance services) in the contract.

Lessee applies the guidance in paragraphs 13–14 of IFRS 16 to allocate

the consideration in the contract to the three lease components and the non-

lease components.

Several suppliers provide maintenance services for a similar bulldozer and

a similar truck. Accordingly, there are observable standalone prices for the

maintenance services for those two items of leased equipment. Lessee is able

to establish observable stand-alone prices for the maintenance of the bulldozer

and the truck of CU32,000 and CU16,000, respectively, assuming similar

payment terms to those in the contract with Lessor. The long-reach excavator

is highly specialised and, accordingly, other suppliers do not lease or provide

maintenance services for similar excavators. Nonetheless, Lessor provides

four-year maintenance service contracts to customers that purchase similar

long-reach excavators from Lessor. The observable consideration for those

four-year maintenance service contracts is a fixed amount of CU56,000,

payable over four years, and a variable amount that depends on the hours

of work performed in maintaining the long-reach excavator. That variable

payment is capped at 2 per cent of the replacement cost of the long-reach

excavator. Consequently, Lessee estimates the stand-alone price of the

maintenance services for the long-reach excavator to be CU56,000 plus any

variable amounts. Lessee is able to establish observable stand-alone prices

for the leases of the bulldozer, the truck and the long-reach excavator of

CU170,000,CU102,000 and CU224,000, respectively.

Lessee allocates the fixed consideration in the contract (CU600,000) to

the lease and non-lease components as follows:

36 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 Illustrative Examples (cont’d)

Bulldozer

Truck

Long-

reach

excavator

Total

Lease

170,000

102,000

224,000

496,000

Non-lease

104,000

Total fixed consideration

600,000

Lessee allocates all of the variable consideration to the maintenance of the

long-reach excavator, and, thus, to the non-lease components of the contract.

Lessee then accounts for each lease component applying the guidance in

IFRS 16, treating the allocated consideration as the lease payments for each

lease component.

(a) In these Illustrative Examples, currency amounts are denominated in ‘currency units’ (CU).

2.3 Contract combinations

Extract from IFRS 16

B2 In applying this Standard, an entity shall combine two or more contracts

entered into at or near the same time with the same counterparty (or related

parties of the counterparty), and account for the contracts as a single contract

if one or more of the following criteria are met:

(a) the contracts are negotiated as a package with an overall commercial

objective that cannot be understood without considering the contracts

together;

(b) the amount of consideration to be paid in one contract depends on the

price or performance of the other contract; or

rights to use underlying assets conveyed in each of the contracts) form

a single lease component as described in paragraph B32.

IFRS 16 requires that two or more contracts entered into at or near the same

time with the same counterparty (or related parties of the counterparty) be

considered a single contract if any one of the following criteria is met:

•

The contracts are negotiated as a package with an overall commercial

objective that cannot be understood without considering the contracts

together

•

The amount of consideration to be paid in one contract depends on the price

or performance of the other contract

•

The rights to use the underlying assets conveyed in the contracts (or some

of the rights to use underlying assets conveyed in each of the contracts) are

a single lease component (refer to section 2.2.1

Identifying and separating

lease components of a contract

)

The IASB indicated in the Basis for Conclusions (BC130-132) that it developed

these criteria to address concerns that separately accounting for multiple

contracts may not result in a faithful representation of the combined transaction.

37 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

3. Key concepts

Lessees and lessors generally apply the same key concepts for the purposes of

identifying, recognising and measuring lease contracts.

3.1 Inception of a contract

Extract from IFRS 16

9 At inception of a contract, an entity shall assess whether the contract

is, or contains, a lease. A contract is, or contains, a lease if the contract

conveys the right to control the use of an identified asset for a period of

time in exchange for consideration. Paragraphs B9–B31 set out guidance

on the assessment of whether a contract is, or contains, a lease.

Appendix A

Defined terms

Inception date of the lease (inception date)

The earlier of the date of a lease agreement and the date of commitment by

the parties to the principal terms and conditions of the lease.

IFRS 16 requires customers and suppliers to determine whether a contract is or

contains a lease at the inception of the contract. The inception date of a lease is

the earlier of the date of a lease agreement and the date of commitment by the

parties to the principal terms and conditions of the lease.

As indicated in the Basis for Conclusions (BC72), after the inception of the lease,

but before the commencement date (refer to section 3.2

Commencement date

of the lease

), the requirements in IAS 37

Provisions, Contingent Liabilities and

Contingent Assets

apply to any contract (and, hence, any lease contract) that

becomes onerous as defined in that standard.

3.2 Commencement date of the lease

Extract from IFRS 16

Appendix A

Defined terms

Commencement date of the lease (commencement date)

The date on which a lessor makes an underlying asset available for use by

a lessee.

Underlying asset

An asset that is the subject of a lease, for which the right to use that asset has

been provided by a lessor to a lessee.

The commencement date is the date on which the lessor makes an underlying

asset (i.e., the asset that is subject to the lease) available for use by the lessee.

In some cases, the commencement date of the lease may be before the date

stipulated in the lease agreement (e.g., the date on which rents become due and

payable). This often occurs when the leased space is modified by the lessee prior

to commencing operations in the leased space (e.g., during the period a lessee

uses the leased space to construct its own leasehold improvements). If a lessee

Entities determine

whether a contract is

or contains a lease at

the inception of the

contract.

38 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

takes possession of, or is given control over, the use of the underlying asset

before it begins operations or making lease payments under the terms of the

lease, the lease term has commenced even if the lessee is not required to pay

rent or the lease arrangement states the lease commencement date is a later

date. The timing of when lease payments begin under the contract does not

affect the commencement date of the lease. For example, a lessee (except for

a lessee applying the short-term lease or low-value asset exemption discussed in

sections 4.1.1

Short-term leases

and 4.1.2

Leases of low-value assets

) initially

recognises a lease liability and related right-of-use asset on the commencement

date and a lessor (for finance leases) initially recognises its net investment in

the lease on the commencement date.

3.3 Lessee involvement with the underlying asset before the

commencement date

An entity may negotiate a lease before the underlying asset is available for use

by the lessee. For some leases, the underlying asset may need to be constructed

or redesigned for use by the lessee. Depending on the terms and conditions

of the contract, a lessee may be required to make payments relating to the

construction or design of the asset.

If the lessee incurs costs relating to the construction or design of an underlying

asset, the lessee accounts for those costs applying other IFRS, such as IAS 16

Property, Plant and Equipment

. Costs relating to the construction or design of

an underlying asset do not include payments made by the lessee for the right to

use the underlying asset. Payments for the right to use an underlying asset are

payments for a lease, regardless of the timing of those payments.

The lessee may obtain legal title to an underlying asset before that legal title is

transferred to the lessor and the asset is leased to the lessee. Obtaining legal

title does not in itself determine how to account for the transaction.

If the lessee controls (or obtains control of) the underlying asset before that

asset is transferred to the lessor, the transaction is a sale and leaseback

transaction that is accounted for as described at section 7 below.

However, if the lessee does not obtain control of the underlying asset before

the asset is transferred to the lessor, the transaction is not a sale and leaseback

transaction. For example, this may be the case if a manufacturer, a lessor

and a lessee negotiate a transaction for the purchase of an asset from the

manufacturer by the lessor, which is in turn leased to the lessee. The lessee may

obtain legal title to the underlying asset before legal title transfers to the lessor.

In this case, if the lessee obtains legal title to the underlying asset, but does not

obtain control of the asset before it is transferred to the lessor, the transaction

is not accounted for as a sale and leaseback transaction, but as a lease.

39 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

3.4 Lease term and purchase options

3.4.1 Lease term

Extract from IFRS 16

18 An entity shall determine the lease term as the non-cancellable period of

a lease, together with both:

(a) periods covered by an option to extend the lease if the lessee is

reasonably certain to exercise that option; and

(b) periods covered by an option to terminate the lease if the lessee is

reasonably certain not to exercise that option.

19 In assessing whether a lessee is reasonably certain to exercise an option

to extend a lease, or not to exercise an option to terminate a lease, an entity

shall consider all relevant facts and circumstances that create an economic

incentive for the lessee to exercise the option to extend the lease, or not

to exercise the option to terminate the lease, as described in paragraphs

B37–B40.

B36 The lease term begins at the commencement date and includes any rent-

free periods provided to the lessee by the lessor.

B37 At the commencement date, an entity assesses whether the lessee is

reasonably certain to exercise an option to extend the lease or to purchase

the underlying asset, or not to exercise an option to terminate the lease. The

entity considers all relevant facts and circumstances that create an economic

incentive for the lessee to exercise, or not to exercise, the option, including

any expected changes in facts and circumstances from the commencement

date until the exercise date of the option. Examples of factors to consider

include, but are not limited to:

(a) contractual terms and conditions for the optional periods compared with

market rates, such as:

(i) the amount of payments for the lease in any optional period;

(ii) the amount of any variable payments for the lease or other contingent

payments, such as payments resulting from termination penalties and

residual value guarantees; and

(iii) the terms and conditions of any options that are exercisable after

initial optional periods (for example, a purchase option that is

exercisable at the end of an extension period at a rate that is currently

below market rates).

(b) significant leasehold improvements undertaken (or expected to be

undertaken) over the term of the contract that are expected to have

significant economic benefit for the lessee when the option to extend

or terminate the lease, or to purchase the underlying asset, becomes

exercisable;

relocation costs, costs of identifying another underlying asset suitable

for the lessee’s needs, costs of integrating a new asset into the lessee’s

operations, or termination penalties and similar costs, including costs

associated with returning the underlying asset in a contractually specified

condition or to a contractually specified location;

40 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Excerpt from IFRS 16 (cont’d)

(d) the importance of that underlying asset to the lessee’s operations,

considering, for example, whether the underlying asset is a specialised

asset, the location of the underlying asset and the availability of suitable

alternatives; and

(e) conditionality associated with exercising the option (ie when the option

can be exercised only if one or more conditions are met), and the

likelihood that those conditions will exist.

B38 An option to extend or terminate a lease may be combined with one or

more other contractual features (for example, a residual value guarantee)

such that the lessee guarantees the lessor a minimum or fixed cash return

that is substantially the same regardless of whether the option is exercised.

In such cases, and notwithstanding the guidance on in-substance fixed

payments in paragraph B42, an entity shall assume that the lessee is

reasonably certain to exercise the option to extend the lease, or not to

exercise the option to terminate the lease.

B39 The shorter the non-cancellable period of a lease, the more likely a lessee

is to exercise an option to extend the lease or not to exercise an option to

terminate the lease. This is because the costs associated with obtaining a

replacement asset are likely to be proportionately higher the shorter the non-

cancellable period.

B40 A lessee’s past practice regarding the period over which it has typically

used particular types of assets (whether leased or owned), and its economic

reasons for doing so, may provide information that is helpful in assessing

whether the lessee is reasonably certain to exercise, or not to exercise, an

option. For example, if the lessee has typically used particular types of assets

for a particular period of time or if the lessee has a practice of frequently

exercising options on leases of particular types of underlying assets, the

lessee shall consider the economic reasons for that past practice in assessing

whether it is reasonably certain to exercise an option on leases of those

assets.

The lease term begins at the lease commencement date and is determined on

that date based on the non-cancellable term of the lease, together with both of

the following:

•

The periods covered by an option to extend the lease if the lessee is

reasonably certain to exercise that option

•

The periods covered by an option to terminate the lease if the lessee is

reasonably certain not to exercise that option

The phrase ‘reasonably certain’ which was also used in IAS 17 is generally

interpreted as a high threshold. Therefore, the IASB does not anticipate

a change in practice.

Purchase options should be assessed in the same way as options to extend

the lease term or terminate the lease. The IASB indicated in the Basis for

Conclusions (BC173) that an option to purchase an underlying asset is

economically similar to an option to extend the lease term for the remaining

economic life of the underlying asset.

41 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

3.4.1.1 Evaluating lease term and purchase options

When evaluating whether a lessee is reasonably certain to exercise an option

to renew the lease, not terminate the lease or to purchase the underlying asset,

lessees and lessors are required to assess all relevant factors that create an

economic incentive for the lessee to exercise lease renewal, termination or

purchase options.

The longer the period from commencement of the lease (refer to section 3.1

Inception of a contract

) to the exercise date of an option, the more difficult

it will be, in certain cases, to determine whether the exercise of the option

is reasonably certain. The difficulty arises from several factors. For example,

a lessee’s estimates of its future needs for the leased asset become less precise

the further into the future the forecast goes. Also, the future fair value of

certain assets such as those involving technology is more difficult to predict

than the future fair value of a relatively stable asset, such as a fully leased

commercial office building located in a prime area.

The further into the future that the option date is, the lower the option price

must be in relation to the estimated future fair value to conclude that the lessee

is reasonably certain to exercise the option. The difference between the option

price and the estimated future fair value of an asset that is subject to significant

changes in value also should be greater than would be the case for an asset with

a relatively stable value.

An artificially short lease term (e.g., a lease of a corporate headquarters,

distribution facility, manufacturing plant or other key property with a four-

year lease term), may effectively create a significant economic incentive for the

lessee to exercise a purchase or renewal option. This may be evidenced by the

significance of the underlying asset to the lessee’s continuing operations and

whether, absent the option, the lessee would have entered into such a lease.

Similarly, the significance of the underlying asset to the lessee’s operations may

affect a lessee’s decisions about whether it is reasonably certain to exercise a

purchase or renewal option. For example, a company that leases a specialised

facility (e.g., manufacturing plant, distribution facility, corporate headquarters)

and does not exercise a purchase or renewal option would face a significant

economic penalty if an alternative facility is not readily available. This would

potentially have an adverse effect on the company while it searched for a

replacement asset.

A lessee may enter into a lease contract for non-consecutive periods. This is

seen in the retail industry when retailers enter into contracts with shopping

centres to lease the same retail space for certain non-consecutive months of

the year (e.g., during an annual holiday period). Similar arrangements also exist

when sports teams lease a sports stadium for particular non-consecutive days of

the year. These arrangements will usually meet the definition of a lease because

during the agreed period of use, the customer controls the right to use the

underlying asset. In these arrangements, the lease term is the aggregate of

the non-consecutive periods, as shown in Illustration 10, Scenario C.

42 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 10 — Determining the lease term

Scenario A

Entity P enters into a lease for equipment that includes a non-cancellable term

of four years and a two-year fixed-priced renewal option with future lease

payments that are intended to approximate market rates at lease inception.

There are no termination penalties or other factors indicating that Entity P is

reasonably certain to exercise the renewal option.

Analysis:

At the lease commencement date, the lease term is four years.

Scenario B

Entity Q enters into a lease for a building that includes a non-cancellable term

of four years and a two-year, market-priced renewal option. Before it takes

possession of the building, Entity Q pays for leasehold improvements. The

leasehold improvements are expected to have significant value at the end of

four years, and that value can only be realised through continued occupancy

of the leased property.

Analysis:

At lease commencement, Entity Q determines that it is reasonably

certain to exercise the renewal option because it would suffer a significant

economic penalty if it abandoned the leasehold improvements at the end of

the initial non-cancellable period. At lease commencement, Entity Q concludes

that the lease term is six years.

Scenario C

Entity R enters into a lease for an identified retail space in a shopping centre.

The retail space will be available to Entity R for only the months of October,

November and December during a non-cancellable term of five years. The

lessor agrees to provide the same retail space for each of the five years.

Analysis:

At the lease commencement date, the lease term is 15 months

(three months per year over the five annual periods specified in the contract).

3.4.1.2 Cancellable leases

Extract from IFRS 16

B34 In determining the lease term and assessing the length of the non-

cancellable period of a lease, an entity shall apply the definition of a contract

and determine the period for which the contract is enforceable. A lease is no

longer enforceable when the lessee and lessor each has the right to terminate

the lease without permission from the other party with no more than an

insignificant penalty.

B35 If only a lessee has the right to terminate a lease, that right is considered

to be an option to terminate the lease available to the lessee that an entity

considers when determining the lease term. If only a lessor has the right to

terminate a lease, the non-cancellable period of the lease includes the period

covered by the option to terminate the lease.

Any non-cancellable periods (by the lessee and the lessor) in contracts that meet

the definition of a lease are considered part of the lease term. If only the lessor

has the right to terminate a lease, the period covered by the option to terminate

the lease is included in the non-cancellable period of the lease. If only the lessee

has the right to terminate a lease, that right is a termination option that is

43 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

considered when determining the lease term. Refer to section 3.4.1.1

Evaluating

lease term and purchase options

An arrangement is not enforceable if both the lessor and lessee each have the

right to terminate the lease without permission from the other party and with

no more than an insignificant penalty. The question arises as to whether penalty

should be interpreted to include only the contractual amount payable by one

party to the other if the termination option is exercised (i.e., the narrow

interpretation) or whether significant economic disincentives should also

be considered a penalty (i.e., the wide interpretation). With respect to the

determination of the lease term, IFRS 16 requires an entity to consider all

relevant facts and circumstances that create an economic incentive for the

lessee to exercise, or not to exercise, the option and thus suggests that all

aspects of termination penalties, whether contractual or financial in nature,

should be considered. Although the guidance may not directly apply in this

situation as the lessee is unable to exercise the option to renew the lease without

the approval of the lessor, we believe, by analogy, it is appropriate to evaluate

the existence of any significant economic disincentives taking into account all

facts and circumstances.

The IFRS Interpretations Committee issued an agenda decision in November

2019 related to this issue. The Committee was asked how to determine the lease

term of a cancellable lease or a renewable lease. Specifically, when applying

paragraph B34 of IFRS 16 and assessing ‘no more than an insignificant penalty’

whether an entity considers the broader economics of the contract or only

contractual termination payments. Such broader economic considerations might

include the cost of abandoning or dismantling leasehold improvements. Another

example may be the importance of the asset to the lessee’s operations.

To determine the lease term, an entity determines the non-cancellable period

and the enforceable period. It then determines where the lease term falls,

depending on the likelihood of exercising the options to extend or terminate

using the reasonably certain threshold. The impact of extension options is shown

in the diagram below, taken from the Committee’s agenda paper.

We believe the impact of termination options on the determination of the lease

term would be similar. That is, the lease term includes the non-cancellable

period, the periods covered by the options to extend if the lessee is reasonably

certain to exercise that option and the periods covered by the option to

terminate, if the lessee is reasonably certain not to exercise that option.

The Committee noted that in applying paragraph B34 and determining the

enforceable period of the lease, an entity considers:

•

The broader economics of the contract (i.e., not only the contractual

termination payments). For example, if either party has an economic

incentive not to terminate the lease such that it would incur a more than

44 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

insignificant penalty on termination, the contract is enforceable beyond the

date on which the contract can be terminated

•

Whether each of the parties has the right to terminate the lease without

permission from the other party with no more than an insignificant penalty.

Applying paragraph B34, a lease is no longer enforceable only when both

parties have such a right. Consequently, if only one party has the right to

terminate the lease without permission from the other party with no more

than an insignificant penalty, the contract is enforceable beyond the date

on which the contract can be terminated by that party

If an entity concludes that the contract is enforceable beyond the notice period

of a cancellable lease, it then applies paragraphs 19 and B37-B40 of IFRS 16

to assess whether the lessee is reasonably certain not to exercise the option to

terminate the lease.

The Committee noted that in assessing whether a lessee is reasonably certain

to extend (or not to terminate) a lease, paragraph B37 of IFRS 16 requires an

entity to consider all relevant facts and circumstances that create an economic

incentive for the lessee. This includes significant leasehold improvements

undertaken (or expected to be undertaken) over the term of the contract that

are expected to have significant economic benefit for the lessee when an option

to extend or terminate the lease becomes exercisable (paragraph B37(b) of

IFRS 16). In addition, an entity considers the broader economics of the contract

when determining the enforceable period of a lease. This includes, for example,

the costs of abandoning or dismantling non-removable leasehold improvements.

If an entity expects to use non-removable leasehold improvements beyond the

date on which the contract can be terminated, the existence of those leasehold

improvements indicates that the entity might incur a more than insignificant

penalty if it terminates the lease. Consequently, applying paragraph B34 of

IFRS 16, an entity considers whether the contract is enforceable for at least

the period of expected utility of the leasehold improvements.

The Committee concluded that the principles and requirements in IFRS 16

provide an adequate basis for an entity to determine the lease term of

cancellable and renewable leases and, therefore, decided not to add this item

to its agenda.

In many jurisdictions, property leases are subject to local property laws in

addition to the contractual terms of the lease arrangement. That is, local laws

and regulations may give the lessee legal renewal options not stated in the lease

contract. Examples of where the local law may provide lessees such rights

include airport terminal and retail shopping space. When assessing the lease

term, entities need to consider whether local laws and regulations create

enforceable rights and obligations that need to be included in the evaluation

of the lease term.

IFRS 16 applies to contracts that are referred to as ‘cancellable’, month-to-

month’, ‘at will’, ‘evergreen’, ‘perpetual’ or ‘rolling’ if they create enforceable

rights and obligations. These types of lease generally allow for the contract

to continue beyond a non-cancellable period until one party gives notice to

terminate the contract (e.g., the contract will roll monthly until the lessee or

the lessor elect to terminate the contract). If both the lessee and the lessor can

terminate the contract without more than an insignificant penalty at any time

at or after the end of the non-cancellable term, then there are no enforceable

rights and obligations beyond the non-cancellable term (i.e., the lease term is

limited to the non-cancellable term). However, if only the lessee holds a renewal

45 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

option, there may be other factors to consider in order to determine whether the

lessee is reasonably certain to extend the lease, including economic disincentives

discussed above.

Illustration 11 — Cancellable leases

A lease contract has an initial non-cancellable period of one year and an

extension for an additional year if both the lessee and the lessor agree.

There is no penalty if the lessee and the lessor do not agree to extend for

the additional year. The initial one-year non-cancellable period meets the

definition of a contract because it creates enforceable rights and obligations.

However, the one-year extension period does not meet the definition of

a contract because both the lessee and the lessor could unilaterally elect

to not extend the arrangement without a more than insignificant penalty.

That is, at lease commencement, neither party has enforceable rights

and obligations beyond the initial non-cancellable period.

3.4.2 Reassessment of the lease term and purchase options

Extract from IFRS 16

20 A lessee shall reassess whether it is reasonably certain to exercise an

extension option, or not to exercise a termination option, upon the occurrence

of either a significant event or a significant change in circumstances that:

(a) is within the control of the lessee; and

(b) affects whether the lessee is reasonably certain to exercise an option

not previously included in its determination of the lease term, or not to

exercise an option previously included in its determination of the lease

term (as described in paragraph B41).

21 An entity shall revise the lease term if there is a change in the non-

cancellable period of a lease. For example, the non-cancellable period of

a lease will change if:

(a) the lessee exercises an option not previously included in the entity’s

determination of the lease term;

(b) the lessee does not exercise an option previously included in the entity’s

determination of the lease term;

not previously included in the entity’s determination of the lease term; or

(d) an event occurs that contractually prohibits the lessee from exercising an

option previously included in the entity’s determination of the lease term.

B41 Paragraph 20 specifies that, after the commencement date, a lessee

reassesses the lease term upon the occurrence of a significant event or a

significant change in circumstances that is within the control of the lessee

and affects whether the lessee is reasonably certain to exercise an option not

previously included in its determination of the lease term, or not to exercise

an option previously included in its determination of the lease term. Examples

of significant events or changes in circumstances include:

(a)

significant leasehold improvements not anticipated at the commencement

date that are expected to have significant economic benefit for the lessee

when the option to extend or terminate the lease, or to purchase the

underlying asset, becomes exercisable;

46 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

(b)

a significant modification to, or customisation of, the underlying asset

that was not anticipated at the commencement date;

(c)

the inception of a sublease of the underlying asset for a period beyond

the end of the previously determined lease term; and

(d)

a business decision of the lessee that is directly relevant to exercising, or

not exercising, an option (for example, a decision to extend the lease of

a complementary asset, to dispose of an alternative asset or to dispose

of a business unit within which the right-of-use asset is employed).

3.4.2.1 Reassessment of the lease term and purchase options- lessees

After lease commencement (refer to section 3.2

Commencement date of the

lease

), IFRS 16 requires lessees to monitor leases for significant changes that

could trigger a change in the lease term. Lessees are required to reassess the

lease term upon the occurrence of either a significant event or a significant

change in circumstances that:

•

Is within the control of the lessee

•

Affects whether the lessee is reasonably certain to exercise an option not

previously included in its determination of the lease term, or not to exercise

an option previously included in its determination of the lease term

Examples of significant events or significant changes in circumstances within

the lessee’s control include:

•

Constructing significant leasehold improvements that are expected to

have significant economic value for the lessee when the option becomes

exercisable

•

Making significant modifications or customisations to the underlying asset

•

Making a business decision that is directly relevant to the lessee’s ability

to exercise, or not to exercise, an option (e.g., extending the lease of

a complementary asset or disposing of an alternative asset)

•

Subleasing the underlying asset for a period beyond the exercise date of

the option

Changes in market-based factors (e.g., a change in market rates to lease or

purchase a comparable asset) are not within the lessee’s control, and they

therefore do not trigger a reassessment by themselves.

IFRS 16 also requires lessees to revise the lease term when the lessee either

exercises an option that it previously deemed it was not reasonably certain

to exercise or does not exercise an option that it previously deemed it was

reasonably certain to exercise. Furthermore, the lease term is revised if an event

occurs that contractually obliges the lessee to exercise an option not previously

included in the entity’s determination of the lease term or an event occurs that

contractually prohibits the lessee from exercising an option previously included

in the entity’s determination of the lease term.

As the lessee is required to reassess the lease term upon the occurrence of

either a significant event or a significant change in circumstances that is within

the control of the lessee, the revision of the lease term often happens before

the actual exercise of the option in these circumstances. Additionally, if the

47 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

reassessment of lease term or the exercise of a purchase option results in

a change, the lessee would remeasure the lease liability, using revised inputs

(e.g., discount rate,) at the reassessment date, and would adjust the right-of-

use asset. However, if the right-of-use asset is reduced to zero, the lessee

would recognise any remaining amount in profit or loss. Refer to section 3.5.9

Reassessment of the lease liability

Refer to Appendix D for a summary of lessee reassessment and remeasurement

requirements.

3.4.2.2 Reassessment of the lease term and purchase options - lessors

IFRS 16 requires the lessor to revise the lease term to account for the lessee’s

exercise of an option to extend or terminate the lease or purchase the

underlying asset, when exercise of such options was not already included

in the lease term.

Refer to Appendix D for a summary of lessor reassessment and remeasurement

requirements.

3.5 Lease payments

Extract from IFRS 16

Appendix A

Defined terms

Lease payments

Payments made by a lessee to a lessor relating to the right to use an

underlying asset during the lease term, comprising the following:

(a) fixed payments (including in-substance fixed payments), less any lease

incentives;

(b) variable lease payments that depend on an index or a rate;

to exercise that option; and

(d) payments of penalties for terminating the lease, if the lease term reflects

the lessee exercising an option to terminate the lease.

For the lessee, lease payments also include amounts expected to be payable

by the lessee under residual value guarantees. Lease payments do not

include payments allocated to non-lease components of a contract, unless

the lessee elects to combine non-lease components with a lease component

and to account for them as a single lease component.

For the lessor, lease payments also include any residual value guarantees

provided to the lessor by the lessee, a party related to the lessee or a third

party unrelated to the lessor that is financially capable of discharging the

obligations under the guarantee. Lease payments do not include payments

allocated to non-lease components

48 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Lease payments are payments, made by a lessee to a lessor, relating to the

right to use an underlying asset during the lease term and include the following

amounts:

•

Fixed (including in-substance fixed) payments, less any lease incentives

receivable from the lessor (refer to section 3.5.1

In-substance fixed lease

payments

and section 3.5.2

Lease incentives

)

•

Variable lease payments that depend on an index or a rate (refer to section

3.5.3

Variable payments that depend on an index or rate

)

•

The exercise price of a purchase option if the lessee is reasonably certain to

exercise that purchase option (refer to section 3.5.4

The exercise price of

a purchase option

)

•

Payments for penalties for terminating a lease, if the lease term reflects

the lessee exercising an option to terminate the lease (refer to section 3.5.5

Payments for penalties for terminating a lease

)

•

Amounts expected to be payable by the lessee under residual value

guarantees (lessee only) (refer to section 3.5.6

Amounts expected to

be payable under residual value guarantees – lessees only

)

•

Residual value guarantees provided to the lessor by the lessee, a party

related to the lessee or a third party unrelated to the lessor that is financially

capable of discharging the obligations under the guarantee (lessor only)

(refer to section 3.5.7

Residual value guarantees – lessors only

)

Lease payments do not include payments allocated to non-lease components

of a contract, unless the lessee elects to combine non-lease components with

a lease component and to account for them as a single lease component.

3.5.1 In-substance fixed lease payments

Extract from IFRS 16

B42 Lease payments include any in-substance fixed lease payments. In-

substance fixed lease payments are payments that may, in form, contain

variability but that, in substance, are unavoidable. In-substance fixed lease

payments exist, for example, if:

(a) payments are structured as variable lease payments, but there is no

genuine variability in those payments. Those payments contain variable

clauses that do not have real economic substance. Examples of those

types of payments include:

(i)

payments that must be made only if an asset is proven to be capable

of operating during the lease, or only if an event occurs that has no

genuine possibility of not occurring; or

(ii)

payments that are initially structured as variable lease payments

linked to the use of the underlying asset but for which the variability

will be resolved at some point after the commencement date so that

the payments become fixed for the remainder of the lease term. Those

payments become in-substance fixed payments when the variability is

resolved.

(b) there is more than one set of payments that a lessee could make, but

only one of those sets of payments is realistic. In this case, an entity shall

consider the realistic set of payments to be lease payments.

but it must make at least one of those sets of payments. In this case, an

entity shall consider the set of payments that aggregates to the lowest

amount (on a discounted basis) to be lease payments.

Variable lease payments

that depend on an index

or a rate are included

in lease payments, but

other variable lease

payments are not.

49 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Some lease agreements include payments that are described as variable, or may

appear to contain variability, but are in-substance fixed payments because the

contract terms ensure that the payment of a fixed amount is unavoidable. Such

payments are included in the lease payments at lease commencement and thus

used to measure entities’ lease assets and lease liabilities.

3.5.2 Lease incentives

Extract from IFRS 16

Appendix A

Defined terms

Lease incentives

Payments made by a lessor to a lessee associated with a lease, or the

reimbursement or assumption by a lessor of costs of a lessee.

A lease agreement with a lessor might include incentives for the lessee to sign

the lease, such as an upfront cash payment to the lessee, payment of costs

for the lessee (such as moving expenses) or the assumption by the lessor of

the lessee’s pre-existing lease with a third party.

For lessees, lease incentives that are received by the lessee at or before

the lease commencement date reduce the initial measurement of a lessee’s

right-of-use asset. Lease incentives that are receivable by the lessee at lease

commencement date reduce a lessee’s lease liability (and therefore, the right-

of-use asset as well).

For lessors, lease incentives that are paid or payable to the lessee are also

deducted from lease payments and affect the lease classification test. For

finance leases, lease incentives that are payable to the lessee reduce the

expected lease receivables at the commencement date and, thereby, the initial

measurement of the lessor’s net investment in the lease. For operating leases,

lessors should defer the cost of any lease incentives paid or payable to the lessee

and recognise that cost as a reduction to lease income over the lease term.

Refer to sections 4

Lessee accounting

and 5

Lessor accounting

, respectively.

In May 2020, the IASB issued Annual Improvements to IFRS Standards 2018 –

2020, which includes an amendment to Illustrative Example 13 to remove the

illustration of the reimbursement of leasehold improvements by the lessor. This

was removed because of concerns that the example did not explain clearly enough

the conclusion as to whether the reimbursement would meet the definition of

a lease incentive in IFRS 16.

50 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

3.5.3 Variable lease payments that depend on an index or rate

Extract from IFRS 16

42 A lessee shall remeasure the lease liability by discounting the revised lease

payments, if either:

(a) there is a change in the amounts expected to be payable under a residual

value guarantee. A lessee shall determine the revised lease payments to

reflect the change in amounts expected to be payable under the residual

value guarantee.

(b) there is a change in future lease payments resulting from a change in an

index or a rate used to determine those payments, including for example

a change to reflect changes in market rental rates following a market

rent review. The lessee shall remeasure the lease liability to reflect those

revised lease payments only when there is a change in the cash flows (ie

when the adjustment to the lease payments takes effect). A lessee shall

determine the revised lease payments for the remainder of the lease term

based on the revised contractual payments.

43 In applying paragraph 42, a lessee shall use an unchanged discount rate,

unless the change in lease payments results from a change in floating interest

rates. In that case, the lessee shall use a revised discount rate that reflects

changes in the interest rate.

Variable lease payments that depend on an index or a rate include, for example,

payments linked to a consumer price index (CPI), payments linked to a

benchmark interest rate (such as LIBOR) or payments that vary to reflect

changes in market rental rates. The payments are included in the lease

payments and are measured using the prevailing index or rate at the

measurement date (e.g., lease commencement date for initial measurement).

The IASB indicated in the Basis for Conclusions (BC165) that, despite the

measurement uncertainty associated with changes to index- or rate-based

payments, the payments meet the definition of an asset (lessor) and a liability

(lessee) because they are unavoidable and do not depend on any future activity

of the lessee. Lessees subsequently remeasure the lease liability if there is a

change in the cash flows (i.e., when the adjustment to the lease payments takes

effect) for future payments resulting from a change in index or rate used to

determine lease payments. Refer to section 4.4

Remeasurement of lease

liabilities

Illustration 12 — Variable lease payment that depends on an index or rate

Entity A enters into a 10-year lease of property. The lease payment for the

first year is CU1,000. The lease payments are linked to the consumer price

index (CPI), i.e., not a floating interest rate. The CPI at the beginning of the

first year is 100. Lease payments are updated at the end of every second

year. At the end of year one, the CPI is 105. At the end of year two, the CPI

is 108.

Analysis

: At the lease commencement date, the lease payments are CU1,000

per year for 10 years. Entity A does not take into consideration the potential

future changes in the index. At the end of year one the payments have not

changed, so the liability is not updated. At the end of year two, when the lease

payments change, Entity A updates the remaining eight lease payments to

CU1,080 per year (CU1,000/100*108) and does not change its discount rate

to remeasure the lease liability (and right-of-use asset).

51 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Lease contracts, particularly those relating to property, may include market rent

reviews at future dates. The following example shows how these clauses may be

treated.

Illustration 13 — Property leases with market rent reviews

Entity A enters into a 5-year lease of property. The lease payment for the first

year is CU1,000. In years 2 and 3, there is a fixed escalation of 4%. At the

beginning of year 4, there is a market rent review that will determine the

lease payment in years 4 and 5.

Analysis

: The lease payments included in the lease liability and right-of-use

asset at the lease commencement date are determined, as follows:

Year 1 – CU1,000

Year 2 – CU1,000 + 4% fixed escalation = CU1,040

Year 3 – CU1,040 + 4% fixed escalation = CU1,082

The market rent review applicable to years 4 and 5 is a variable lease

payment that depends on an index or a rate (as described in IFRS 16

paragraph 28). Entity A assesses the market rent at commencement date for

the lease of the property for a period of two years, which is the length of the

remaining lease term. This is determined to be CU1,035 per annum for years

4 and 5.

3.5.4 The exercise price of a purchase option

If the lessee is reasonably certain to exercise a purchase option, the exercise

price is included as a lease payment. That is, entities consider the exercise

price of asset purchase options included in lease contracts consistently with

the evaluation of lease renewal and termination options (refer to section 3.4

Lease term and purchase options

3.5.5 Payments for penalties for terminating a lease

If it is reasonably certain that the lessee will not terminate a lease, the lease

term is determined assuming that the termination option would not be exercised,

and any termination penalty is excluded from the lease payments. Otherwise,

the lease termination penalty is included as a lease payment. The determination

of whether to include lease termination penalties as lease payments is similar to

the evaluation of lease renewal options.

3.5.6 Amounts expected to be payable under residual value guarantees –

lessees only

IFRS 16 requires lessees to include amounts expected to be payable to the lessor

under residual value guarantees as lease payments.

A lessee may provide a guarantee to the lessor that the value of the underlying

asset it returns to the lessor at the end of the lease will be at least a specified

amount. Such guarantees are enforceable obligations that the lessee has

assumed by entering into the lease. Uncertainty related to a lessee’s guarantee

of a lessor’s residual value affects the measurement of the obligation rather than

the existence of an obligation.

52 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

A lessee is required to remeasure the lease liability if there is a change in the

amounts expected to be payable under a residual value guarantee. Refer to

section 3.5.9

Reassessment of the lease liability

Illustration 14 — Residual value guarantee included in lease payments

Entity R (lessee) enters into a lease and guarantees that the lessor will realise

CU15,000 from selling the asset to another party at the end of the lease. At

lease commencement, based on Entity R’s estimate of the residual value of

the underlying asset, Entity R determines that it expects that it will owe

CU6,000 at the end of the lease.

Analysis

: Because it is expected that it will owe the lessor CU6,000 under the

residual value guarantee, Entity R includes that amount as a lease payment.

How we see it

IFRS 16 does not state how frequently reassessment should occur for

expected changes under residual value guarantees. We would expect entities

to apply judgement to determine the frequency of reassessment based on

the relevant facts and circumstances.

3.5.7 Residual value guarantees – lessors only

IFRS 16 requires lessors to include in the lease payments, any residual value

guarantees provided to the lessor by the lessee, a party related to the lessee,

or a third party unrelated to the lessor that is financially capable of discharging

the obligations under the guarantee. This amount included in the lease payments

is different from that for a lessee which only includes the amount expected to be

payable (refer to section 3.5.6

Amounts expected to be payable under residual

value guarantees – lessees only

3.5.8 Variable lease payments which do not depend on an index or rate

Variable lease payments that do not depend on an index or rate and are not,

in substance, fixed (refer to section 3.5.1

In-substance fixed lease payments

such as those based on performance (e.g., a percentage of sales) or usage

of the underlying asset (e.g., the number of hours flown, the number of units

produced), are not included as lease payments. Instead, they are recognised in

profit or loss (unless they are included in the carrying amount of another asset

in accordance with other IFRS) in the period in which the event that triggers the

payment occurs.

In some cases, the variability may be resolved during the lease term, so that

payments become fixed for the remainder of the lease term. The new fixed

payments are then used to remeasure the lease liability (with an offset

to the right-of-use asset). In some cases, the contract specifies that when

the contingency is resolved, the lessee is required to make an immediate

catch-up payment. The catch-up payment relates specifically to the lessee’s

prior use of the asset. In this case, we believe, when the contingency is resolved,

the catch-up obligation is recognised as part of the lease liability and is expensed

immediately (rather than adjusting the right-of-use asset).

53 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 15 — Variable lease payments that do not depend on an index or

rate

Entity A is a medical equipment manufacturer and a supplier of the related

consumables. Customer B operates a medical centre. Under the agreement

entered into by both parties, Entity A grants Customer B the right to

use a medical laboratory machine at no cost and Customer B purchases

consumables for use in the equipment from Entity A at CU100 each. The

consumables can only be used for that equipment and Customer B cannot

use other consumables as substitutes. There is no minimum purchase amount

required in the contract.

Based on its historical experience, Customer B estimates that it is highly likely

to purchase at least 8,000 units of consumables annually. Customer B has

appropriately assessed that the arrangement contains a lease of medical

equipment. There are no residual value guarantees or other forms of

consideration included in the contract.

Analysis: There are two components in the arrangement, a lease of

equipment and the purchase of consumables.

Even though Customer B may believe that it is highly unlikely to purchase

fewer than 8,000 units of consumables every year, in this example, there

are no lease payments for purposes of initial measurement (Entity A and

Customer B) and lease classification (Entity A).

Entity A and Customer B would allocate the payments associated with the

future payments to the lease and consumables component of the contract.

Lease payments do not include payments allocated to the non-lease components

of a contract. However, lease payments include amounts that would otherwise

be allocable to the non-lease components of a contract when the lessee makes

an accounting policy election to account for the lease and non-lease components

as a single lease component. Refer to section 2.2.2

Identifying and separating

lease from non-lease components of a contract

3.5.9 Security deposits

At the commencement of a lease, a lessee may be required to pay a security

deposit to the lessor. As long as the deposit is a true deposit and not a prepaid

lease payment, the deposit gives the lessee a right to receive the money back in

cash from the lessor and is, therefore, a financial asset for the lessee and a

financial liability for the lessor and is within the scope of IFRS 9 Financial

Instruments. The deposit must initially be accounted for at fair value. The fair

value of the deposit is determined based on the prevailing market rate of interest

for a similar loan to the lessor, considering the lessor’s credit-worthiness and,

depending on facts and circumstances, any additional security available to the

lessee.

When the deposit earns interest below the market rate, the excess of the

principal amount of the deposit over its fair value is accounted for by both the

lessee and lessor as a prepaid lease payment. It is therefore considered by the

lessor in determining whether the lease is an operating or finance lease. The

lessee includes this amount in the cost of its right-of-use asset at the lease

commencement date. For the lessor, if the lease is classified as an operating

lease, the prepaid lease payment is included in the total lease payments that are

recognised as income on either a straight-line basis or another systematic basis,

if that basis is more representative of the pattern in which benefit from the use

of the underlying asset is diminished. If the lease is classified as a finance lease,

the lessor includes the prepaid lease payment in the consideration for the lease

54 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

(i.e., lease payments) and, therefore, in the determination of the gain or loss on

derecognition of the underlying asset, if any.

Interest on the deposit is accounted for using the effective interest method by

both the lessee and the lessor.

3.5.10 Value added tax and property taxes

When a lessee enters into a lease contract the lessor may be required to

charge the lessee VAT in accordance with the local tax regulations. In many

jurisdictions, the lessor charges VAT on behalf of the tax authority and payment

is remitted to the tax authority. In circumstances when the VAT is the obligation

of the lessee (i.e., not the lessor’s obligation) the VAT charged is not a lease

payment from the perspective of the lessor. From a lessee’s perspective,

typically the lessee only incurs a liability for the VAT when the lessor invoices

the lease payment. In some cases, VAT is not fully recoverable by the lessee,

usually because either the activities of the lessee prohibit the recovery of VAT

or recovery is prohibited due to the nature of the leased asset. Generally, we

expect that lessees will not include VAT in lease payments in these situations.

Non-recoverable VAT payments are in the scope of IFRS 21

Levies

In some circumstances, a lessee may enter into a contract to lease property

and the lessor is required to pay property taxes levied by a local government

authority. The lease contract may specify that the lessee pays an additional

amount to cover the lessor’s tax costs. Property tax that is reimbursable by the

lessee to the lessor as the owner of the office building, according to the contract,

does not transfer any goods or services to the lessee and, as such, it is not a

separate component of the contract. Rather, it is part of the total consideration

and should be allocated to the separately identified components of the contract.

Unlike the non-recoverable VAT payments discussed above, the property tax

reimbursable by the lessee to the lessor is not a collection of tax by the lessor

on behalf of the tax authority. The obligation to pay the property tax rests with

the lessor as the owner (regardless of whether the lessee ends up making any

payments to the lessor). That is, the property tax is a cost of ownership and the

lessee’s payment to the lessor simply compensates the lessor for the use of the

office building.

3.5.11 Co-tenancy clauses

A co-tenancy clause is a clause in a lease contract that could result in changes

in a lessee’s lease payments if certain events involving other tenants occur (e.g.,

if key tenants, or a certain number of tenants, leave a retail shopping centre).

A co-tenancy clause, if triggered, may temporarily reduce a lessee’s lease

payments or contractually change the lease payments from fixed lease

payments to variable lease payments (e.g., payments that were previously fixed

are changed to a percentage of sales). Generally, when the co-tenancy clause

is resolved (e.g., the anchor tenant is replaced or occupancy levels return to a

stated percentage), the lease payments will revert back to the previous amounts.

If after lease commencement, a co-tenancy clause is triggered, we believe

a lessee generally would not remeasure the lease payments. IFRS 16 requires

a lessee to remeasure lease payments when a contingency, upon which some

or all of the variable lease payments that will be paid over the remainder of the

lease term are based, is resolved and those payments now meet the definition

of lease payments. A co-tenancy clause would typically result in the inverse

scenario because it would temporarily lower the lease payment or temporarily

cause fixed payments to become variable. Therefore, we believe any temporary

55 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

change in lease payments that results from a co-tenancy clause being triggered

should be recognised in profit or loss similar to variable lease payments.

However, in certain circumstances, when it is likely the co-tenancy clause will

not be resolved (e.g., the lease space is an aging shopping centre with a low

likelihood of locating replacement tenants that comply with the clause), we

believe a lessee may reasonably conclude it should remeasure the lease

payments. In this example, the lease payments would be remeasured resulting

in a reduction to the existing lease liability. The effect of a co-tenancy clause

when reassessing lease payments will depend on facts and circumstances.

3.5.12 Reassessment of the lease liability

IFRS 16 contains specific requirements about how to remeasure the lease

liability to reflect changes to the lease payments (see 4.4). A lessee recognises

the amount of the remeasurement of the lease liability as an adjustment to the

right-of-use asset. However, if the carrying amount of the right-of-use asset is

reduced to zero and there is a further reduction in the measurement of the lease

liability, a lessee recognises any remaining amount of the remeasurement in

profit or loss. Refer to Appendix D for a summary of lessee reassessment and

remeasurement requirements.

3.5.13 Remeasurement by lessors

Lessors remeasure the lease payments upon a modification (i.e., a change in the

scope of a lease, or the consideration for a lease that was not part of its original

terms and conditions) that is not accounted for as a separate contract. Refer to

section 5.5

Lease modifications

3.6 Discount rates

Extract from IFRS 16

Appendix A

Defined terms

Interest rate implicit in the lease

The rate of interest that causes the present value of (a) the lease payments

and (b) the unguaranteed residual value to equal the sum of (i) the fair value

of the underlying asset and (ii) any initial direct costs of the lessor.

Lessee’s incremental borrowing rate

The rate of interest that a lessee would have to pay to borrow over a similar

term, and with a similar security, the funds necessary to obtain an asset of

a similar value to the right-of-use asset in a similar economic environment.

Discount rates are used to determine the present value of the lease payments,

which are used to determine lease classification (refer to section 5.1

Lease

classification

) and to measure a lessor’s net investment in the lease and

a lessee’s lease liability.

56 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

For a lessor, the discount rate for the lease is the interest rate implicit in

the lease, which is the rate that causes the following:

Initial direct costs, other than those incurred by manufacturer or dealer lessors,

are included in the initial measurement of the net investment in the lease

and reduce the amount of income recognised over the lease term. Refer to

section 5

Lessor accounting

. Also refer to section 3.7

Initial direct costs.

For lessees, lease payments are discounted using the interest rate implicit in

the lease as described above if that rate can be readily determined. If that rate

cannot be readily determined, the lessee uses the incremental borrowing rate.

The term readily determinable is not equivalent to estimable. Therefore, when

the interest rate implicit in the lease can only be determined by using estimates

and/or assumptions, then the interest rate implicit in the lease is not readily

determinable.

The lessee’s incremental borrowing rate is the rate of interest that the lessee

would have to pay to borrow over a similar term, and with a similar security,

the funds necessary to obtain an asset of a similar value to the right-of-use

asset in a similar economic environment.

In determining the incremental borrowing rate, the lessee considers borrowings

with a similar term and security to the right-of-use asset, not the underlying

asset. For example, in the case of a five-year property lease, the lessee

considers borrowings with a similar term to the five year right-of-use asset,

not the property itself, which may have a significantly longer life. Observable

rates, such as a property yield can be used as a starting point to determine

the incremental borrowing rate, but adjustments need to be considered for an

asset with a value similar to the right-of-use asset. Other potential sources of

adjustment may include the credit profile of the lessee, the borrowing currency,

or the length of the lease term. It is likely that in some cases significant

judgement will be needed to determine the incremental borrowing rate.

Market interest rates, particularly risk-free rates, can be negative.

IFRS 16 does

not contain a floor of zero for the discount rate and therefore it is possible that

a lessee’s incremental borrowing rate could be below zero. However, as stated

above, observable borrowings with negative nominal interest rates may be

a starting point and entities will need to consider all potential sources of

adjustment (e.g., its own credit rating, lease term, currency) to determine its

own incremental borrowing rate.

In certain cases, particularly for high value assets, the incremental borrowing

rate may be lower than the lessee would expect the lessor’s interest rate implicit

in the lease to be, because the lessor is exposed to the residual value risk of the

The present

value of lease

payments

made by

the lessee

for the right

to use the

underlying

asset

The

unguaranteed

residual value

The fair value

of the

underlying

asset

Any initial

direct costs

of the lessor

57 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

asset at the end of the lease term. This asset risk premium is not adjusted for as

it does not meet the definition of the incremental borrowing rate in IFRS 16.

As explained above, the lessee’s incremental borrowing rate reflects the rate

of interest that a lessee would have to pay, among others, in a similar economic

environment. This is generally a nominal discount rate. If the contract requires

lease payments to be made in a currency other than the functional currency of

the lessee, the incremental borrowing rate of the lessee should be determined

based on a borrowing of a similar amount in that foreign currency. Leases

denominated in a foreign currency are discussed further at 4.6.2 below.

In June and September 2019, the IFRS Interpretations Committee discussed

whether a lessee’s incremental borrowing rate is required to reflect the interest

rate on a loan with both a similar maturity to the lease and a similar payment

profile to the lease. Specifically, whether an entity should use the interest rate

for an amortising loan (whereby the principal and interest are paid down over

time) or the interest rate for a bullet repayment loan, (whereby the interest is

paid over time with a single bullet payment of the principal at the end of the

loan). Interest rates for bullet repayment loans are often higher than those for

amortising loans.

The Committee noted that the lessee’s incremental borrowing rate is a lease-

specific rate that the Board defined ‘to take into account the terms and conditions

of the lease.

’ The definition of a lessee’s incremental borrowing rate in IFRS 16

does not explicitly require a lessee to determine its incremental borrowing rate to

reflect the interest rate on a loan with a similar payment profile to the lease

payments. Nonetheless, the Committee observed that it would be consistent with

the Board’s objective (when developing the definition of incremental borrowing

rate) for a lessee to refer, as a starting point, to a readily observable rate for a

loan with a similar payment profile to that of the lease. The Committee concluded

that the principles and requirements in IFRS 16 provide an adequate basis for a

lessee to determine its incremental borrowing rate and decided not to add the

matter to its standard-setting agenda.

Given the lack of prescriptive guidance, we believe that the use of an amortising

loan rate that has a similar payment profile to the lease is always acceptable.

The use of other rates (e.g., bullet loan rates) may also be acceptable depending

on the facts and circumstances (e.g., when the use of such rates aligns with the

lessee’s normal borrowing practices).

How we see it

The interest rate implicit in the lease is not necessarily the rate stated in

the contract and reflects, among other things, the lessor’s initial direct costs

and estimates of residual value. Therefore, lessees may find it difficult to

determine the interest rate implicit in the lease, in which case, they will need

to determine the incremental borrowing rate.

3.6.1 Determination of the incremental borrowing rate by a subsidiary with

centralised treasury functions

Some groups maintain centralised treasury functions and all funding

requirements for the group are managed by the parent entity. Under IFRS 16,

subsidiaries participating in a centralised treasury function cannot default to

their parent’s incremental borrowing rate. Rather, all facts and circumstances

should be considered to determine the subsidiary/lessee’s incremental

borrowing rate. The existence of guarantees of the subsidiary’s obligations

IFRS 16 Basis for Conclusions paragraph BC162.

58 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

may result in a rate that is similar to the parent’s rate as if the parent had

entered into the lease directly.

3.6.2 Reassessment of the discount rate

Refer to sections 3.5.9

Reassessment of the lease liability

and

4.5

Lease modifications

3.7 Initial direct costs

Extract from IFRS 16

69 Initial direct costs, other than those incurred by manufacturer or dealer

lessors, are included in the initial measurement of the net investment in the

lease and reduce the amount of income recognised over the lease term. The

interest rate implicit in the lease is defined in such a way that the initial direct

costs are included automatically in the net investment in the lease; there is no

need to add them separately.

Appendix A

Defined terms

Initial direct costs

Incremental costs of obtaining a lease that would not have been incurred

if the lease had not been obtained, except for such costs incurred by

a manufacturer or dealer lessor in connection with a finance lease.

59 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Under IFRS 16, initial direct costs are incremental costs that would not have

been incurred if the lease had not been obtained (e.g., commissions, certain

payments made to an existing lessee to incentivise that lessee to terminate

its lease). Lessees and lessors apply the same definition of initial direct costs.

The requirements under IFRS 16 for initial direct costs are consistent with the

concept of incremental costs in IFRS 15. Under IAS 17, initial direct costs are

incremental costs that are directly attributable to negotiating and arranging

a lease, except for such costs incurred by manufacturer or dealer lessors.

How we see it

The revised definition of initial direct costs could result in some changes in

practice for lessors. In addition to excluding allocated costs (e.g., salaries),

which are excluded under IAS 17, lessors’ initial direct costs also exclude

costs that are incurred regardless of whether the lease is obtained (e.g.,

certain legal advice).

3.7.1 Lessor accounting for initial direct costs

IFRS 16 requires lessors, other than manufacturer or dealer lessors, to include

initial direct costs in the initial measurement of their net investments in finance

leases and reduce the amount of income recognised over the lease term. The

interest rate implicit in the lease is defined in such a way that the initial direct

costs are included automatically in the net investment in the lease and they

are not added separately. Initial direct costs related to finance leases incurred

by manufacturer or dealer lessors are expensed at lease commencement.

IFRS 16 requires lessors to include initial direct costs in the carrying amount

of the underlying asset in an operating lease. These initial direct costs are

recognised as an expense over the lease term on the same basis as lease

income.

3.7.2 Lessee accounting for initial direct costs

IFRS 16 requires lessees to include their initial direct costs in their initial

measurement of the right–of-use asset.

How we see it

Certain costs associated with acquiring an asset within the scope of IAS 16

are required to be capitalised upon initial recognition. However, IFRS 16 does

not address the accounting for lessees’ costs incurred directly attributable

to bringing a right-of-use asset to the location and condition necessary for it

to be capable of operating in the manner intended by management. To the

extent that costs related to acquiring a right-of-use asset are not subject to

capitalisation under other IFRS (e.g. IAS 16), it remains to be seen in practice

whether they are charged to profit or loss when incurred or capitalised by

analogy to IAS 16. For example, a lessee may incur costs when leasing an

asset, by paying a third party to ship the asset, prepare the site and install

the underlying asset. We believe lessees may analogise to IAS 16 to

determine if such costs can be capitalised.

Initial direct costs are

incremental costs that

would not have been

incurred if the lease

had not been obtained.

60 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

3.8 Economic life

Extract from IFRS 16

Appendix A

Defined terms

Economic life

Either the period over which an asset is expected to be economically usable by

one or more users or the number of production or similar units expected to be

obtained from an asset by one or more users.

3.9 Fair value

Extract from IFRS 16

Appendix A

Defined terms

Fair value

For the purpose of applying the lessor accounting requirements in this

Standard, the amount for which an asset could be exchanged, or a liability

settled, between knowledgeable, willing parties in an arm’s length transaction.

The definition of fair value for lessors is the same as the definition of fair value in

IAS 17. This is a result of the IASB’s decision to substantially carry forward the

lessor accounting model in IAS 17.

61 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4. Lessee accounting

4.1 Initial recognition

Extract from IFRS 16

Appendix A

Defined terms

Short term lease

A lease that, at the commencement date, has a lease term of 12 months or

less. A lease that contains a purchase option is not a short-term lease.

5 A lessee may elect not to apply the requirements in paragraphs 22-49 to:

(a)

short-term

leases

; and

(b) leases for which the

underlying asset

is of low value (as described in

paragraphs B3-B8).

6 If a lessee elects not to apply the requirements in paragraphs 22-49 to

either short-term leases or leases for which the underlying asset is of low

value, the lessee shall recognise the

lease payments

associated with those

leases as an expense on either a straight-line basis over the

lease term

another systematic basis. The lessee shall apply another systematic basis if

that basis is more representative of the patter of the lessee’s benefit.

7 If a lessee accounts for short-term leases applying paragraph 6, the lessee

shall consider the lease to be a new lease for the purposes of this Standard if:

(a) there is a

lease modification

; or

(b) there is any change in the lease term (for example, the lessee exercises

an option not previously included in its determination of the lease term).

8 The election for short-term leases shall be made by class of underlying asset

to which the right of use relates. A class of underlying asset is a grouping of

underlying assets of a similar nature and use in an entity’s operations. The

election for leases for which the underlying asset is of low-value can be made

on a lease-by-lease basis.

22 At the commencement date, a lessee shall recognise a right-of-use asset

and a lease liability.

IFRS 16 requires lessees to recognise a liability to make lease payments and an

asset representing the right to use the underlying asset (i.e., the right-of-use

asset) during the lease term for all leases, except for short-term leases (refer

to section 4.1.1

Short-term leases

) and leases of low-value assets (refer

to section 4.1.2

Leases of low-value assets

) if they choose to apply such

exemptions. The short-term lease and leases of low-value assets accounting

policy elections are intended to reduce the cost and complexity of applying

IFRS 16. However, a lessee that makes such elections must make certain

quantitative and qualitative disclosures about short-term leases and leases

of low-value assets. Refer to section 4.8

Disclosure

62 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.1.1 Short-term leases

A short-term lease is defined as a lease that, at the commencement date, has

a lease term of 12 months or less and does not include an option to purchase

the underlying asset.

The short-term lease exemption can be made by class of underlying asset to

which the right of use relates. A class of underlying asset is a grouping of

underlying assets of a similar nature and use in an entity’s operations.

A lessee that makes this accounting policy election does not recognise a lease

liability or right-of-use asset on its balance sheet. Instead, the lessee recognises

the lease payments associated with those leases as an expense on either a

straight-line basis over the lease term or another systematic basis. The lessee

is required to apply another systematic basis if that basis is more representative

of the pattern of the lessee’s benefit.

When determining whether a lease qualifies as a short-term lease, a lessee

evaluates the lease term in the same manner as all other leases. Refer to section

3.4

Lease term and purchase options.

That is, the lease term includes the non-

cancellable term of the lease, periods covered by an option to extend the lease

if the lessee is reasonably certain to exercise that option and periods covered

by an option to terminate the lease if the lessee is reasonably certain not to

exercise that option. As the determination is made at commencement date,

a lease cannot be classified as short-term if the lease term is subsequently

reduced to less than 12 months. In addition, to qualify as a short-term lease,

the lease cannot include an option to purchase the underlying asset.

A lease that qualifies as a short-term lease at the commencement is a new

lease if there is a lease modification or a change in a lessee’s assessment of

the lease term (e.g., the lessee exercises an option not previously included in

the determination of the lease term). The new lease is evaluated to determine

whether it qualifies for the short-term exemption, similar to any other new lease.

The short-term lease accounting policy election is intended to reduce the cost

and complexity of applying IFRS 16. However, a lessee that makes the election

must make certain quantitative and qualitative disclosures about short-term

leases. Refer to section 4.8

Disclosure

Once a lessee establishes a policy for a class of underlying assets, all future

short-term leases for that class are required to be accounted for in accordance

with the lessee’s policy. A lessee evaluates any potential change in its accounting

policy in accordance with IAS 8

Accounting Policies, Changes in Accounting

Estimates and Errors

Illustration 16: Short-term lease

Scenario A

A lessee enters into a lease with a nine-month non-cancellable term with

an option to extend the lease for four months. The lease does not have a

purchase option. At the lease commencement date, the lessee concludes that

it is reasonably certain to exercise the extension option because the monthly

lease payments during the extension period are significantly below market

rates.

Analysis

: The lease term is greater than 12 months (i.e., 13 months).

Therefore, the lessee may not account for the lease as a short-term lease.

Lessees can make

an accounting policy

election (by class of

underlying asset) not

to recognise right-of-

use assets and lease

liabilities for short-term

leases.

63 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 16: Short-term lease (cont’d)

Scenario B

Assume the same facts as Scenario A except, at the lease commencement

date, the lessee concludes that it is not reasonably certain to exercise the

extension option because the monthly lease payments during the optional

extension period are at what the lessee expects to be market rates and

there are no other factors that would make exercise of the renewal option

reasonably certain.

Analysis: The lease term is 12 months or less, i.e., nine months. Therefore,

the lessee may (subject to its accounting policy, by class of underlying asset)

account for the lease under the short-term lease exemption, i.e., it recognises

lease payments as an expense on a either a straight-line basis over the lease

term or another systematic basis and does not recognise a lease liability or

right-of-use asset on its balance sheet, similar to an operating lease under

IAS 17.

4.1.2 Leases of low-value assets

Extract from IFRS 16

B3 Except as specified in paragraph B7, this Standard permits a lessee to

apply paragraph 6 to account for leases for which the underlying asset is

of low value. A lessee shall assess the value of an underlying asset based on

the value of the asset when it is new, regardless of the age of the asset being

leased.

B4 The assessment of whether an underlying asset is of low value is

performed on an absolute basis. Leases of low-value assets qualify for the

accounting treatment in paragraph 6 regardless of whether those leases are

material to the lessee. The assessment is not affected by the size, nature or

circumstances of the lessee. Accordingly, different lessees are expected to

reach the same conclusions about whether a particular underlying asset is

of low value.

B5 An underlying asset can be of low value only if:

(a) the lessee can benefit from use of the underlying asset on its own or

together with other resources that are readily available to the lessee; and

(b) the underlying asset is not highly dependent on, or highly interrelated

with, other assets.

B6 A lease of an underlying asset does not qualify as a lease of a low-value

asset if the nature of the asset is such that, when new, the asset is typically

not of low value. For example, leases of cars would not qualify as leases of

low-value assets because a new car would typically not be of low value.

B7 If a lessee subleases an asset, or expects to sublease an asset, the head

lease does not qualify as a lease of a low-value asset.

B8 Examples of low-value underlying assets can include tablet and personal

computers, small items of office furniture and telephones.

64 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Lessees can also make an election for leases for which the underlying asset is of

low value (i.e., low-value assets). This election can be made on a lease-by-lease

basis. A lessee that makes this election does not recognise a lease liability or

right-of-use asset on its statement of financial position. Instead, the lessee

recognises the lease payments associated with those leases as an expense

on either a straight-line basis over the lease term or another systematic basis,

if that basis is more representative of the pattern of the lessee’s benefit.

A lessee assesses the value of an underlying asset based on the value of

the asset when it is new, regardless of the age of the asset being leased.

The assessment of whether an underlying asset is of low value is performed

on an absolute basis. Leases of low-value assets qualify for the exemption

regardless of whether those leases are material to the lessee. The assessment

is not affected by the size, nature or circumstances of the lessee. Accordingly,

different lessees are expected to reach the same conclusion about whether a

particular underlying asset is of low-value. At the time of reaching its decisions

about the exemption, the IASB had in mind leases of underlying assets with

a value, when new, of US$5,000 or less. Examples of low-value assets include

desktop and laptop computers, small items of office furniture, telephones and

other low-value equipment and excludes cars because a new car would typically

not be of low value.

An underlying asset can only be of low-value if both:

•

The lessee can benefit from use of the assets on their own, or together with,

other resources that are readily available to the lessee

•

The underlying asset is not dependent on, or highly interrelated with, other

assets

For example, an entity may lease a truck for use in its business and the lease

includes the use of the tyres attached to the truck. To use the tyres for their

intended purpose, they can only be used with the truck and as such, they

are dependent on, or highly interrelated with the truck. Therefore, the tyres

would not qualify for the low-value asset exemption.

An intermediate lessor who subleases, or expects to sublease an asset, cannot

account for the head lease as a lease of a low-value asset. Refer to section 6.2

Intermediate lessor accounting.

4.2 Initial measurement

4.2.1 Right-of-use assets

Extract from IFRS 16

Initial measurement

Initial measurement of the right-of-use asset

23 At the commencement date, a lessee shall measure the right-of-use

asset at cost.

24 The cost of the right-of-use asset shall comprise:

(a) the amount of the initial measurement of the lease liability, as described in

paragraph 26;

(b) any lease payments made at or before the commencement date, less any

lease incentives

received;

initial direct costs

incurred by the lessee; and

65 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 (cont’d)

(d) an estimate of costs to be incurred by the lessee in dismantling and

removing the underlying asset, restoring the site on which it is located

or restoring the underlying asset to the condition required by the terms

and conditions of the lease, unless those costs are incurred to produce

inventories. The lessee incurs the obligation for those costs either at

the commencement date or as a consequence of having used the

underlying asset during a particular period.

25 A lessee shall recognise the costs described in paragraph 24(d) as part of

the cost of the right-of-use asset when it incurs an obligation for those costs.

A lessee applies IAS 2

Inventories

to costs that are incurred during a particular

period as a consequence of having used the right-of-use asset to produce

inventories during that period. The obligations for such costs accounted for

applying this Standard or IAS 2 are recognised and measured by applying

IAS 37

Provisions, Contingent Liabilities and Contingent Assets

A lessee initially measures the right-of-use asset at cost, which consists of all of

the following:

•

The amount of the initial measurement of the lease liability (refer to

section 4.2.2

Lease liabilities

)

•

Any lease payments made to the lessor at or before the commencement

date, less any lease incentives received from the lessor (refer to

section 3.5.2

Lease incentives

)

•

Any initial direct costs incurred by the lessee (refer to section 3.7

Initial

direct costs

)

•

An estimate of the costs to be incurred by the lessee in dismantling and

removing the underlying asset, restoring the site on which the underlying

asset is located or restoring the underlying asset to the condition required

by the terms and conditions of the lease, unless those costs are incurred to

produce inventories

On initial measurement, a lessee is required to recognise dismantling, removal

and restoration costs as part of the right-of-use asset. Costs may be incurred at

lease commencement or during a particular period as a consequence of having

used an underlying asset. Costs that are incurred during a particular period as

a consequence of having used the right-of-use asset to produce inventories are

accounted for under IAS 2

Inventories

. The liability associated with dismantling,

removal and restoration costs is recognised and measured in accordance with

IAS 37

Provisions, Contingent Liabilities and Contingent Assets

In certain retail property leases, a lessee may sign a lease contract with a lessor

and also make a payment to the existing lessee in return for vacating the

property. This is sometimes referred to as key money. The existing lessee is

released from all obligations under the lease contract with the lessor (i.e., this

is not a sublease arrangement). The new lessee also has the right to transfer

its rights and obligations in the lease contract to another party in exchange

for payment, which would also release the new lessee from all obligations

with the lessor. On initial recognition of the lease contract, the payment to

the previous lessee is accounted for as an initial direct cost and is included

in the measurement of the ROU asset. The payment is not in the scope of

IAS 38

Intangible Assets

. The new lessee applies the requirements described in

section 4.3.1 below to the subsequent measurement of the right-of-use asset.

66 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.2.2 Lease liabilities

Extract from IFRS 16

Initial measurement of the lease liability

26 At the commencement date, a lessee shall measure the lease liability at

the present value of the lease payments that are not paid at that date. The

lease payments shall be discounted using the interest rate implicit in the

lease, if that rate can be readily determined. If that rate cannot be readily

determined, the lessee shall use the lessee’s incremental borrowing rate.

27 At the commencement date, the lease payments included in the

measurement of the lease liability comprise the following payments for

the right to use the underlying asset during the lease term that are not paid

at the commencement date:

(a)

fixed payments

(including in-substance fixed payments as described in

paragraph B42), less any lease incentives receivable;

(b)

variable lease payments

that depend on an index or a rate, initially

measured using the index or rate as at the commencement date (as

described in paragraph 28);

residual value

guarantees

;

(d) the exercise price of a purchase option if the lessee is reasonably certain

to exercise that option (assessed considering the factors described in

paragraphs B37–B40); and

(e) payments of penalties for terminating the lease, if the lease term reflects

the lessee exercising an option to terminate the lease

At the commencement date, a lessee initially measures the lease liability at the

present value of the lease payments to be made over the lease term. Lessees

apply the concepts previously described in sections 2 and 3 to identify the lease

components and to determine the lease term, lease payments and discount rate

as of the commencement date of the lease.

4.3 Subsequent measurement

4.3.1 Right-of-use assets

Extract from IFRS 16

Subsequent measurement of the right-of-use asset

29 After the commencement date, a lessee shall measure the right-of-use

asset applying a cost model, unless it applies either of the measurement

models described in paragraphs 34 and 35.

Cost model

30 To apply a cost model, a lessee shall measure the right-of-use asset at

cost:

(a) less any accumulated depreciation and any accumulated impairment

losses; and

(b) adjusted for any remeasurement of the lease liability specified in

paragraph 36(c).

67 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 (cont’d)

31 A lessee shall apply the depreciation requirements in IAS 16

Property,

Plant and Equipment

in depreciating the right-of-use asset, subject to the

requirements in paragraph 32.

32 If the lease transfers ownership of the underlying asset to the lessee by

the end of the lease term or if the cost of the right-of-use asset reflects that

the lessee will exercise a purchase option, the lessee shall depreciate the

right-of-use asset from the commencement date to the end of the

useful life

of the underlying asset. Otherwise, the lessee shall depreciate the right-of-use

asset from the commencement date to the earlier of the end of the

useful life

of the right-of-use asset or the end of the lease term.

33 A lessee shall apply IAS 36

Impairment of Assets

to determine whether

the right-of-use asset is impaired and to account for any impairment loss

identified.

Other measurement models

34 If a lessee applies the fair value model in IAS 40

Investment Property

to its

investment property, the lessee shall also apply that fair value model to right-

of-use assets that meet the definition of investment property in IAS 40.

35 If right-of-use assets relate to a class of property, plant and equipment to

which the lessee applies the revaluation model in IAS 16, a lessee may elect to

apply that revaluation model to all of the right-of-use assets that relate to that

class of property, plant and equipment.

A lessee subsequently measures the right-of-use asset using a cost model,

unless it applies one of the other measurement models discussed below.

Cost model

When a lessee applies the cost model, the right-of-use asset is subsequently

measured at cost less accumulated depreciation and accumulated impairment

losses.

A lessee applies the depreciation requirements in IAS 16 in depreciating the

right-of-use asset, subject to the following requirements:

If the lease transfers ownership of the underlying asset to the lessee by the end

of the lease term, or if the cost of the right-of-use asset reflects that the lessee

will exercise a purchase option, the lessee depreciates the right-of-use asset

from the commencement date to the end of the useful life of the underlying

asset. Otherwise, the lessee depreciates the right-of-use asset from the

commencement date to the earlier of the end of the useful life of the right-of

-use asset or the end of the lease term. The leased asset is depreciated from the

commencement date of the lease even if the lessee chooses not to use the asset

from the commencement date, for example, because leasehold improvements

are being constructed.

Depreciation of the right-of-use asset is recognised in a manner consistent with

existing standards for property, plant and equipment. IAS 16 is not prescriptive

about the methods of depreciation, mentioning straight line, diminishing balance

and units of production as possibilities. The overriding requirement of IAS 16 is

that the depreciation charge reflects the pattern of consumption of the benefits

the asset brings over its useful life and is applied consistently from period to

period.

68 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

IAS 16 also requires that each part of an item of property, plant and equipment

with a cost that is significant in relation to the total cost of the item is

depreciated separately. An entity allocates the amount initially recognised with

respect to an item of property, plant and equipment to its significant parts and

separately depreciates each such part. For example, as noted in IAS 16, it may

be appropriate to depreciate separately the airframe and engines of an aircraft.

In many cases, the right-of-use asset will relate to one underlying asset or

significant part and so a component approach may not be necessary. However,

entities will need to assess whether it should be applied for right-of-use assets

that have significant parts with different useful economic lives.

A lessee applies IAS 36

Impairment of Assets

to determine whether the right-of-

use asset is impaired and to account for any impairment loss identified.

Other measurement models

If a lessee applies the fair value model in IAS 40

Investment Property

to its

investment property, the lessee also applies the fair value model to right-of-use

assets that meet the definition of investment property in IAS 40.

If right-of-use assets relate to a class of property, plant and equipment to which

the lessee applies the revaluation model in IAS 16, the lessee may elect to apply

that revaluation model to all the right-of-use assets that relate to that class of

property, plant and equipment.

4.3.2 Lease liabilities

Extract from IFRS 16

Subsequent measurement of the lease liability

36 After the commencement date, a lessee shall measure the lease liability

by:

(a) increasing the carrying amount to reflect interest on the lease liability;

(b) reducing the carrying amount to reflect the lease payments made; and

modifications specified in paragraphs 39-46, or to reflect revised in-

substance fixed lease payments (see paragraph B42).

Interest on the lease liability in each period during the lease term shall

be the amount that produces a constant periodic rate of interest on the

remaining balance of the lease liability. The periodic rate of interest is the

discount rate described in paragraph 26, or if applicable the revised discount

rate described in paragraph 41, paragraph 43 or paragraph 45(c).

38 After the commencement date, a lessee shall recognise in profit or loss,

unless the costs are included in the carrying amount of another asset applying

other applicable Standards, both:

(a) interest on the lease liability; and

(b) variable lease payments not included in the measurement of the lease

liability in the period in which the event or condition that triggers those

payments occurs.

The IASB indicated in the Basis for Conclusions (BC182) that a lease liability

should be accounted for in a manner similar to other financial liabilities (i.e., on

an amortised cost basis). Consequently, the lease liability is accreted using an

amount that produces a constant periodic discount rate on the remaining balance

of the liability (i.e., the discount rate determined at commencement, as long as

69 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

a reassessment requiring a change in the discount rate has not been triggered).

Lease payments reduce the lease liability when paid. Refer to sections 3.5.9

Remeasurement of the lease liability

and 4.5

Lease modifications

, respectively.

4.3.3 Expense recognition

Lessees recognise the following items in expense for leases:

•

Depreciation of the right-of-use asset

•

Interest on the lease liability

•

Variable lease payments that are not included in the lease liability (e.g.,

variable lease payments that do not depend on an index or rate)

•

Impairment of the right-of-use asset

Depreciation of the right-of-use asset and interest on the lease liability

After the commencement date, a lessee recognises depreciation of the right-

of-use asset and separately recognises interest on the lease liability.

When a lessee depreciates the right-of-use asset on a straight-line basis,

the total periodic expense (i.e., the sum of interest and depreciation expense)

is generally higher in the early periods and lower in the later periods. Because

a constant interest rate is applied to the lease liability, interest expense

decreases as cash payments are made during the lease term and the lease

liability decreases. Therefore, more interest expense is incurred in the early

periods and less in the later periods. This trend in the interest expense,

combined with straight-line depreciation of the right-of-use asset, results in

a front-loaded expense recognition pattern.

Variable lease payments

After the commencement date, lessees recognise in profit or loss, any variable

lease payments not included in the measurement of the lease liability in the

period in which the event or condition that triggers those payments occur.

Impairment of the right-of-use asset

Lessees’ right-of-use assets are subject to existing impairment requirements in

IAS 36

Impairment of Assets

If a lessee determines that a right-of-use asset is impaired, it recognises an

impairment loss and measures the right-of-use asset at its carrying amount

immediately after the impairment. A lessee subsequently depreciates, generally

on a straight-line basis, the right-of-use asset from the date of the impairment

to the earlier of the end of the useful life of the right-of-use asset or the end of

the lease term. However, the depreciation period is the remaining useful life

of the underlying asset if the lessee is reasonably certain to exercise an option

to purchase the underlying asset or if the lease transfers ownership of the

underlying asset to the lessee by the end of the lease term. Refer to section

4.6.1

Impairment of right-of-use assets

, for additional discussion of impairment

of right-of-use assets.

Lessees will generally

have a front-loaded

expense recognition

pattern.

70 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.3.4 Example – lessee accounting

Illustration 17 — Lessee accounting

Entity H (lessee) enters into a three-year lease of equipment. Entity H agrees

to make the following annual payments at the end of each year: CU10,000 in

year one, CU12,000 in year two and CU14,000 in year three. For simplicity,

there are no other elements to the lease payments (e.g., purchase

options, lease incentives from the lessor or initial direct costs). The initial

measurement of the right-of-use asset and lease liability is CU33,000

(present value of lease payments using a discount rate of approximately

4.235%). Entity H uses its incremental borrowing rate because the interest

rate implicit in the lease cannot be readily determined. Entity H depreciates

the right-of-use asset on a straight-line basis over the lease term.

Analysis

: At lease commencement, Entity H would recognise the lease-related

asset and liability:

Right-of-use asset

CU33,000

Lease liability

CU33,000

To initially recognise the lease-related asset and liability

The following journal entries would be recorded in the first year:

Interest expense

CU1,398

Lease liability

CU1,398

To record interest expense and accrete the lease liability using the interest

method (CU33,000 x 4.235%)

Depreciation expense

CU11,000

Right-of-use asset

CU11,000

To record depreciation expense on the right-of-use asset (CU33,000 ÷ 3

years)

Lease liability

CU10,000

Cash

CU10,000

To record lease payment

A summary of the lease contract’s accounting (assuming no changes due to

reassessment) is, as follows:

•

Initial

Year 1

Year 2

Year 3

Cash lease payments

CU10,000

CU12,000

CU14,000

Lease expense

recognised

Interest expense

CU1,398

CU1,033

CU569

Depreciation expense

11,000

Total periodic expense

CU12,398

CU12,033

CU11,569

Balance sheet

Right-of-use asset

CU33,000

CU22,000

CU11,000

—

Lease liability

CU(33,000)

CU(24,398)

CU(13,431)

—

71 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.4 Remeasurement of lease liabilities

Extract from IFRS 16

39 After the commencement date, a lessee shall apply paragraphs 40-43

to remeasure the lease liability to reflect changes to the lease payments. A

lessee shall recognise the amount of the remeasurement of the lease liability

as an adjustment to the right-of-use asset. However, if the carrying amount

of the right-of-use asset is reduced to zero and there is a further reduction in

the measurement of the lease liability, a lessee shall recognise any remaining

amount of the remeasurement in profit or loss.

40 A lessee shall remeasure the lease liability by discounting the revised lease

payments using a revised discount rate, if either:

(a) there is a change in the lease term, as described in paragraphs 20–21.

A lessee shall determine the revised lease payments on the basis of the

revised lease term; or

(b) there is a change in the assessment of an option to purchase the

underlying asset, assessed considering the events and circumstances

described in paragraphs 20–21 in the context of a purchase option.

A lessee shall determine the revised lease payments to reflect the change

in amounts payable under the purchase option.

41 In applying paragraph 40, a lessee shall determine the revised discount

rate as the interest rate implicit in the lease for the remainder of the lease

term, if that rate can be readily determined, or the lessee’s incremental

borrowing rate at the date of reassessment, if the interest rate implicit in

the lease cannot be readily determined.

42 A lessee shall remeasure the lease liability by discounting the revised lease

payments, if either:

(a) there is a change in the amounts expected to be payable under a residual

value guarantee. A lessee shall determine the revised lease payments to

reflect the change in amounts expected to be payable under the residual

value guarantee.

(b) there is a change in future lease payments resulting from a change in an

index or a rate used to determine those payments, including for example

a change to reflect changes in market rental rates following a market

rent review. The lessee shall remeasure the lease liability to reflect those

revised lease payments only when there is a change in the cash flows (ie

when the adjustment to the lease payments takes effect). A lessee shall

determine the revised lease payments for the remainder of the lease term

based on the revised contractual payments.

43 In applying paragraph 42, a lessee shall use an unchanged discount rate,

unless the change in lease payments results from a change in floating interest

rates. In that case, the lessee shall use a revised discount rate that reflects

changes in the interest rate.

IFRS 16 requires lessees to remeasure lease liabilities when there is a lease

modification (i.e., a change in the scope of a lease, or the consideration for

a lease that was not part of the original terms and conditions of the lease) that

is not accounted for as a separate contract. Refer to the section 4.5

Lease

modifications

. Lessees are also required to remeasure lease payments upon

a change in any of the following:

72 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

•

The lease term (refer to section 3.4.1

Lease term

)

•

The assessment of whether the lessee is reasonably certain to exercise an

option to purchase the underlying asset (refer to section 3.4.1.1

Evaluating

lease term and purchase options

)

•

The amounts expected to be payable under residual value guarantees (refer

to section 3.5.6

Amounts expected to be payable under residual value

guarantees – lessees only

)

•

Future lease payments resulting from a change in an index or rate

(refer to section 3.5.3

Variable lease payments that depend on an index

or rate

)

•

In-substance fixed lease payments (refer to section 3.5.1

In-substance

fixed lease payments

)

Lessees use a revised discount rate when lease payments are updated for

a change in the lease term or a revised assessment of a purchase option. The

revised discount rate is based on the interest rate implicit in the lease for the

remainder of the lease term. If that rate cannot be readily determined, the lessee

uses its incremental borrowing rate. Lessees use the original discount rate when

lease payments are updated for a change in expected amounts for residual value

guarantees and payments dependent on an index or rate, unless the rate is a

floating interest rate.

When a lease includes a market rate adjustment (a market rent review), the

negotiations between the lessee and the lessor may take some time to complete

(the negotiation period). For example, consider a 10-year lease that has a

market rate adjustment that applies from the end of year 5. The market rent

review negotiations begin during year 5, but are not completed until later in

year 6. During year 6, while the negotiation is ongoing, the lessee is required to

pay the original contractual lease payments. At the conclusion of the negotiation

period (i.e., upon a final determination of the lease payments for year 6 until

year 10), the new lease payments apply retrospectively from the beginning of

year 6.

In this example, the lessee does not adjust the lease payments at the beginning

of year 6 for the expected increase in rent. Rather, any adjustment is recognised

as an adjustment to lease payments when the market rent review is finalised and

the change in contractual cash flows takes effect.

The accounting for changes in lease payments arising from rent concessions

when the lessee applies

Covid-19-Related Rent Concessions – Amendment to

IFRS 16 Leases

is dealt with in a separate publication

Applying IFRS: Accounting

for covid-19 related rent concessions (updated July 2020)

73 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.5 Lease modifications

Extract from IFRS 16

Appendix A

Defined terms

Lease modification

A change in the scope of a lease, or the consideration for a lease, that was not

part of the original terms and conditions of the lease (for example, adding or

terminating the right to use one or more underlying assets, or extending or

shortening the contractual lease term).

If a lease is modified (i.e., a change in the scope of a lease, or the consideration

for a lease, that was not part of the original terms and conditions of the lease),

the modified contract is evaluated to determine whether it is or contains a lease.

Refer to section 2.1.7

Reassessment of the contract

. If a lease continues to

exist, lease modification can result in:

•

A separate lease. Refer to section 4.5.1

Determining whether a lease

modification results in a separate lease

•

A change in the accounting for the existing lease (i.e., not a separate lease).

Refer to section 4.5.2,

Lessee accounting for a modification that does not

result in a separate lease

The exercise of an existing purchase or renewal option or a change in the

assessment of whether such options are reasonably certain to be exercised are

not lease modifications but can result in the remeasurement of lease liabilities

and right-of-use assets. Refer to section 3.5.9

Remeasurement of the lease

liability

In April 2020, the IASB issued an educational document explaining how an entity

evaluates whether a rent concession constitutes a lease modification. On 28 May

2020, the IASB issued

Covid-19-Related Rent Concessions - Amendment to

IFRS 16 Leases

(the amendment). The Board amended the standard to provide

a temporary optional relief to lessees from applying IFRS 16 guidance on lease

modification accounting for rent concessions arising as a direct consequence of

the coronavirus pandemic. Application of the amendment and the accounting

consequences that arise from covid-19-related rent concessions are dealt with

in a separate publication

Applying IFRS: Accounting for covid-19 related rent

concessions (updated July 2020)

4.5.1 Determining whether a lease modification results in a separate lease

Extract from IFRS 16

44 A lessee shall account for a lease modification as a separate lease if both:

(a) the modification increases the scope of the lease by adding the right to

use one or more underlying assets; and

(b) the consideration for the lease increases by an amount commensurate

with the stand-alone price for the increase in scope and any appropriate

adjustments to that stand-alone price to reflect the circumstances of the

particular contract.

A lease modification is

a change in the scope

of a lease, or the

consideration for a lease,

that was not part of

the original terms and

conditions of the lease.

74 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

A lessee accounts for a lease modification (i.e., a change in the scope of a lease,

or the consideration for a lease, that was not part of the original terms and

conditions of the lease) as a separate lease (i.e., separate from the original

lease) when both of the following conditions are met:

•

The modification increases the scope of the lease by adding the right to use

one or more underlying assets.

•

The consideration for the lease increases commensurate with the standalone

price for the increase in scope and any adjustments to that stand-alone price

reflect the circumstances of the particular contract.

If both of these conditions are met, the lease modification results in two separate

leases, the unmodified original lease and a separate new lease. Lessees account

for the separate contract that contains a lease in the same manner as other

new leases. Refer to IFRS 16’s Example 15 that illustrates this concept in section

4.5.3

Examples — lessees’ accounting for lease modifications

If either of the conditions are not met, the modified lease is not accounted for as

a separate lease. Refer to section 3.5.9

Remeasurement of the lease liability

4.5.2 Lessee accounting for a modification that does not result in a separate

lease

Extract from IFRS 16

45 For a lease modification that is not accounted for as a separate lease, at

the

effective date of the lease

modification

the lessee shall:

(a) allocate the consideration in the modified contract applying paragraphs

13-16;

(b) determine the lease term of the modified lease applying paragraphs

18–19; and

using a revised discount rate. The revised discount rate is determined as

the interest rate implicit in the lease for the remainder of the lease term, if

that rate can be readily determined, or the lessee’s incremental borrowing

rate at the effective date of the modification, if the interest rate implicit in

the lease cannot be readily determined.

46 For a lease modification that is not accounted for as a separate lease,

the lessee shall account for the remeasurement of the lease liability by:

(a) decreasing the carrying amount of the right-of-use asset to reflect

the partial or full termination of the lease for lease modifications that

decrease the scope of the lease. The lessee shall recognise in profit or

loss any gain or loss relating to the partial or full termination of the lease.

(b) making a corresponding adjustment to the right-of-use asset for all other

lease modifications.

For those lease modifications that do not result in a separate lease, lessees

allocate the consideration in the contract (refer to section 2.2.3.2

Allocating the

consideration in the contract – lessees

) and remeasure the lease liability (using

the lease term of the modified lease and the discount rate (i.e., the interest rate

implicit in the lease for the remainder of the lease term if that rate can be readily

determined or if not the lessee’s incremental borrowing rate) as determined at

the effective date of the modification).

75 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

For a modification that fully or partially decreases the scope of the lease

(e.g., reduces the square footage of leased space), IFRS 16 requires a lessee

to decrease the carrying amount of the right-of-use asset to reflect partial

or full termination of the lease. Any difference between those adjustments is

recognised in profit or loss at the effective date of the modification. Refer to

IFRS 16’s Examples 17 and 18 in section 4.5.3,

Examples — lessees’ accounting

for lease modifications

For all other lease modifications which are not accounted for as a separate lease,

IFRS 16 requires the lessee to recognise the amount of the remeasurement

of the lease liability as an adjustment to the corresponding right-of-use asset

without affecting profit or loss. Refer to IFRS 16’s Examples 16, 18 and 19 that

illustrate this concept in section 4.5.3,

Examples — lessees’ accounting for lease

modifications

In the IASB’s view as illustrated in the Basis for Conclusions (BC204), this

approach results in accounting outcomes that faithfully represent the substance

of a lease modification and closely aligns gain or loss recognition with a

corresponding change in the lessee’s rights and obligations under the lease.

This is because a lease gives rise to both a right-of-use asset and a lease liability.

Accordingly, a lease modification can result in a change to the lessee’s rights

(i.e., a change to the right-of-use asset), a change to the lease liability, or both.

In some cases, the lessee and lessor may agree to a modification to the lease

contract that starts at a later date (i.e., the terms of the modification take effect

at a date later than the date when both parties agreed to the modification).

For example, a lessee enters into a lease arrangement with a lessor to lease

an asset for 10 years. At the beginning of year 8, the lessee and lessor agree to

a modification to the contract that will take effect from the beginning of year 9.

•

If the modification is an increase in the scope that does not result in a

separate lease, the lessee will re-allocate the consideration in the modified

contract to each of the existing lease and non-lease components and

remeasure the lease liability at the date both parties agreed to the

modification (the beginning of year 8).

•

If the modification results in a separate lease component, the lessee will

allocate the consideration in the modified contract to each of the existing

and new lease and non-lease components at the date both parties agreed

to the modification (the beginning of year 8). The lessee will remeasure

the lease liability for the existing lease components at that date as well.

However, recognition of the lease liability and right-of-use asset for any

new lease component occurs at the commencement date of the new lease

component (the beginning of year 9).

•

If the modification is a decrease in the scope, the lessee will re-allocate the

consideration in the modified contract to each existing lease and non-lease

component and remeasure the lease liability and right-of-use asset at the

effective date of the modification (the beginning of year 8).

Refer to Appendix D for a summary of lessee reassessment and remeasurement

requirements.

76 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.5.3 Examples – lessees’ accounting for lease modifications

Extract from IFRS 16 Illustrative Examples

Example 15—Modification that is a separate lease

Lessee enters into a 10-year lease for 2,000 square metres of office space.

At the beginning of Year 6, Lessee and Lessor agree to amend the original

lease for the remaining five years to include an additional 3,000 square metres

of office space in the same building. The additional space is made available for

use by Lessee at the end of the second quarter of Year 6. The increase in total

consideration for the lease is commensurate with the current market rate for

the new 3,000 square metres of office space, adjusted for the discount that

Lessee receives reflecting that Lessor does not incur costs that it would

otherwise have incurred if leasing the same space to a new tenant (for

example, marketing costs).

Lessee accounts for the modification as a separate lease, separate from

the original 10-year lease. This is because the modification grants Lessee an

additional right to use an underlying asset, and the increase in consideration

for the lease is commensurate with the stand-alone price of the additional

right-of-use adjusted to reflect the circumstances of the contract. In this

example, the additional underlying asset is the new 3,000 square metres of

office space. Accordingly, at the commencement date of the new lease (at

the end of the second quarter of Year 6), Lessee recognises a right-of-use

asset and a lease liability relating to the lease of the additional 3,000 square

metres of office space. Lessee does not make any adjustments to the

accounting for the original lease of 2,000 square metres of office space

as a result of this modification.

Example 16—Modification that increases the scope of the lease by

extending the contractual lease term

Lessee enters into a 10-year lease for 5,000 square metres of office space.

The annual lease payments are CU100,000 payable at the end of each year.

The interest rate implicit in the lease cannot be readily determined. Lessee’s

incremental borrowing rate at the commencement date is 6 per cent per

annum. At the beginning of Year 7, Lessee and Lessor agree to amend the

original lease by extending the contractual lease term by four years. The

annual lease payments are unchanged (ie CU100,000 payable at the end of

each year from Year 7 to Year 14). Lessee’s incremental borrowing rate at

the beginning of Year 7 is 7 per cent per annum.

At the effective date of the modification (at the beginning of Year 7), Lessee

remeasures the lease liability based on: (a) an eight-year remaining lease

term, (b) annual payments of CU100,000 and (c) Lessee’s incremental

borrowing rate of 7 per cent per annum. The modified lease liability equals

CU597,130. The lease liability immediately before the modification (including

the recognition of the interest expense until the end of Year 6) is CU346,511.

Lessee recognises the difference between the carrying amount of the

modified lease liability and the carrying amount of the lease liability

immediately before the modification (CU250,619) as an adjustment to

the right-of-use asset.

77 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 Illustrative Examples (cont’d)

Example 17—Modification that decreases the scope of the lease

Lessee enters into a 10-year lease for 5,000 square metres of office space.

The annual lease payments are CU50,000 payable at the end of each year.

The interest rate implicit in the lease cannot be readily determined. Lessee’s

incremental borrowing rate at the commencement date is 6 per cent per

annum. At the beginning of Year 6, Lessee and Lessor agree to amend the

original lease to reduce the space to only 2,500 square metres of the original

space starting from the end of the first quarter of Year 6. The annual fixed

lease payments (from Year 6 to Year 10) are CU30,000. Lessee’s incremental

borrowing rate at the beginning of Year 6 is 5 per cent per annum.

At the effective date of the modification (at the beginning of Year 6), Lessee

remeasures the lease liability based on: (a) a five-year remaining lease term,

(b) annual payments of CU30,000 and (c) Lessee’s incremental borrowing

rate of 5 per cent per annum. This equals CU129,884.

Lessee determines the proportionate decrease in the carrying amount of the

right-of-use asset on the basis of the remaining right-of-use asset (ie 2,500

square metres corresponding to 50 per cent of the original right-of-use asset).

50 per cent of the pre-modification right-of-use asset (CU184,002) is

CU92,001. Fifty per cent of the pre-modification lease liability (CU210,618) is

CU105,309. Consequently, Lessee reduces the carrying amount of the right-

of-use asset by CU92,001 and the carrying amount of the lease liability by

CU105,309. Lessee recognises the difference between the decrease in

the lease liability and the decrease in the right-of-use asset (CU105,309 –

CU92,001 = CU13,308) as a gain in profit or loss at the effective date of

the modification (at the beginning of Year 6).

Lessee recognises the difference between the remaining lease liability of

CU105,309 and the modified lease liability of CU129,884 (which equals

CU24,575) as an adjustment to the right-of-use asset reflecting the change

in the consideration paid for the lease and the revised discount rate.

Example 18—Modification that both increases and decreases the scope of

the lease

Lessee enters into a 10-year lease for 2,000 square metres of office space.

The annual lease payments are CU100,000 payable at the end of each year.

The interest rate implicit in the lease cannot be readily determined. Lessee’s

incremental borrowing rate at the commencement date is 6 per cent per

annum. At the beginning of Year 6, Lessee and Lessor agree to amend the

original lease to (a) include an additional 1,500 square metres of space in the

same building starting from the beginning of Year 6 and (b) reduce the lease

term from 10 years to eight years. The annual fixed payment for the 3,500

square metres is CU150,000 payable at the end of each year (from Year 6 to

Year 8). Lessee’s incremental borrowing rate at the beginning of Year 6 is 7

per cent per annum.

The consideration for the increase in scope of 1,500 square metres of space

is not commensurate with the stand-alone price for that increase adjusted to

reflect the circumstances of the contract. Consequently, Lessee does not

account for the increase in scope that adds the right to use an additional 1,500

square metres of space as a separate lease.

78 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 Illustrative Examples (cont’d)

The pre-modification right-of-use asset and the pre-modification lease liability

in relation to the lease are as follows.

Year

Lease liability

Right-of-use asset

Beginning

balance

interest

expense

Lease

payment

Ending

balance

Beginning

balance

Depreciation

charge

Ending

balance

736,009

44,160

(100,000)

680,169

736,009

(73,601)

662,408

680,169

40,810

(100,000)

620,979

662,408

(73,601)

588,807

620,979

37,259

(100,000)

558,238

588,807

(73,601)

515,206

558,238

33,494

(100,000)

491,732

515,206

(73,601)

441,605

491,732

29,504

(100,000)

421,236

441,605

(73,601)

368,004

421,236

368,004

At the effective date of the modification (at the beginning of Year 6), Lessee

remeasures the lease liability on the basis of: (a) a three-year remaining

lease term, (b) annual payments of CU150,000 and (c) Lessee’s incremental

borrowing rate of 7 per cent per annum. The modified liability equals

CU393,647, of which (a) CU131,216 relates to the increase of CU50,000

in the annual lease payments from Year 6 to Year 8 and (b) CU262,431

relates to the remaining three annual lease payments of CU100,000 from

Year 6 to Year 8.

Decrease in the lease term

At the effective date of the modification (at the beginning of Year 6), the

pre-modification right-of-use asset is CU368,004. Lessee determines the

proportionate decrease in the carrying amount of the right-of-use asset based

on the remaining right-of-use asset for the original 2,000 square metres of

office space (ie a remaining three-year lease term rather than the original

five-year lease term). The remaining right-of-use asset for the original 2,000

square metres of office space is CU220,802 (ie CU368,004 ÷ 5 × 3 years).

At the effective date of the modification (at the beginning of Year 6), the pre-

modification lease liability is CU421,236. The remaining lease liability for the

original 2,000 square metres of office space is CU267,301 (ie present value

of three annual lease payments of CU100,000, discounted at the original

discount rate of 6 per cent per annum).

Consequently, Lessee reduces the carrying amount of the right-of-use asset

by CU147,202 (CU368,004 – CU220,802), and the carrying amount of the

lease liability by CU153,935 (CU421,236 – CU267,301). Lessee recognises

the difference between the decrease in the lease liability and the decrease

in the right-of-use asset (CU153,935 – CU147,202 = CU6,733) as a gain in

profit or loss at the effective date of the modification (at the beginning of

Year 6).

Lease liability

CU153,935

Right-of-use asset

CU147,202

Gain

CU6,733

79 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 Illustrative Examples (cont’d)

At the effective date of the modification (at the beginning of Year 6), Lessee

recognises the effect of the remeasurement of the remaining lease liability

reflecting the revised discount rate of 7 per cent per annum, which is

CU4,870 (CU267,301 – CU262,431), as an adjustment to the right-of-use

asset.

Lease liability

CU4,870

Right-of-use asset

CU4,870

Increase in the leased space

At the commencement date of the lease for the additional 1,500 square

metres of space (at the beginning of Year 6), Lessee recognises the increase

in the lease liability related to the increase in scope of CU131,216 (i.e.,

present value of three annual lease payments of CU50,000, discounted at

the revised interest rate of 7 per cent per annum) as an adjustment to the

right-of-use asset.

Lease liability

CU131,216

Right-of-use asset

CU131,216

The modified right-of-use asset and the modified lease liability in relation to

the modified lease are as follows.

Year

Lease liability

Right-of-use asset

Beginning

balance

7% interest

expense

Lease

payment

Ending

balance

Beginning

balance

Depreciation

charge

Ending

balance

393,647

27,556

(150,000)

271,203

347,148

(115,716)

231,432

271,203

18,984

(150,000)

140,187

231,432

(115,716)

115,716

140,187

9,813

(150,000)

115,716

(115,716)

Example 19—Modification that is a change in consideration only

Lessee enters into a 10-year lease for 5,000 square metres of office space. At

the beginning of Year 6, Lessee and Lessor agree to amend the original lease

for the remaining five years to reduce the lease payments from CU100,000

per year to CU95,000 per year. The interest rate implicit in the lease

cannot be readily determined. Lessee’s incremental borrowing rate at the

commencement date is 6 per cent per annum. Lessee’s incremental borrowing

rate at the beginning of Year 6 is 7 per cent per annum. The annual lease

payments are payable at the end of each year.

At the effective date of the modification (at the beginning of Year 6), Lessee

remeasures the lease liability based on: (a) a five-year remaining lease term,

(b) annual payments of CU95,000, and (c) Lessee’s incremental borrowing

rate of 7 per cent per annum. Lessee recognises the difference between the

carrying amount of the modified liability (CU389,519) and the lease liability

immediately before the modification (CU421,236) of CU31,717 as an

adjustment to the right-of-use asset.

80 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.6 Other lessee matters

4.6.1 Impairment of right-of-use assets

Extract from IFRS 16

33 A lessee shall apply IAS 36

Impairment of Assets

to determine whether

the right-of-use asset is impaired and to account for any impairment loss

identified.

Lessees’ right-of-use assets are subject to existing impairment requirements in

IAS 36

Impairment of Assets.

IAS 36 requires an impairment indicator analysis at each reporting period. If

any indicators are present, the entity is required to estimate the recoverable

amount of the asset (or the cash-generating unit (CGU) of which the asset is a

part). The entity has to recognise an impairment loss if the recoverable amount

of the CGU is less than the carrying amount of the CGU. After an impairment loss

is recognised, the adjusted carrying amount of the right-of-use asset would be its

new basis for depreciation.

Subsequent reversal of a previously recognised impairment loss needs to be

assessed if there is any indication that an impairment loss recognised in prior

periods may no longer exist or may have decreased. In recognising any reversal,

the increased carrying amount of the asset must not exceed the carrying

amount that would have been determined after depreciation, had there been

no impairment.

Lessees currently apply the same impairment analysis to assets held under

finance leases. This analysis would be new for leases currently accounted for as

operating leases and could significantly affect the timing of expense recognition.

How we see it

For leases that are not currently on the balance sheet (i.e., leases that are

operating leases under IAS 17), the requirement to test right-of-use assets

for impairment could accelerate expense recognition (i.e., if an impairment

occurs).

4.6.2 Leases denominated in a foreign currency

Lessees apply IAS 21

The Effects of Changes in Foreign Exchange Rates

, to

leases denominated in a foreign currency. As they do for other monetary

liabilities, lessees remeasure the foreign currency-denominated lease liability

using the exchange rate at each reporting date. Any changes to the lease liability

due to exchange rate changes are recognised in profit or loss. Because the

right-of-use asset is a non-monetary asset measured at historical cost, it is not

affected by changes in the exchange rate.

The IASB acknowledged in the Basis for Conclusions (BC199) that this approach

could result in volatility in profit or loss from the recognition of foreign currency

exchange gains or losses, but it will be clear to users of financial statements that

the gains or losses result solely from changes in exchange rates.

81 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.6.3 Portfolio application

Extract from IFRS 16

B1 This Standard specifies the accounting for an individual lease. However, as

a practical expedient, an entity may apply this Standard to a portfolio of leases

with similar characteristics if the entity reasonably expects that the effects on

the financial statements of applying this Standard to the portfolio would not

differ materially from applying this Standard to the individual leases within

that portfolio. If accounting for a portfolio, an entity shall use estimates and

assumptions that reflect the size and composition of the portfolio.

IFRS 16 applies to individual leases. However, entities that have a large number

of leases of similar assets (e.g., leases of a fleet of similar rolling stock) may

face practical challenges in applying the leases model on a lease-by-lease basis.

The IASB in the Basis for Conclusions (BC83) acknowledged the concerns and

included a practical expedient that allows entities to use a portfolio approach

for leases with similar characteristics if the entity reasonably expects that

the effects on the financial statements would not differ materially from

the application of the standard to the individual leases in that portfolio.

How we see it

The IASB decided to include the portfolio approach to be consistent with

IFRS 15. A decision to use the portfolio approach would be similar to

a decision some entities make today to expense, rather capitalise, certain

assets when the accounting difference is, and would continue

to be, immaterial to the financial statements.

4.6.4 Income tax accounting

IFRS 16 could affect lessees’ accounting for income taxes. For lessees, IFRS 16

requires recognition of lease-related assets and liabilities and could change the

measurement of other lease-related assets and liabilities. These changes affect

certain aspects of accounting for income taxes such as the following:

•

Recognition and measurement of deferred tax assets and liabilities

•

Assessment of the recoverability of deferred tax assets

4.7 Presentation

Extract from IFRS 16

47 A lessee shall either present in the statement of financial position, or

disclose in the notes:

(a) right-of-use assets separately from other assets. If a lessee does not

present right-of-use assets separately in the statement of financial

position, the lessee shall:

(i) include right-of-use assets within the same line item as that within

which the corresponding underlying assets would be presented if

they were owned; and

(ii) disclose which line items in the statement of financial position include

those right-of-use asset

82 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 (cont’d)

(b) lease liabilities separately from other liabilities. If the lessee does not

present lease liabilities separately in the statement of financial position,

the lessee shall disclose which line items in the statement of financial

position include those liabilities.

48 The requirement in paragraph 47(a) does not apply to right-of-use assets

that meet the definition of investment property, which shall be presented in

the statement of financial position as investment property.

49 In the statement of profit or loss and other comprehensive income,

a lessee shall present interest expense on the lease liability separately

from the depreciation charge for the right-of-use asset. Interest expense

on the lease liability is a component of finance costs, which paragraph 82(b)

of IAS 1

Presentation of Financial Statements

requires to be presented

separately in the statement of profit or loss and other comprehensive income.

50 In the statement of cash flows, a lessee shall classify:

(a) cash payments for the principal portion of the lease liability within

financing activities;

(b) cash payments for the interest portion of the lease liability applying

the requirements in IAS 7

Statement of Cash Flows

for interest paid;

(c)

short-term lease payments, payments for leases of low-value assets and

variable lease payments not included in the measurement of the lease

liability within operating activities.

Right-of-use assets and lease liabilities are subject to the same considerations

as other assets and liabilities in classifying them as current and non-current in

the statement of financial position.

The following table summarises how lease-related amounts and activities are

presented in lessees’ financial statements:

Financial

statement

Lessee presentation

Balance sheet

•

Right-of-use assets presented either:

• Separately from other assets (e.g., owned assets)

• Together with other assets as if they were owned,

with disclosures of the balance sheet line items

that include right-of-use assets and their amounts

•

Right-of-use assets that meet the definition of investment

property are presented as investment property

•

Lease liabilities presented either:

• Separately from other liabilities

• Together with other liabilities with disclosure of

the balance sheet line items that include lease

liabilities and their amounts

Statement of

profit or loss

Lease-related depreciation and lease-related interest expense

are presented separately (i.e., lease-related depreciation and

lease-related interest expense cannot be combined). Interest

expense on the lease liability is a component of finance costs.

83 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Financial

statement

Lessee presentation

Statement of

cash flows

•

Cash payments for the principal portion of the lease

liability are presented within financing activities

•

Cash payments for the interest portion of the lease liability

are presented based on an accounting policy election in

accordance with IAS 7

Statement of Cash Flow

•

Lease payments for short-term leases and leases of low-

value assets not recognised on the balance sheet and

variable lease payments not included in the lease liability

are presented within operating activities

•

Non-cash activity (e.g., the initial recognition of the lease

at commencement) is disclosed as a supplemental non-

cash item

4.8 Disclosure

4.8.1 Disclosure objective

Extract from IFRS 16

Disclosure

51 The objective of the disclosures is for lessees to disclose information in

the notes that, together with the information provided in the statement of

financial position, statement of profit or loss and statement of cash flows,

gives a basis for users of financial statements to assess the effect that

leases have on the financial position, financial performance and cash flows

of the lessee. Paragraphs 52–60 specify requirements on how to meet this

objective.

The objective of lessee disclosures is to enable financial statement users to assess

the effect that leases have on a lessee’s financial statements (e.g., the amount,

timing and uncertainty of cash flows arising from leases). In accordance with

the Basis for Conclusions (BC215), the IASB believes that if a lessee is required to

assess whether the overall quality and informational value of its lease disclosures

are sufficient to meet the stated objective, the lessees’ interpretation and

implementation of the disclosure requirements will be improved.

IFRS 16 requires lessees to present all disclosures in a single note or separate

section in the financial statements. In accordance with the Basis for Conclusions

(BC228), the IASB believes this will often be the most effective way to present

information about leases in the manner required by paragraph 113 of

IAS 1

Presentation of Financial Statements

84 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.8.2 Disclosures of assets, liabilities, expenses and cash flows

IFRS 16 includes the following disclosure requirements for lessees:

Extract from IFRS 16

53 A lessee shall disclose the following amounts for the reporting period:

(a) depreciation charge for right-of-use assets by class of underlying asset;

(b) interest expense on lease liabilities;

paragraph 6. This expense need not include the expense relating to leases

with a lease term of one month or less;

(d) the expense relating to leases of low-value assets accounted for applying

paragraph 6. This expense shall not include the expense relating to short-

term leases of low-value assets included in paragraph 53(c);

(e) the expense relating to variable lease payments not included in the

measurement of lease liabilities;

(f) income from subleasing right-of-use assets;

(g) total cash outflow for leases;

(h) additions to right-of-use assets;

(i) gains or losses arising from sale and leaseback transactions; and

(j) the carrying amount of right-of-use assets at the end of the reporting

period by class of underlying asset.

54 A lessee shall provide the disclosures specified in paragraph 53 in a tabular

format, unless another format is more appropriate. The amounts disclosed

shall include costs that a lessee has included in the carrying amount of

another asset during the reporting period.

55 A lessee shall disclose the amount of its lease commitments for short-term

leases accounted for applying paragraph 6 if the portfolio of short-term leases

to which it is committed at the end of the reporting period is dissimilar to the

portfolio of short-term leases to which the short-term lease expense disclosed

applying paragraph 53(c) relates.

56 If right-of-use assets meet the definition of investment property, a lessee

shall apply the disclosure requirements in IAS 40. In that case, a lessee is not

required to provide the disclosures in paragraph 53(a), (f), (h) or (j) for those

right-of-use assets.

57 If a lessee measures right-of-use assets at revalued amounts applying

IAS 16, the lessee shall disclose the information required by paragraph 77

of IAS 16 for those right-of-use assets.

58 A lessee shall disclose a maturity analysis of lease liabilities applying

paragraphs 39 and B11 of IFRS 7

Financial Instruments: Disclosures

separately from the maturity analyses of other financial liabilities.

Lessees are required to disclose the following information, which users of

financial statements identified as being most useful to their analyses:

•

Carrying amount of right-of-use assets and depreciation charge for those

assets, split by class of underlying asset

85 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

•

Interest expense on lease liabilities

•

Short-term lease expense for such leases with a lease term greater than

one month

•

Low-value asset lease expense (except for portions related to short-term

leases)

•

Variable lease expense (i.e., for variable lease payments not included in

the lease liability)

•

Income from subleasing right-of-use assets

•

Total cash outflow for leases

•

Additions to right-of-use assets

•

Gains and losses arising from sale and leaseback transactions

•

Carrying amount of right-of-use assets at the end of the reporting period

by class of underlying asset

All of the above disclosures are required to be presented in tabular format,

unless another format is more appropriate. The amounts disclosed include

costs that a lessee has included in the carrying amount of another asset during

the reporting period.

Lessees also are required to disclose a maturity analysis of lease liabilities

in accordance with paragraphs 39 and B11 of IFRS 7

Financial Instruments:

Disclosures

. Lessees are required to disclose this maturity analysis separately

from the maturity analyses of other financial liabilities. In accordance with

the Basis for Conclusions (BC222), the IASB believes that because the lessee

accounting model is based on the premise that a lease liability is a financial

liability, it is appropriate for lessees to apply the same maturity analysis

disclosure requirements to lease liabilities as to those applied to other financial

liabilities.

A lessee is required to disclose the amount of its lease commitments for short-

term leases when short-term lease commitments at the end of the reporting

period are dissimilar to same period’s short-term lease expense (that is

otherwise required to be disclosed).

A lessee is not required to provide the disclosures required in IFRS 16.53(a),

(f), (h) or (j) for right-of-use assets that meet the definition of investment

property. Instead, a lessee applies the disclosure requirements in IAS 40.

If a lessee measures right-of-use assets at revalued amounts when applying

IAS 16, the lessee is required to disclose the information required by IAS 16.77

for those right-of-use assets.

How we see it

IFRS 16 requires disclosure of the total cash outflow for leases. It does not

explicitly state that leases of low-value assets and short-term leases are

excluded. Therefore, we believe the cash outflows related to those leases

should be included in the disclosure.

86 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

4.8.3 Additional disclosures

Extract from IFRS 16

59 In addition to the disclosures required in paragraphs 53–58, a lessee shall

disclose additional qualitative and quantitative information about its leasing

activities necessary to meet the disclosure objective in paragraph 51 (as

described in paragraph B48). This additional information may include, but is

not limited to, information that helps users of financial statements to assess:

(a) the nature of the lessee’s leasing activities;

(b) future cash outflows to which the lessee is potentially exposed that are

not reflected in the measurement of lease liabilities. This includes

exposure arising from:

(i) variable lease payments (as described in paragraph B49);

(ii) extension options and termination options (as described in paragraph

B50);

(iii) residual value guarantees (as described in paragraph B51); and

(iv) leases not yet commenced to which the lessee is committed.

(d) sale and leaseback transactions (as described in paragraph B52).

60 A lessee that accounts for short-term leases or leases of low-value assets

applying paragraph 6 shall disclose that fact.

In providing additional information, lessees are required to consider:

(a) Whether that information is relevant to users of financial statements. The

additional information specified above is included only if that information

is expected to be relevant to users of financial statements. In this context,

this is likely to be the case if it helps those users to understand:

(i) The flexibility provided by leases. Leases may provide flexibility if, for

example, a lessee can reduce its exposure by exercising termination

options or renewing leases with favourable terms and conditions

(ii) Restrictions imposed by leases. Leases may impose restrictions, for

example, by requiring the lessee to maintain particular financial ratios

(iii) Sensitivity of reported information to key variables. Reported

information may be sensitive to, for example, future variable lease

payments

(iv) Exposure to other risks arising from leases

(v) Deviations from industry practice. Such deviations may include, for

example, unusual or unique lease terms and conditions that affect

a lessee’s lease portfolio

(b) Whether that information is apparent from information either presented

in the primary financial statements or disclosed in the notes. A lessee

need not duplicate information that is already presented elsewhere in

the financial statements

Additional information relating to variable lease payments that, depending on

the circumstances, may be needed to satisfy the disclosure objective could

include information that helps users of financial statements to assess, for

example:

87 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

(a) The lessee’s reasons for using variable lease payments and the prevalence

of those payments

(b) The relative magnitude of variable lease payments to fixed payments

payments are expected to vary in response to changes in those key

variables

(d) Other operational and financial effects of variable lease payments

Additional information relating to extension options or termination options

that, depending on the circumstances, may be needed to satisfy the disclosure

objective could include information that helps users of financial statements to

assess, for example:

(a) The lessee’s reasons for using extension options or termination options

and the prevalence of those options

(b) The relative magnitude of optional lease payments to lease payments

measurement of lease liabilities

(d) Other operational and financial effects of those options

Optional lease payments are payments made by a lessee to a lessor for the right

to use an underlying asset during periods covered by an option to extend or

terminate a lease that are not included in the lease term.

Additional information relating to residual value guarantees that, depending

on the circumstances, may be needed to satisfy the disclosure objective could

include information that helps users of financial statements to assess, for

example:

(a) The lessee’s reasons for providing residual value guarantees and

the prevalence of those guarantees

(b) The magnitude of a lessee’s exposure to residual value risk

(d) Other operational and financial effects of those guarantees

4.8.4 Disclosures required by IAS 1

In addition to the disclosure requirements under IFRS 16 described above, an

entity is required to make disclosures in accordance with IAS 1

Presentation of

Financial Statements

An entity is required to disclose its significant accounting policies comprising:

(a) the measurement basis (or bases) used in preparing the financial

statements; and

(b) the other accounting policies used that are relevant to an understanding

of the financial statements.

An entity discloses, along with its significant accounting policies or other notes,

the judgements that management has made in the process of applying the

entity’s accounting policies and that have the most significant effect on the

amounts recognised in the financial statements. An entity also discloses

information about the assumptions it makes about the future, and other major

sources of estimation uncertainty at the end of the reporting period, that have

a significant risk of resulting in a material adjustment to the carrying amounts of

assets and liabilities within the next financial year. In respect of those assets and

liabilities, the notes include details of:

88 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

(a) their nature, and

(b) their carrying amount as at the end of the reporting period.

There are a number of judgements and estimates that entities may make in

applying IFRS 16, which may require disclosure in accordance with IAS 1.

These include, but are not limited to, application of the definition of a lease,

determination of the lease term and determination of the incremental borrowing

rate.

89 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

5. Lessor accounting

IFRS 16 substantially carries forward the lessor accounting model in IAS 17. The

significant differences between the lessor accounting requirements in IFRS 16

and those in IAS 17 are primarily a consequence of decisions reached about

the lessee accounting model in IFRS 16. IFRS 16 does change certain aspects of

the lessor accounting model, including changes to the accounting for subleases,

initial direct costs and lessor disclosures.

5.1 Lease classification

Extract from IFRS 16

61 A lessor shall classify each of its leases as either an operating lease or

a finance lease.

62 A lease is classified as a finance lease if it transfers substantially all the

risks and rewards incidental to ownership of an underlying asset. A lease is

classified as an operating lease if it does not transfer substantially all the

risks and rewards incidental to ownership of an underlying asset.

B53 The classification of leases for lessors in this Standard is based on

the extent to which the lease transfers the risks and rewards incidental to

ownership of an underlying asset. Risks include the possibilities of losses

from idle capacity or technological obsolescence and of variations in return

because of changing economic conditions. Rewards may be represented by

the expectation of profitable operation over the underlying asset’s economic

life and of gain from appreciation in value or realisation of a residual value.

B54 A lease contract may include terms and conditions to adjust the lease

payments for particular changes that occur between the inception date

and the commencement date (such as a change in the lessor’s cost of the

underlying asset or a change in the lessor’s cost of financing the lease). In

that case, for the purposes of classifying the lease, the effect of any such

changes shall be deemed to have taken place at the inception date.

At inception, lessors classify all leases as finance leases or operating leases.

Lease classification determines how and when a lessor recognises lease income

and what assets are recorded. The criteria used for lease classification is the

same as in IAS 17 and are discussed in detail below.

5.1.1 Criteria for lease classification

The classification of leases in IFRS 16 has not changed from IAS 17.

Classification is based on the extent to which the risks and rewards incidental to

ownership of the underlying asset lie with the lessor or the lessee. It depends on

the substance of the transaction rather than the form of the contract. IFRS 16

lists a number of examples that individually, or in combination, would normally

lead to a lease being classified as a finance lease:

•

The lease transfers ownership of the asset to the lessee by the end of the

lease term

•

The lessee has the option to purchase the asset at a price that is expected

to be sufficiently lower than the fair value at the date the option becomes

exercisable for it to be reasonably certain, at the inception date, that the

option will be exercised

IFRS 16 substantially

carries forward the

lessor accounting model

in IAS 17.

90 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

•

The lease term is for the major part of the economic life of the asset even if

title is not transferred

•

At the inception date, the present value of the lease payments amounts to

at least substantially all of the fair value of the asset

•

The asset is of such a specialised nature that only the lessee can use it

without major modifications

IFRS 16 does not provide quantitative indicators or thresholds for the

assessment of the terms “major part” and “substantially all” to determine that

a lease should be classified as a finance lease rather than as an operating lease.

Under IFRS 16, entities apply qualitative, rather than quantitative, assessments

to determine whether the risks and rewards incident to ownership of a leased

asset lie with the lessor or the lessee. Accordingly, assessing whether a lease

term is for the major part of the economic life of an asset or whether the present

value of the lease payments amounts to at least substantially all of the fair value

of a leased asset is a matter of judgement.

In addition, IFRS 16 lists the following indicators of situations that, individually

or in combination, could also lead to a lease being classified as a finance lease:

•

If the lessee can cancel the lease, the lessor’s losses associated with the

cancellation are borne by the lessee

•

Gains or losses from the fluctuation in the fair value of the residual accrue to

the lessee (e.g., in the form of a rent rebate that is equal to most of the sale

proceeds at the end of the lease)

•

The lessee has the ability to continue the lease for a secondary period at

a rent that is substantially lower than market rent

In our view, other considerations that could be made in determining the

economic substance of the lease arrangement include the following:

•

Are the lease rentals based on a market rate for use of the asset (which

would indicate an operating lease) or a financing rate for use of the funds,

which would be indicative of a finance lease?

•

Is the existence of put and call options a feature of the lease? If so, are they

exercisable at a predetermined price or formula (indicating a finance lease)

or are they exercisable at the market price at the time the option is exercised

(indicating an operating lease)?

5.1.2 Lease classification test for land and buildings

For a lease that includes both land and buildings elements, the lessor separately

assesses the classification of each element as a finance lease or an operating

lease, noting that land normally has an indefinite economic life. The lessor

allocates lease payments between the land and the buildings elements in

proportion to the relative fair values of the leasehold interests in the land

element and buildings element of the lease at the inception date. If the lease

payments cannot be allocated reliably between these two elements, the entire

lease is classified as a finance lease, unless it is clear that both elements are

operating leases, in which case, the entire lease is classified as an operating

lease.

91 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

For a lease of land and buildings in which the amount for the land element

is immaterial to the lease, the lessor may treat the land and buildings as a single

unit for the purpose of lease classification and classify it as a finance lease or

an operating lease. In such a case, the lessor regards the economic

life of the buildings as the economic life of the entire underlying asset.

5.1.3 Residual value guarantees included in the lease classification test

In evaluating IFRS 16’s lease classification criteria, lessors are required to

include in the ‘substantially all’ test any (i.e., the maximum obligation) residual

value guarantees provided by both lessees and any other third party unrelated

to the lessor.

5.1.4 Reassessment of lease classification

Extract from IFRS 16

66 Lease classification is made at the inception date and is reassessed only if

there is a lease modification. Changes in estimates (for example, changes in

estimates of the economic life or of the residual value of the underlying asset),

or changes in circumstances (for example, default by the lessee), do not give

rise to a new classification of a lease for accounting purposes.

Lessors are required to reassess the lease classification only if there is a lease

modification (i.e., a change in the scope of a lease, or the consideration for

a lease, that was not part of the original terms and conditions of the lease).

Lessors reassess lease classification as at the effective date of the modification

using the modified conditions at that date. If a lease modification results in a

separate new lease, that new lease would be classified in the same manner as

any new lease.

Refer to section 5.5

Lease modifications

. Also refer to Appendix D for

a summary of lessor reassessment and remeasurement requirements.

5.2 Key concepts applied by lessor

Extract from IFRS 16

Appendix A

Defined terms

Gross investment in the lease

The sum of:

(a) the lease payments receivable by a lessor under a finance lease; and

(b) any unguaranteed residual value accruing to the lessor.

Net investment in the lease

The gross investment in the lease discounted at the interest rate implicit

in the lease.

Unguaranteed residual value

That portion of the residual value of the underlying asset, the realisation of

which by a lessor is not assured or is guaranteed solely by a party related to

the lessor.

92 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

At lease commencement, lessors apply the key concepts described in section 3

such as determining the initial direct costs, lease term, lease payments, fair

value of the underlying asset and the interest rate implicit in the lease. Lessors

also apply the following lessor accounting concepts to recognise and measure

their leases.

Gross investment in the lease

The lessor’s gross investment in the lease consists of the following undiscounted

amounts:

•

Lease payments receivable by the lessor under a finance lease. Refer to

section 3.5

Lease payments

•

Any unguaranteed residual value accruing to the lessor - the unguaranteed

residual value is the portion of the residual value of the underlying asset,

the realisation of which by a lessor is not assured or is guaranteed solely

by a party related to the lessor.

Net investment in the lease

A lessor’s net investment in a finance lease consists of the gross investment in

the lease discounted at the interest rate implicit in the lease.

5.3 Finance leases

5.3.1 Initial recognition and measurement

Extract from IFRS 16

Recognition and measurement

67 At the commencement date, a lessor shall recognise assets held under

a finance lease in its statement of financial position and present them as

a receivable at an amount equal to the net investment in the lease.

Initial measurement

68 The lessor shall use the interest rate implicit in the lease to measure

the net investment in the lease. In the case of a sublease, if the interest rate

implicit in the sublease cannot be readily determined, an intermediate lessor

may use the discount rate used for the head lease (adjusted for any initial

direct costs associated with the sublease) to measure the net investment

in the sublease.

69 Initial direct costs, other than those incurred by manufacturer or dealer

lessors, are included in the initial measurement of the net investment in the

lease and reduce the amount of income recognised over the lease term. The

interest rate implicit in the lease is defined in such a way that the initial direct

costs are included automatically in the net investment in the lease; there is no

need to add them separately.

Initial measurement of the lease payments included in the net investment

in the lease

70 At the commencement date, the lease payments included in the

measurement of the net investment in the lease comprise the following

payments for the right to use the underlying asset during the lease term

that are not received at the commencement date:

(a) fixed payments (including in-substance fixed payments as described in

paragraph B42), less any lease incentives payable;

93 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Extract from IFRS 16 (cont’d)

(b) variable lease payments that depend on an index or a rate, initially

measured using the index or rate as at the commencement date;

a party related to the lessee or a third party unrelated to the lessor that

is financially capable of discharging the obligations under the guarantee;

(d) the exercise price of a purchase option if the lessee is reasonably certain

to exercise that option (assessed considering the factors described in

paragraph B37); and

(e) payments of penalties for terminating the lease, if the lease term reflects

the lessee exercising an option to terminate the lease.

Illustration 18 – The lessor’s gross and net investment in the lease

Details of a non-cancellable lease are, as follows:

•

The asset has a fair value of CU10,000

•

The lessee is required to make five annual rentals payable in advance of

CU2,100

•

The unguaranteed estimated residual value at the end of five years is

CU1,000.

The lessor’s direct costs have been excluded for simplicity.

The interest rate implicit in the lease is that which gives a present value of

CU10,000 for

the five rentals plus the total estimated residual value at the end of year 5.

This rate is 6.62%.

Year

Net investment

in the lease

at start of

period

Rental

received

Finance

income

(6.62%

per

annum)

Gross

investment

at end of

period

Gross

earnings

allocated to

future

periods

Receivable

at end of

period

10,000

2,100

523

9,400

977

8,423

2,100

419

7,300

558

6,742

2,100

307

5,200

251

4,949

2,100

189

3,100

3,038

2,100

1,000

–

1,000

10,500

1,500

The lessor’s gross investment in the lease is the total rents receivable of

CU10,500 and the unguaranteed residual value of CU1,000. The gross

earnings are therefore CU1,500.

The gross investment in the lease at any point in time comprises the

aggregate of the rentals receivable in future periods and the unguaranteed

residual value, e.g., at the end of year 2, the gross investment of CU7,300 is

three years’ rental of CU2,100 plus the unguaranteed residual of CU1,000.

The net investment, which is the amount at which the debtor will be recorded

in the statement of financial position, is CU7,300 less the earnings allocated

to future periods of CU558 = CU6,742.

94 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

At lease commencement, a lessor accounts for a finance lease, as follows:

•

Derecognises the carrying amount of the underlying asset

•

Recognises the net investment in the lease

•

Recognises, in profit or loss, any selling profit or selling loss

For finance leases (other than those involving manufacturer and dealer lessors),

initial direct costs are included in the initial measurement of the finance lease

receivable. Initial direct costs are included in the interest rate implicit in the lease

and are not added separately.

The net investment in the lease is initially measured as the sum of: (1) the

present value of both the lease payments (section 3.5

Lease payments

); and

(2) the present value of the unguaranteed residual asset, both discounted using

the interest rate implicit in the lease (section 3.6

Discount rates

). Any selling

profit or loss is measured as the difference between the fair value of the

underlying asset or the lease receivable, if lower, and the carrying amount

of the underlying asset, net of any unguaranteed residual asset.

5.3.2 Manufacturer or dealer lessors

Extract from IFRS 16

71 At the commencement date, a manufacturer or dealer lessor shall

recognise the following for each of its finance leases:

(a) revenue being the fair value of the underlying asset, or, if lower, the

present value of the lease payments accruing to the lessor, discounted

using a market rate of interest;

(b) the cost of sale being the cost, or carrying amount if different, of the

underlying asset less the present value of the

unguaranteed residual

value

; and

of sale) in accordance with its policy for outright sales to which IFRS 15

applies. A manufacturer or dealer lessor shall recognise selling profit or

loss on a finance lease at the commencement date, regardless of whether

the lessor transfers the underlying asset as described in IFRS 15.

72 Manufacturers or dealers often offer to customers the choice of either

buying or leasing an asset. A finance lease of an asset by a manufacturer

or dealer lessor gives rise to profit or loss equivalent to the profit or loss

resulting from an outright sale of the underlying asset, at normal selling

prices, reflecting any applicable volume or trade discounts.

73 Manufacturer or dealer lessors sometimes quote artificially low rates of

interest in order to attract customers. The use of such a rate would result

in a lessor recognising an excessive portion of the total income from the

transaction at the commencement date. If artificially low rates of interest

are quoted, a manufacturer or dealer lessor shall restrict selling profit to

that which would apply if a market rate of interest were charged.

74 A manufacturer or dealer lessor shall recognise as an expense costs

incurred in connection with obtaining a finance lease at the commencement

date because they are mainly related to earning the manufacturer or dealer’s

selling profit. Costs incurred by manufacturer or dealer lessors in connection

with obtaining a finance lease are excluded from the definition of initial direct

costs and, thus, are excluded from the net investment in the lease.

95 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

At the commencement date, a manufacturer or dealer lessor recognises selling

profit or loss in accordance with its policy for outright sales to which IFRS 15

applies.

Therefore, at lease commencement, a manufacturer or dealer lessor recognises

the following:

•

The fair value of the underlying asset as revenue (or if lower, the present

value of the lease payments discounted using a market rate of interest)

•

The cost (or carrying amount) of the asset less the present value of the

unguaranteed residual value, as cost of sale

•

The selling profit or loss in accordance with the policy for outright sales.

A manufacturer or dealer lessor recognises selling profit or loss on a finance

lease at the commencement date, regardless of whether the lessor transfers

the underlying asset as described in IFRS 15

Costs incurred by a manufacturer or dealer lessor in connection with obtaining

a finance lease are recognised as an expense at the commencement date and

are excluded from the net investment in the lease because they are mainly

related to earning the manufacturer or dealer’s selling profit.

Illustration 19 – Manufacturer or dealer lessors

A company manufactures specialised machinery. The company offers

customers the choice of either buying or leasing the machinery. A customer

chooses to lease the machinery. Details of the arrangement are, as follows:

(i) The lease commences on 1 January 20X1 and lasts for three years.

(ii) The lessee is required to make three annual rentals payable in arrears of

CU57,500.

(iii) The leased machinery is returned to the lessor at the end of the lease.

(iv) The fair value of the machinery is CU150,000, which is equivalent to

the selling price of the machinery.

(v) The machinery cost CU100,000 to manufacture. The lessor incurred

costs of CU2,500 to negotiate and arrange the lease.

(vi) The expected useful life of the machinery is 3 years. The machinery

has an expected residual value of CU10,000 at the end of year three.

(vii) The interest rate implicit in the lease is 10.19%.

The lessor classifies the lease as a finance lease.

The cost to the lessor of providing the machinery for lease consists of the

book value of the machinery (CU100,000), plus the initial direct costs

associated with entering into the lease (CU2,500), less the future income

expected from disposing of the machinery at the end of the lease (the present

value of the unguaranteed residual value of CU10,000, being CU7,475). This

gives a cost of sale of CU95,025.

The lessor records the following entries at the commencement of the lease:

Debit

Credit

Net investment in the lease

150,000

Cost of sales

95,025

Inventory

100,000

Revenue

142,525

Creditors / cash (initial direct costs)

2,500

If a manufacturer or

dealer lessor quotes

artificially low rates of

interest, the selling

profit is restricted to

that which would apply

if a market rate of

interest were charged.

96 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 19 – Manufacturer or dealer lessors (cont’d)

The sales profit recognised by the lessor at the commencement of the lease is

therefore CU47,500 (CU142,525 – CU95,025). This is equal to the fair value

of the machinery of CU150,000, less the book value of the machinery

(CU100,000) and the initial direct costs of entering into the lease (CU2,500).

Revenue is equal to the lease receivable (CU150,000), less the present value

of the unguaranteed residual value (CU7,475).

Lease payments received from the lessee will then be allocated over the lease

term, as follows:

Year

Lease

receivable

at the start

of the year

(CU)

Lease

payments

(CU)

Interest

income

(10.19%

per

annum)

(CU)

Decrease

in lease

receivable

(CU)

Lease

receivable

at the end

of the year

(CU)

(a)

(b)

(c)

(d)=(b)–(c)

(e)=(a)–(d)

150,000

57,500

15,280

42,220

107,780

57,500

10,979

46,521

61,260

57,500

6,240

51,260

10,000

The lessor will record the following entries:

Debit

Credit

Year 1

Cash

57,500

Lease receivable

42,220

Interest income

15,280

Debit

Credit

Year 2

Cash

57,500

Lease receivable

46,521

Interest income

10,979

Year 3

Cash

57,500

Lease receivable

51,260

Interest income

6,240

At the end of the three-year lease term, the leased machinery will be returned

to the lessor, who will record the following entries:

Inventory

10,000

Lease receivable

10,000

97 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

5.3.3 Subsequent measurement

Extract from IFRS 16

Subsequent measurement

75 A lessor shall recognise finance income over the lease term, based on

a pattern reflecting a constant periodic rate of return on the lessor’s net

investment in the lease.

76 A lessor aims to allocate finance income over the lease term on

a systematic and rational basis. A lessor shall apply the lease payments

relating to the period against the

gross investment in the lease

to reduce

both the principal and the

unearned finance income

After lease commencement, a lessor accounts for a finance lease, as follows:

•

Recognises finance income (in profit or loss) over the lease term in an

amount that produces a constant periodic rate of return on the remaining

balance of the net investment in the lease (i.e., using the interest rate

implicit in the lease). Income is recognised on the components of the net

investment in the lease, including:

• Interest on the lease receivable

• Interest via accretion of the unguaranteed residual asset to its expected

value at the end of the lease

•

Reduces the net investment in the lease for lease payments received (net of

finance income calculated above)

•

Separately recognises income from variable lease payments that are not

included in the net investment in the lease (e.g., performance- or usage-

based variable payments) in the period in which that income is earned

•

Recognises any impairment of the net investment in the lease

The question arises as to whether the finance income should be calculated based

on the gross lease receivable or the net amount of the lease receivable less any

expected credit loss? We believe the staging approach

in IFRS 9

Financial

Instruments

can be applied to determine how finance income recognised over

the lease term is calculated:

•

On a gross basis (excluding the effect of expected credit losses) for lease

receivables in stages 1 or 2 of the expected credit loss model in IFRS 9; and

•

On a net basis (based on the net investment in the lease less expected credit

losses) for lease receivables in stage 3 of the expected credit loss model in

IFRS 9.

The election (or non-election) of the simplified approach allowed by IFRS 9 does

not affect this conclusion.

In the absence of prescriptive guidance in IFRS, entities may apply the above

accounting as an accounting policy choice. Alternative approaches may also be

acceptable.

Credit losses should be presented separately in the income statement in

accordance with paragraph 82 of IAS 1

Presentation of Financial Statements

IFRS 9, paragraph 5.4.1.

98 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

The net investment in the lease should generally be presented net of the loss

allowance. However, a separate presentation of the net investment in the lease,

gross of the lease allowance and the loss allowance itself may be appropriate

when the presentation is relevant to understanding the entity’s financial

position. For example, where the loss allowance has significantly reduced

an otherwise material net investment in the lease.

The following illustration shows how a lessor accounts for a finance lease that

gives rise to selling profit;

Illustration 20 – Lessor accounting for a finance lease (dealer-lessor case)

Assume Lessor enters into a 10-year lease of equipment with Lessee. The

equipment is not specialised in nature and is expected to have alternative

use to Lessor at the end of the 10-year lease term. Under the lease:

•

Lessor receives annual lease payments of CU15,000, payable at the end

of the year

•

Lessor expects the residual value of the equipment to be CU50,000 at

the end of the 10-year lease term

•

Lessee provides a residual value guarantee that protects Lessor from the

first CU30,000 of loss for a sale at a price below the estimated residual

value at the end of the lease term (i.e., CU50,000)

•

The equipment has an estimated remaining economic life of 15 years,

a carrying amount of CU100,000 and a fair value of CU111,000

•

The lease does not transfer ownership of the underlying asset to Lessee

at the end of the lease term or contain an option to purchase the

underlying asset

•

The interest rate implicit in the lease is 10.078%.

Lessor classifies the lease as a finance lease because the sum of the present

value of lease payments amounts to substantially all of the fair value of the

underlying asset.

At lease commencement, Lessor accounts for the finance lease, as follows:

To record the net investment in the finance lease and derecognise the

underlying asset:

Net investment in the lease

CU111,000

(a)

Cost of goods sold

CU92,344

(b)

Revenue

CU103,344

(c)

Property held for lease

CU100,000

(d)

99 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 20 – Lessor accounting for a finance lease (cont’d)

(a) The net investment in the lease consists of (1) the present value of the

10 annual payments of CU15,000 plus the guaranteed residual value of

CU30,000, both discounted at the interest rate implicit in the lease, which

equals CU103,344 (i.e., the lease payment) and (2) the present value of

unguaranteed residual asset of CU20,000, which equals CU7,656. Note

that the net investment in the lease is subject to the same considerations

as other assets in classification as current or non-current assets in a

classified balance sheet (refer to section 5.7

Presentation)

(b) Cost of goods sold is the carrying amount of the equipment of CU100,000

less the present value of the unguaranteed residual asset of CU7,656

(c)I Revenue equals the lease receivable

(d) The carrying amount of the underlying asset

At lease commencement, Lessor recognises selling profit of CU11,000 which

is calculated as the lease payment of CU103,344 less the carrying amount of

the asset (CU100,000), net of any unguaranteed residual asset (CU7,656),

which equals CU92,344.

Year 1 journal entries for a finance lease:

Cash

CU15,000

(e)

Net investment in the lease

CU3,813

(f)

Interest income

CU11,187

(g)

(e) Receipt of annual lease payments at the end of the year

(f) Reduction of the net investment in the lease for lease payments received

of (CU15,000), net of interest income of CU11,187

(g) Interest income is the amount that produces a constant periodic discount

rate on the remaining balance of the net investment in the lease. See

computation below

The following table summarises the interest income from this lease and

the related amortisation of the net investment over the lease term:

Year

Annual rental

payment

Annual interest

income

(h)

Net investment

at end of year

Initial net investment

CU —

CU111,000

15,000

11,187

107,187

15,000

10,803

102,990

15,000

10,380

98,370

15,000

9,914

93,284

15,000

9,401

87,685

15,000

8,837

81,522

15,000

8,216

74,738

15,000

7,532

67,270

15,000

6,780

59,050

15,000

5,950

50,000

(i)

(h) Interest income equals 10.078% of the net investment in the lease at

the beginning of each year. For example, Year 1 annual interest income

is calculated as CU111,000 (initial net investment) x 10.078%.

(i) The estimated residual value of the equipment at the end of the lease

term.

100 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

5.3.4 Unguaranteed residual values

Income recognition by lessors can be extremely sensitive to the amount

recognised as the asset’s residual value. This is because the amount of the

residual value directly affects the computation of the amount of finance income

earned over the lease term – this is shown in Illustration 21 below. The standard

gives no guidance regarding the estimation of unguaranteed residual values, but

it does require them to be reviewed regularly. If there has been a reduction in

the estimated value, the income allocation over the lease term is revised and any

reduction in respect of amounts accrued is recognised immediately.

Illustration 21 – Reduction in residual value

At lease commencement, the lessor accounts for the finance lease, as follows:

Details of a non-cancellable lease are:

•

The asset has a fair value of CU10,00

•

The lessee is required to make five annual rentals payable in advance of

CU2,100

•

The unguaranteed estimated residual value at the end of five years is

CU1,000.

The lessor’s direct costs have been excluded for simplicity.

Year

Receivable

at start of

period

Rental

received

Finance

income

(6.62% per

annum)

Gross

investment

at end of

period

Gross

earnings

allocated

to future

periods

Receivable

at end of

period

10,000

2,100

523

9,400

977

8,423

2,100

419

7,300

558

6,742

2,100

307

5,200

251

4,949

2,100

189

3,100

3,038

2,100

1,000

–

1,000

10,500

1,500

The gross investment in the lease at any point in time comprises the

aggregate of the rentals receivable in future periods and the unguaranteed

residual value, e.g., at the end of year 2, the gross investment of CU7,300 is

three years’ rental of CU2,100 plus the unguaranteed residual of CU1,000.

The net investment, which is the amount that will be recorded in the

statement of financial position, is CU7,300 less the earnings allocated to

future periods of CU558 = CU6,742. The gross earnings allocated to future

periods is the total finance income of CU1,500 less the finance income

already recognised.

101 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 21 – Reduction in residual value (cont’d)

The lessor concludes at the end of year 2 that the residual value of the asset

is only CU500 and revises the income allocation over the lease term

accordingly.

Year

Receivable

at start of

period

Rental

received

Finance

income

(6.62%

per

annum)

Gross

investment

at end of

period*

Gross

earnings

allocated

to future

periods

Receivable

at end of

period

8,423

2,100

419

6,800

471

6,329

2,100

280

4,700

191

4,509

2,100

160

2,600

2,569

2,100

500

–

500

* The gross investment in the lease now takes account of the revised unguaranteed residual of

CU500, rather than the original CU1,000.

The lessor will have to write off CU413, being the difference between the

carrying amount of the receivable and the revised balance above (CU6,742 –

CU6,329). This is the present value as at the end of year 2 of CU500 and

represents the part of the unguaranteed residual written off.

5.3.5 Remeasurement of the net investment in the lease

After lease commencement, the net investment in a lease is remeasured when

the following occurs:

•

The lease is modified (i.e., a change in the scope of the lease, or the

consideration for the lease, that was not part of its original terms and

conditions) and the modified lease is not accounted for as a separate

contract. Refer to section 5.5

Lease modifications

•

The lease term is revised when there is a change in the non-cancellable

period of the lease. Refer to section 3.4.2.2

Reassessment of the lease

term and purchase options - lessors.

•

There is a change in the estimated unguaranteed residual value. Refer to

section 5.3.4

Unguaranteed residual values.

A lessor includes in its initial measurement of the net investment in the lease,

variable lease payments that depend on an index or rate. IFRS 16 is silent on the

accounting for any subsequent changes in future cash flows resulting from a

change in an index or rate or variable lease payments becoming in-substance

fixed. In the absence of further guidance, we believe lessors have an accounting

policy choice regarding whether variable lease payments that do not depend on

an index or rate are remeasured.

102 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

5.4 Operating leases

Extract from IFRS 16

Recognition and measurement

81 A lessor shall recognise lease payments from operating leases as income

on either a straight-line basis or another systematic basis. The lessor shall

apply another systematic basis if that basis is more representative of the

pattern in which benefit derived from the use of the underlying asset is

diminished.

82 A lessor shall recognise costs, including depreciation, incurred in earning

the lease income as an expense.

83 A lessor shall add initial direct costs incurred in obtaining an operating

lease to the carrying amount of the underlying asset and recognise those costs

as an expense over the lease term on the same basis as the lease income.

Under IFRS 16, lessors account for operating leases in a manner similar to the

requirements under IAS 17. That is, they continue to recognise the underlying

asset and do not recognise a net investment in the lease on the balance sheet

or initial profit (if any) on the income statement. The underlying asset continues

to be accounted for in accordance with applicable accounting standards (e.g.,

IAS 16).

Lessors subsequently recognise lease payments over the lease term on either

a straight-line basis or another systematic and rational basis if that basis better

represents the pattern in which benefit is expected to be derived from the use

of the underlying asset. If the lessor pays the lessee an incentive to enter the

lease, this is accounted for as described in 3.5.2

Lease incentives

above. After

lease commencement, lessors recognise variable lease payments that do not

depend on an index or rate (e.g., performance- or usage- based payments) as

they are earned.

IFRS 16 also requires lessors of operating leases to defer initial direct costs at

lease commencement and recognise them over the lease term on the same basis

as lease income.

Refer to section 3.4.2.2

Reassessment of the lease term and purchase options-

lessors

5.4.1 Operating lease income

Unlike other standards such as IFRS 15, IFRS 16 does not refer to collectability

to determine whether (and when) lease income should be recognised. Therefore,

we believe that a lessor may continue to recognise operating lease income even

when collectability is not probable. However, other approaches may also be

appropriate when there is significant doubt about collectability. Therefore, there

could be diversity in practice, and it is important to consider the views of local

regulators. Regardless of the approach followed, IFRS 9’s guidance on credit

losses continues to be applicable to recognised lease receivables.

103 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 22 – Operating lease income not expected to be fully collectible

Restaurant A leases space in a shopping mall from Lessor B. Lessor B

classifies the lease as an operating lease.

Under the terms of the lease, Restaurant A makes fixed lease payments of

CU100 to Lessor B at the beginning of each month. The non-cancellable lease

term ends on 28 February 2022. The contract does not include any non-lease

components, extension, termination or purchase options.

Due to significant financial difficulties, at the end of June, Restaurant A has

indicated that it will only pay 25% of the lease receivable due for the month of

July 2020. Up to 31 July 2020, CU25 has been collected and Lessor B does

not expect the remaining amount of CU75 due in respect of July to be

recovered considering Restaurant A’s financial condition.

Analysis

Approach 1 – Recognising the full operating lease income

Lessor B recognises the full operating lease income on a straight-line basis

of CU100 per month in accordance with paragraph 81 of IFRS 16.

Lessor B recognises a lease receivable and an impairment loss of CU75

reflecting the remote likelihood of collection in accordance with IFRS 9.

Under this approach, Lessor B records the following entries

Dr Lease receivable CU100

Cr Operating lease income CU100

To record the operating lease income and lease receivable for July 2020

Dr Impairment loss on lease receivable CU75

Cr Impairment allowance on lease receivable CU75

To record an impairment loss against the lease receivable

Dr Cash CU25

Cr Lease receivable CU25

To record receipt of CU25 from the lessee

Approach 2 – Recognition of operating lease income to the extent

collectable

Under this approach, Lessor B accounts for the monthly lease income to

the extent collectable. This approach reflects the high uncertainty related

to the collectability of the full lease payments and Lessor B’s concerns

about the appropriateness of reporting income when the likelihood of

collecting the full amount is considered to be remote.

Under this approach, Lessor B records the following entries:

Dr Lease receivable CU25

Cr Operating lease income CU25

To record the operating lease income for July 2020

Dr Cash CU25

Cr Lease receivable CU25

To record receipt of CU25 from the lessee

104 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

5.5 Lease modifications

Extract from IFRS 16

Appendix A

Defined terms

Lease modification

A change in the scope of a lease, or the consideration for a lease, that was not

part of the original terms and conditions of the lease (for example, adding or

terminating the right to use one or more underlying assets, or extending or

shortening the contractual lease term).

If a finance lease is modified (i.e., there is a change in the scope of a lease, or the

consideration for a lease, that was not part of the original terms and condition of

the lease), the modified lease is evaluated to determine whether it is or contains

a lease. Refer to section 2.1

Determining whether an arrangement contains a

lease

. If a lease continues to exist, a modification to a finance lease may result

in:

•

A separate lease (refer to section 5.5.1.1

Determining whether a lease

modification results in a separate lease

)

•

A change in the accounting for the existing lease (i.e., not a separate lease)

(refer to section 5.5.1.2

Lessor accounting for a modification that does not

result in a separate lease

)

If an operating lease is modified, it is treated as a new lease from the effective

date of the modification. Refer to section 5.5.2

Modification to an operating lease

5.5.1 Modifications to a finance lease

5.5.1.1 Determining whether a lease modification results in a separate lease

Extract from IFRS 16

79 A lessor shall account for a modification to a finance lease as a separate

lease if both:

(a) the modification increases the scope of the lease by adding the right to

use one or more underlying assets; and

(b) the consideration for the lease increases by an amount commensurate

with the stand-alone price for the increase in scope and any appropriate

adjustments to that stand-alone price to reflect the circumstances of the

particular contract.

Lessors account for a lease modification to a finance lease as a separate lease

(i.e., separate from the original lease) when both of the following conditions are

met:

•

The modification increases the scope of the lease by adding the right to use

one or more underlying assets.

•

The consideration for the lease increases by an amount commensurate

with the standalone price for the increase in scope and any appropriate

adjustments to that stand-alone price to reflect the circumstances of the

particular contract.

105 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

If both of these conditions are met, the lease modification results in two separate

leases, the unmodified original finance lease and a separate lease. Lessors

account for the separate lease in the same manner as other new leases. If either

of the conditions is not met, the lease modification does not result in a separate

lease. The accounting for a modification that does not result in a separate lease

is discussed further in section 5.5.1.2

Lessor accounting for a modification that

does not result in a separate lease.

5.5.1.2 Lessor accounting for a modification that does not result in a separate

lease

Extract from IFRS 16

80 For a modification to a finance lease that is not accounted for as

a separate lease, a lessor shall account for the modification as follows:

(a) if the lease would have been classified as an operating lease had

the modification been in effect at the inception date, the lessor shall:

(i) account for the lease modification as a new lease from the effective

date of the modification; and

(ii) measure the carrying amount of the underlying asset as the net

investment in the lease immediately before the effective date of

the lease modification.

(b) otherwise, the lessor shall apply the requirements of IFRS 9.

If a finance lease is modified and does not result in a separate lease, lessors

account for the modification depending on the classification of the modified

lease. If the lease would have been classified as an operating lease had the

modification been in effect at the inception date, lessors account for such

modifications as the creation of a new lease that commences on the effective

date of the modification. The carrying amount of the underlying asset is measured

as the net investment in the original lease immediately before the effective date of

the modification. Otherwise, the net investment in the lease is accounted for in

accordance with IFRS 9

Financial Instruments

Refer to Appendix D for a summary of lease reassessment and remeasurement

requirements.

5.5.2 Modification to an operating lease

Extract from IFRS 16

87 A lessor shall account for a modification to an operating lease as a new

lease from the effective date of the modification, considering any prepaid or

accrued lease payments relating to the original lease as part of the lease

payments for the new lease.

If an operating lease is modified and the arrangement continues to be or

contains a lease, it is treated as a new lease from the effective date of the

modification. Accounting for the new lease includes identifying and separating

the lease and non-lease components of the contract as discussed in section 2.2

Identifying and separating lease and non-lease components of a contract and

allocating contract consideration

Lessors reassess the

lease classification

at the effective date

of a finance lease

modification that is

not accounted for as

a separate contract.

106 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Upon modification, the classification criteria is reassessed (refer to 5.1

Lease

classification

). As a result, the new lease may be an operating lease or

a finance lease. Any remaining prepaid or accrued lease payments relating to

the original lease are included as part of the lease payments for the new lease.

Illustration 23 shows how the modification guidance is applied for a concession

that involves the forgiveness of future lease payments.

Illustration 23 – Forgiveness of future lease payments on an operating lease

Restaurant A leases space in a shopping mall from Lessor B. Lessor B

classifies the lease as an operating lease.

Under the terms of the lease, Restaurant A makes fixed lease payments of

CU100 to Lessor B at the beginning of each month. The non-cancellable

lease term ends on 28 February 2022. The contract does not include any

non-lease components, extension, termination or purchase options.

All lease payments due up to 30 June 2020 have been received in a timely

manner. On 30 June 2020, in compensation for the closure of the shopping

mall. Lessor B agrees to forgive Restaurant A’s future lease payments for

the months of July, August and September 2020.

Analysis:

The rent concession results in a decrease in the total lease payments. Thus,

there has been a change in the consideration for a lease that was not part

of the original terms and conditions of the contract. Therefore, the rent

concession constitutes a lease modification. The modification does not

change the classification of the lease as an operating lease.

•

On the effective date of the modification (i.e., 30 June 2020), Lessor B

accounts for the modification as a new lease, as follows:

• The remaining lease payments under the modified lease comprise

CU1,700 (lease payments of CU100 per month from October 2020 to

February 2022).

• The remaining lease term is 20 months.

The monthly operating lease income to be recognised over the remaining

lease term is therefore CU1,700 / 20 months = CU85.

In some cases, a lessor may forgive past lease payments that are recognised

as a lease receivable in an operating lease. The rent concession results in

a change in the consideration for the lease that was not part of the original

terms of the lease and, therefore, may be viewed as a lease modification. An

alternative view may be to consider that the forgiveness of the past lease

payments is an extinguishment of the operating lease receivable and the

derecognition requirements of IFRS 9 apply. Paragraph 2.1(b)(i) of IFRS 9

clarifies that operating lease receivables recognised by a lessor are subject

to the derecognition and impairment requirements of IFRS 9. When IFRS 9 is

applied in these situations, we believe the lessor has an accounting policy choice,

to be applied consistently, to either include or exclude the expected forgiveness

of lease payments in the ECL assessment of operating lease receivables. The

approaches applying IFRS 9 and IFRS 16 are illustrated below.

107 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 24 – Waiver of a lease receivable in an operating lease

Restaurant A leases space in a shopping mall from Lessor B. Lessor B

classifies the lease as an operating lease.

Under the terms of the lease, Restaurant A makes fixed lease payments of

CU100 to Lessor B at the beginning of each month. The non-cancellable

lease term ends on 28 February 2022. The contract does not include any

non-lease components, extension, termination or purchase options.

Due to financial difficulties, Restaurant A did not pay the lease payment for

June 2020. Consequently, Lessor B recognised, in accordance with IFRS 9,

an impairment loss of CU20 on 30 June 2020, which takes into

consideration the collateral in the contract.

On 1 July 2020, Lessor B grants a rent concession that waives CU60 of the

outstanding amount for June 2020. The remaining amount (CU40) is paid

shortly after.

Analysis

Approach 1- Lease modification under IFRS 16

The rent concession results in a decrease in the total lease payments and,

thus, there has been a change in the consideration for a lease that was not

part of the original terms and conditions of the contract. Therefore, the

rent concession constitutes a lease modification. Assume the modification

does not change the classification of the lease as an operating lease.

Lessor B records the following entries for June 2020:

Dr Lease receivable CU100

Cr Operating lease income CU100

To record the operating lease income and lease receivable for June 2020

Dr Impairment loss on lease receivable CU20

Cr Impairment allowance on lease receivable CU20

To record an impairment loss against the lease receivable

Paragraph 87 of IFRS 16 requires that a lessor accounts for a modification

to an operating lease as a new lease from the effective date of the

modification, considering any prepaid or accrued lease payments relating

to the original lease as part of the lease payments for the new lease.

Therefore, at the effective date of the modification (i.e., 1 July 2020),

Lessor B accounts for the new lease with a lease term that ends in February

2022. The remaining lease payments after taking into account the partial

forgiveness of the June lease payment amount to CU1,940 (CU2,000 –

CU60).

Lessor B records the following entries for July 2020:

Dr Lease receivable CU60

Cr Lease receivable CU60

Dr Impairment allowance on lease receivable CU20

Cr Profit/loss CU20

108 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

Illustration 24 – Waiver of a lease receivable in an operating lease (cont’d)

To recognise the lease incentive (forgiveness of CU60) to enter into the

modified lease and reverse the IFRS 9 allowance recognised in June 2020

Dr Cash CU40

Cr Lease receivable CU40

To record receipt of partial payment

Dr Lease receivable CU100

Cr Operating lease income CU100

Dr Operating lease income CU3

Cr Lease incentive CU3

To recognise July 2020 lease income of CU100 (based on the monthly

CU100 payments) less amortisation of the lease incentive of CU3 (CU60

divided by 20 months).

Therefore, operating lease income of CU97 will be recognised each month

for the remainder of the new lease term. The IFRS 9 impairment loss of

CU20 is written back to profit or loss when the CU60 of the receivable is

forgiven.

Under this approach, since the remaining CU40 recognised receivable of

the pre-modified lease has already been recognised in income and will be

received, it is not carried forward to the new lease.

Approach 2 - Derecognition of past lease receivable under IFRS 9

Lessor B records the following entries for June 2020:

Dr Lease receivable CU100

Cr Operating lease income CU100

To record the operating lease income and lease receivable for June 2020

Dr Impairment loss on lease receivable CU20

Cr Impairment allowance on lease receivable CU20

To record an impairment loss against the lease receivable

Lessor B records the following entries for July 2020:

Dr Impairment allowance on lease receivable CU20

Dr Derecognition loss on lease receivable CU40

Cr Lease receivable CU60

To derecognise the past lease receivable that is forgiven

Under this approach, the forgiveness of the lease receivables that were

previously impaired under IFRS 9 does not impact the lease modification

accounting. Therefore, the lessor in this illustration would continue to

recognise CU100 of lease income over the new lease term (i.e., based on

the regular payments of CU100 over the new lease term).

109 December 2020 Applying IFRS - A closer look at IFRS 16 Leases

5.6 Other lessor matters

5.6.1 Impairment of the net investment in the lease

Extract from IFRS 16

77 A lessor shall apply the derecognition and impairment requirements in

IFRS 9 to the net investment in the lease. A lessor shall review regularly

estimated unguaranteed residual values used in computing the gross

investment in the lease. If there has been a reduction in the estimated

unguaranteed residual value, the lessor shall revise the income allocation

over the lease term and recognise immediately any reduction in respect of

amounts accrued.

Lessors evaluate their net investment in the lease for impairment by applying

the derecognition and impairment requirements in IFRS 9

Financial Instruments

5.6.2 Portfolio application