Understanding the practical application of accounting standards like IFRS 16 (AASB 16) is crucial for businesses striving for compliance and accurate financial reporting. In this article, we provide an IFRS 16 worked example to illustrate how it can be applied in real-world scenarios, shedding light on its implications for lease accounting.
IFRS 16 Worked Example Overview
Before we dive into the IFRS 16 worked example, it’s important to understand some key definitions. An IFRS 16 lease typically comprises a specified lease term and a regular lease payment schedule. For instance, an initial term of 5 years with the option to renew for an additional five years, involving monthly payments of $8,000, the payment date is 1st of every month in advance. Certain leases, categorised as short-term (12 months or less) or low value by the entity, may be exempt from specific IFRS 16 calculations, necessitating only expense entries in the accounting journals as opposed to the complex Lease Liability and Right-of-Use Asset calculation.
A simple IFRS 16 lease encompasses regular lease payments, lease terms, and a discount rate implicit in the lease or the incremental borrowing rate.
The calculation would produce two account balances: Lease Liability and Right-of-Use Asset. Lease Liability represents future lease obligations; the Right-of-Use Asset reflects the "right to use" the asset. Both account balances are based on the length of the lease and the future minimum lease payment. If the lease has no specific payments or the finance team has not made particular judgements, the Right-of-Use Asset usually equals Lease Liability at commencement.
Lease Liability Calculation
The initial Lease Liability calculation involves discounting regular lease payments over the lease terms by the interest rate to reflect the net present value of all lease payments.
If the lease undergoes any contractual changes or reassessment, such as an extension of the lease terms that is not originally in the contractual terms, a CPI or Market Rent Review, the lease liability will be remeasured accordingly. Generally, any changes that increase lease payments or the lease term's length would increase the Lease Liability balance for the lease, and vice versa.
Right-of-Use Asset Calculation
The initial Right-of-Use Asset calculation is less intricate. It commences with the beginning value of the Right-of-Use calculation equating to the Lease Liability value at the commencement, then adjusted by any associated costs and payments made, such as any costs classified as an initial direct cost, or a lease payment prepaid prior to the commencement of the lease. Any subsequent contractual changes and reassessment of the lease will impact the Right-of-Use Asset calculation in the same way as the changes in Lease Liability. There are some exceptions where the Right-of-Use Asset balance is separately calculated from Lease Liability, such as:
- Impairment
- Decrease in asset (such as a decrease in leased office space)
- Decrease in the lease term
Lease Expense Recognition
Under IFRS 16, the lease payment is effectively presented as depreciation and interest expense in the income statements, as opposed to a lease expense in the expenditure section under the old standard IAS 17, or Short-Term/Low-Value leases under the exemption of IFRS 16. The recognition of lease payments now strictly adheres to the due date of the regular lease payments as specified in the lease, as opposed to being based on the invoice or cash basis in accounting.
Impact on Financial Statements
Historically, under IAS 17, the contractual lease obligation was effectively concealed from the balance sheet, with minimal disclosure requirements. With the transition to the new presentation of leases on the balance sheet under IFRS 16, users of financial statements can promptly evaluate the future lease obligation that the entity has committed to, with extensive disclosure requirements necessitating the clear presentation of commitments in coming years and maturity analysis in the disclosure report and notes section, detailing the lease portfolio, obligations and activities of the leased assets. Enhanced disclosure fosters greater transparency and comparability across financial statements.
This IFRS 16 worked example clearly demonstrates its implications for lease accounting and financial reporting. By understanding the mechanics of lease liability calculation, right-of-use asset recognition, and lease expense recognition, organisations can ensure compliance with IFRS 16 while providing stakeholders with transparent and accurate financial information.
To learn more about IFRS 16 and its application, download our comprehensive IFRS 16 Guide!
