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Implementing IFRS 16: What You Need To Do

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4. Implementing IFRS 16:

What You Need To DoLearningObjectives:

SegmentOverview:

Field of Study:

RecommendedAccreditation:

Required Reading(Self-Study):

Running Time:

Course Level:

CoursePrerequisites:

Advance Preparation:

Expiration Date:

Accounting

April 13, 2018

Work experience in financial reporting or accounting, or an introductory course in accounting

None

1 hour group live2 hours self-study

Update

“IASB Issues IFRS 16, ‘Leases’”Published by Deloitte Canada (January 2016)For additional info: http://www2.deloitte.com/ca/en.html

See page 4–7.

35 minutes

Recent guidance from the International Accounting StandardsBoard ushers in a new era in which companies will be required torecognize most leases on their balance sheets. Well before this newstandard becomes effective, most businesses will need to assesshow widespread its effects will be, so that they can plan forneeded accounting and process changes. In our final segment, Dr. Peter Chant, IFRS expert and past chair of the CanadianAccounting Standards Board, explains what you should do now toprepare for a smooth transition to the new lease accounting rules.

Upon successful completion of this segment, you should be able to:l Distinguish between a lease (with a right-to-use asset) and a

service;l Identify the leases, licenses and agreements that are not subject

to IFRS 16;l Determine the impact of IFRS 16 on income and cash flow; l Recognize how low-value assets are affected by IFRS 16.

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Outline

A. IFRS 16 on Lease Accounting

1. Effective 1/1/2019

2. For 120+ jurisdictions that useInternational Financial ReportingStandards

B. Developing New Standards for aComplex Issue

1. Leasing involves subdividingproperty by time or physicalownership

2. Current practice developed onexisting accounting attributes

C. From Convergence to 2 Standards:FASB ASC 840 and IFRS 16

1. Same general principle: all leases ofany substantive nature are going tobe capitalized

2. Diverging implementation details:cash flow statement

I. Evolution of IFRS 16

A. Decision for Companies

1. Most enterprises have already madedecision (or had decision made forthem by incorporation)

2. But lease standards may cause somecompanies to reconsider theirreporting framework

B. Is It a Lease or a Service?

1. Leasing of computers vs. providinginformation technology services

2. Leasing a specific mainframe vs.ability to process x number oftransactions

3. Leasing a software package vs.commitment for customer servicelevels

C. Which Outcome Do You Want?

1. A transfer of assets = lease = balancesheet debt

2. A transfer of services = no lease =no debt

3. Lessee: is it better to lease a truck orto arrange for logistical services?

II. IFRS vs. U.S. GAAP

A. IFRS 16, “Leases”

1. All contracts conveying right to usean asset for a period of time

a. In exchange for consideration

2. Lessee’s liability is based ondiscounted payments under lease

a. Taking lease term into account

B. IFRS 16 Does NOT Apply to

1. Licenses of intellectual property

2. Rights under licensing agreements

3. Leases of biological assets

4. Service concession agreements

5. Leases to explore for minerals, oil,gas

C. Leasing of Intangibles and IntellectualProperty

1. Subdividing an economic interest,rather than physical asset

2. IFRS 16: no mandatory coverage,but optional use

III. Applying IFRS 16

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A. Impact on Income and Cash Flow

1. Obligation to make payments forright-to-use assets will becapitalized

2. IFRS: payment for property =financing transaction, not operatingexpense; could result in increasedoperating cash flow

3. U.S. GAAP: payment for property =operating expense, not financingtransaction; should not result inincreased cash flow

“...there is going to be no relief onthe operating cash flow statementfrom this accounting re-characterization of the leasepayment as the creation of an assetand the setting up of an obligation.”

- Peter Chant

B. Covenants with Cash Flow Tests Basedupon EBITDA

1. Add back depreciation, but do notadd back operating lease expense

2. Good news: could result inincreased EBITDA

3. Bad news: could also result in lower“times interest earned”

C. Capitalizing a Lease Obligation WillResult in

1. Two liabilities: current and long-term

2. Current ratio: reduction in netcurrent assets; increase in currentliabilities

D. Lease Accounting Will Affect FinancialRatios and Performance Metrics

1. Current ratio and EBITDA

2. Net income and operating cashflows

IV. Impact on Income Statement

A. You May Elect Not to RecognizeAssets and Liabilities for

1. Leases with a lease term of 12months or less

2. Leases of low value assets, such as$5,000 when new

B. Peter Chant’s Perspective on “NuisanceAccounting”

1. At what threshold of transactionsize are enterprises indifferentbetween expensing and capitalizing

a. For accounting and taxpurposes?

2. Will FASB argue that any exclusionshould be based on materiality tothe organization

a. Rather than the price of a singleitem?

C. Compromises in Standard Setting?

1. IASB: didn’t compromise on cashflow

a. But did exclude low-value items

2. FASB: changed cash flowcharacterization

a. But did not exclude low valueitems

D. Impact of Leasing Standard on PrivateCompanies

1. Will not give up cash basis, unlessthey anticipate “going public”

2. Impact of standard on customersthat are public companies: do youneed to rethink services and pricesoffered?

3. Impact of standard on competitorsthat are public companies: it isworth comparing ratios and metrics

V. Different Parameters – IASB & FASB

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A. Preparing for Lease AccountingStandard

1. What will be the impact on debtcovenants?

2. What changes should we makebefore implementation?

3. Should we restate comparativeinformation?

a. Or apply IFRS 16 as anadjustment to opening equity atthe date of initial application?

“Focus on what you can do, andchange, between now and theIFRS 16 implementation date.”

- Peter Chant

B. IFRS 15, “Revenue from Contracts withCustomers”

1. Developed with, and crossreferences to, new leasing standard

2. Should be implemented at the sametime, or before, leasing standard

C. The March of Progress on Leasing

1. It was inevitable that, someday,assets and liabilities related to leasecontracts would be on balance sheets

2. Implementing new leasing standardwill require investment and willinvolve new tasks

a. Including better integration ofaccounting and finance withenterprise

D. Peter Chant’s Perspective on FinancialReporting

1. 1995: vast differences between IFRSand U.S. GAAP

2. 2015: more harmonization,convergence and comparability

VI. Going Forward

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1. To what extent is your organizationengaged in lease activities? To whatextent are you involved in accountingfor leases?

2. At one time on our program (2010), Dr.Peter Chant predicted that there wouldbe a “converged” accounting standard onleases. Instead, we have separate leasestandards for IFRS and U.S. GAAP. Areyou surprised? What impact, if any, willhaving two standards have on yourorganization’s policy and procedures?

3. According to Dr. Chant, what is the BIGdeal issue involved in the transition tothe new leasing standard? How will itaffect your organization?

4. What other issues are likely to surface asyour organization makes the transition tothe new lease accounting standards?How will they affect your duties andresponsibilities?

5. Under IFRS (as opposed to FASB), youmay elect NOT to recognize assets orliabilities for low-value assets. Whatimpact will this election have on yourorganization? To what extent are youlikely to continue expensing, rather thancapitalizing, those low-value assets?

6. Peter Chant recommends thatorganizations implement the newaccounting standards on revenuerecognition before – or at the same timeas – the changes in lease accounting.Has your organization considered itstimetable for implementation of the twonew standards? In what time frame willthey be implemented?

7. We have previously provided coverageof IFRS accounting standards at thesame time as (or as a footnote to) U.S.GAAP standards issued by FASB. Towhat extent should we providecontinued coverage of IFRS accountingstandards on an ongoing basis?

Discussion Questions

Group Live Option

You may want to assign these discussion questions to individual participants before viewingthe video segment.

4. Implementing IFRS 16: What You Need To Do

l As the Discussion Leader, you shouldintroduce this video segment with wordssimilar to the following:

“In this segment, Dr. Peter Chantexplains what you should do now toprepare for a smooth transition to thenew lease accounting rules.”

l Show Segment 4.

l After playing the video, use thequestions provided or ones you havedeveloped to generate discussion. Theanswers to our discussion questions areon page 4–6.

l After the discussion, complete theevaluation form on page A-1.

Instructions for SegmentFor additional information concerning CPE requirements, see page vi at the beginning of this guide.

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s1. To what extent is your organization

engaged in lease activities? To whatextent are you involved in accounting forleases?l Participant response is based on your

organization, its strategy (buy vs.rent), its locations, and its operations,as well as on your perspective,experience and job responsibilities.

2. At one time on our program (2010), Dr.Peter Chant predicted that there would bea “converged” accounting standard onleases. Instead, we have separate leasestandards for IFRS and U.S. GAAP. Areyou surprised? What impact, if any, willhaving two standards have on yourorganization’s policy and procedures?l Participant response is based on your

organization, its strategy (buy vs.rent), its locations, and its operations,as well as on your perspective,experience and job responsibilities.

3. According to Dr. Chant, what is the BIGdeal issue involved in the transition tothe new leasing standard? How will itaffect your organization?l Dr. Chant believes that organizations

should focus on the impact of theaccounting standard on your cashflow, as well as on those loancovenants that contain cash flowmetrics.

l Participant response is based on yourorganization, its strategy (buy vs.rent), its locations, and its operations,as well as on your perspective,experience and job responsibilities.

4. What other issues are likely to surface asyour organization makes the transition tothe new lease accounting standards? Howwill they affect your duties andresponsibilities?l Since the new standard does not

permit “grandfathering” of existingleases, your organization must beprepared to deal with theconsequences – of recognizedliabilities and of comparability issues– for long-term leases.

l Participant response is based on yourorganization, its strategy (buy vs.rent), its locations, and its operations,as well as on your perspective,experience and job responsibilities.

5. Under IFRS (as opposed to FASB), youmay elect NOT to recognize assets orliabilities for low-value assets. Whatimpact will this election have on yourorganization? To what extent are youlikely to continue expensing, rather thancapitalizing, those low-value assets?l Participant response is based on your

organization – its policies and itsassets – as well as on yourperspective, experience and jobresponsibilities.

6. Peter Chant recommends thatorganizations implement the newaccounting standards on revenuerecognition before – or at the same timeas – the changes in lease accounting. Hasyour organization considered itstimetable for implementation of the twonew standards? In what time frame willthey be implemented?l Participant response is based on your

organization – its accounting policiesand procedures – as well as on yourperspective, experience and jobresponsibilities.

7. We have previously provided coverage ofIFRS accounting standards at the sametime as (or as a footnote to) U.S. GAAPstandards issued by FASB. To whatextent should we provide continuedcoverage of IFRS accounting standardson an ongoing basis?l Participant response is based on your

organization – its locations andoperations – as well as on yourperspective, experience and jobresponsibilities.

4. Implementing IFRS 16: What You Need To Do

Suggested Answers to Discussion Questions 4 – 64 – 64 – 6

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Self-Study Option

1. Viewing the video (approximately 30–35 minutes).

2. Completing the Required Reading (approximately 25–30 minutes). The Required Reading for this segment starts below.

3. Completing the online steps (approximately 35–45 minutes).

Please see pages iii to v at the beginningof this guide for instructions oncompleting these steps.

When taking an FMN segment on a self-study basis, an individual earns CPE credit by doingthe following:

Instructions for Segment

Required Reading (Self-Study)

Published by Deloitte Canada (January 2016)For additional info:http://www2.deloitte.com/ca/en.html

IntroductionIFRS 16 is the result of the joint projectinitiated by the IASB together with the U.S.national standard-setter, the FinancialAccounting Standards Board (FASB), toaddress concerns raised by users of financialstatements in respect of reducedcomparability between financial statementsdue to the very different accounting appliedto operating and finance leases andlimitations in the information provided onoperating leases and on entities’ exposure torisks arising from lease arrangements.

To address those concerns, the two boardsdecided to develop a new approach to lesseeaccounting that requires a lessee to recognizeassets and liabilities for the rights andobligations created by leases (with somelimited exceptions) and to enhance therequired disclosures on leases.

Observation: The project’s original aim wasthe production of a converged IFRS and U.S.

GAAP standard. However, the IASB andFASB reached different conclusions on anumber of issues including the recognitionand presentation of expenses by lessees. As aresult, the FASB’s leasing standard (ASU2016-02, Topic 842) differs from IFRS 16 inseveral respects.

ScopeThe new Lease Standard applies to all leases,including leases of right of use assets in asublease, with the exception of specific itemscovered by other standards, namely:

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

l contracts within the scope of IFRIC 12Service Concession Arrangements;

l for lessors, licenses of intellectualproperty within the scope of IFRS 15Revenue from Contracts with Customers;and

l for lessees, leases of biological assetswithin the scope of IAS 41 Agricultureand rights held under licensing

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IASB ISSUES IFRS 16, “LEASES”

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agreements within the scope of IAS 38Intangible Assets for items such asmotion picture films, video recordings,plays, manuscripts, patents andcopyrights.

Lessees are permitted, but not required, toapply IFRS 16 to leases of other intangibleassets.

Short-Term Leases andLeases of Low Value Assets

In response to concerns raised over the costof applying the requirements of the newStandard, the IASB decided to provide arecognition exemption for preparers byallowing short-term leases and leases of lowvalue assets to be accounted for by simplyrecognizing an expense, typically straight-line, over the lease term (so, in a mannerconsistent with the current accounting foroperating leases).

A ‘short-term lease’ is defined as one thatdoes not include a purchase option and has alease term at commencement date of 12months or less. Lessees must apply, or notapply, the exception for short-term leasesconsistently for each class of underlyingleased asset.

The exception for leases of low value assetscan, on the other hand, be applied on a leaseby lease basis.

Observation: The ‘low value’ exception isunusual in that it applies in absolute termsrather than by reference to the size of thereporting entity (i.e. it is not a measure of thelease’s materiality). The Standard does notprovide a monetary value that should beconsidered ‘low’ for these purposes, but doesstate that the assessment should be madebased on the asset’s value when new (even ifa used asset is leased) and the Basis forConclusions notes that, at the time ofreaching its decision to provide an exception,the IASB had in mind leases of underlyingassets with a value, when new, in the order ofmagnitude of US$5,000 or less. It shouldalso be noted that the ‘low value’ exceptiononly applies to leased assets that are nothighly dependent on, or highly interrelatedwith, other assets.

Lease Term

The lease term is defined as the non-cancellable period of the lease, including:

a) periods covered by an option to extendthe lease if the lessee is reasonably certain toexercise that option; and

b) periods covered by an option toterminate the lease if the lessee is reasonablycertain not to exercise that option.

An entity is required to revise the lease termif there is a change in the non-cancellableperiod of a lease.

Definition of a LeaseThe Standard aims to distinguish a leasefrom a service contract on the basis ofwhether a customer is able to control theasset being leased.

A contract is, or contains, a lease if thecontract provides a customer with the right tocontrol the use of the identified asset for aperiod of time in exchange for consideration.Control is considered to exist if the customerhas:

(a) the right to obtain substantially all of theeconomic benefits from use of an identifiedasset; and

(b) the right to direct the use of that asset.

An entity is required to identify whether acontract is, or contains, a lease at inceptionand it will only reassess whether the contractis or contains a lease in case of amodification to the terms and conditions ofthe contract. The inception of a lease is theearlier of the date of a lease agreement andthe date of commitment by the parties to theprincipal terms and conditions of the lease.

Observation: The definition emphasizes thenotion of control because the IASB decidedthat to control the use of an asset, a customeris required to have not only the right toobtain substantially all of the economicbenefits from use of an asset throughout theperiod of use (a ‘benefits’ element) but alsothe ability to direct the use of that asset (a‘power’ element). This guidance is consistentwith the concept of control in IFRS 10

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Consolidated Financial Statements and IFRS15 Revenue from Contracts with Customers,and with the IASB’s proposals regardingcontrol in the Conceptual FrameworkExposure Draft. The Standard providesdetailed guidance to determine whether thoseconditions are met. It is expected thatsignificant judgement will be required tomake this assessment in some cases.

Observation: The Standard does not providea definition of services; however, the Basisfor Conclusions provides someconsiderations made by the IASB todistinguish leases from services. Forexample, it indicates that leases create rightsand obligations that are different from thosethat arise from service contracts. This isbecause the lessee obtains and controls theright-of-use asset at the time that theunderlying asset is made available for use bythe lessee, on the other hand, in a servicecontract, the customer does not obtain anasset that it controls at commencement of thecontract.

Accounting for Leases inFinancial Statements ofLessees

Recognition: A lessee will recognize at leasecommencement a right-of-use asset and alease liability. The commencement date of alease is defined in the Standard as the dateon which a lessor makes an underlying assetavailable for use by a lessee.

Observation: The IASB decided to require asingle accounting model for leases in whicha lease will be recognized in the statement offinancial position (unless any of IFRS 16’sscope exceptions are available). The IASBconcluded that a lessee’s right to use anunderlying asset meets the definition of anasset for the following reasons: (i) the lesseecontrols the right to use the underlying assetthroughout the lease term; (ii) the lessee hasthe ability to determine how to use theunderlying asset and, thus, how it generatesfuture economic benefits from that right ofuse; and (iii) the right to control and use theasset exists even when a lessee’s right to usean asset includes some restrictions on its use;and the lessee’s control of the right of usearises from past events – not only the

commitment to the lease contract but also theunderlying asset being made available foruse by the lessee for the duration of the non-cancellable period of the lease.

Right-of-use asset: A lessee is required toinclude the following items as part of thecosts of the right-of-use assets:

l the amount of the initial measurement ofthe lease liability (see below);

l any lease payments made to the lessor ator before the commencement date, lessany lease incentives;

l any initial direct costs incurred by thelessee; and

l an estimate of costs to be incurred by thelessee in dismantling and removing theunderlying asset, restoring the site onwhich it is located or restoring theunderlying asset to the condition requiredby the terms and conditions of the lease,unless those costs are incurred toproduce inventories. The lessee incursthe obligation for those costs either at thecommencement date or as a consequenceof having used the underlying assetduring a particular period.

Subsequently, an entity will measure theright-of-use asset using either the cost orrevaluation model of IAS 16 Property, Plantand Equipment (thus, recognisingdepreciation and impairment expenses inprofit or loss and, if that model is applied,revaluations in other comprehensiveincome). However, the Standard requires theright-of-use asset of leased investmentproperty to be measured at fair value if theentity uses the fair value model under IAS 40Investment Property to its other investmentproperties.

As noted below, right-of-use assets are alsoadjusted as a result of certain changes in thelease liability subsequent to commencementof the lease.

Lease liability: An entity will measure thelease liability at the present value of leasepayments discounted using the rate implicitin the lease if that rate can be readilydetermined. If an entity is unable to estimate

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the rate implicit in the lease, then the lesseeshould use its incremental borrowing rate.

Observation: The rate implicit in the lease isdefined in the Standard as the rate of interestthat at commencement date causes theaggregate present value of lease paymentsand the residual value of the asset at the endof the lease term to equal the sum of the fairvalue of the underlying asset and any initialdirect cost of the lessor. The IASB indicatesthat the interest rate implicit in the lease islikely to be similar to the lessee’sincremental borrowing rate in many cases.This is because both rates take into accountthe credit standing of the lessee, the length ofthe lease, the nature and quality of thecollateral provided and the economicenvironment in which the transaction occurs.

The lease payments should include thefollowing items:

l fixed payments (including in-substancefixed payments), less any leaseincentives receivable from the lessor;

Observation: Lease payments should includefixed payments regardless of the form inwhich they were structured in the contract.For this reason, the IASB included theconcept of ‘in-substance fixed payments’which intend to capture payments that could,according to the contract, be variable but arein reality unavoidable.

l variable lease payments that depend onan index or a rate (such as the ConsumerPrice Index or a benchmark interest rate),using the index or rate as at thecommencement date;

Observation: A lease may include variablepayments related to future performance. TheStandard requires that any variable leasepayment not related to an index or a rate willbe recognized in profit or loss as incurred.The IASB decided to exclude those variablepayments from the initial measurement of thelease liability primarily for cost and benefitsreasons. There was no specific conclusion asto whether variable payments related tofuture performance meet the definition of aliability.

l amounts expected to be payable by thelessee under residual value guarantees;

l the exercise price of a purchase option ifthe lessee is reasonably certain toexercise that option; and

l payments of penalties for terminating thelease, if the lease term reflects the lesseeexercising an option to terminate thelease.

Subsequently, a lessee will increase the leaseliability to reflect interest accrued (andrecognized in profit or loss), deduct leasepayments made from the liability andremeasure the carrying amount to reflect anyreassessment, lease modification, or revisionto in-substance fixed payments.

Observation: The differing treatment of theright-of-use asset (depreciation typicallyrecognized on a straight-line basis) and thelease liability (interest calculated using aconstant rate of return method) results inprobably the most significant impact of thenew Standard on a lessee’s net profit as thetotal expense recognized will be weightedtowards the start of the lease term (due to thehigher interest cost arising at that time),whereas under IAS 17 the cost of anoperating lease is usually recognized on astraight-line basis across the lease term.

Reassessment of the lease liability: A lesseeis required to remeasure the lease liability inthe following circumstances:

l a change in the amount expected to bepayable under a residual value guarantee;

l a change in future lease payments toreflect a change in an index or rate usedto determine those payments (including,for example, a market rent review);

l a change in the lease term resulting froma change in the non-cancellable period ofthe lease (for example, the lessee notexercising an option previously includedin the determination of the lease term);or

l a change in the assessment of an optionto purchase the underlying asset.

Changes resulting from revisions to residualvalue guarantees and changes in an index orrate are calculated using the interest ratedetermined at commencement of the lease,

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whilst changes to the lease term or in theassessment of a purchase option requirecalculation of a revised interest rate at thedate of the change.

A lessee is required to recognize the amountof the re-measurement of the lease liabilityas an adjustment to the right-of-use assetunless the carrying amount of the right-of-use asset is reduced to zero, in that situation,a lessee will recognize any remainingamount in profit or loss.

Disclosure: The disclosure objective of theStandard is that an entity is required toprovide information to enable users offinancial statements to assess the effect thatleases have on the financial position,financial performance and cash flows of thelessee.

Observation: Consistently with therequirements being discussed under theIASB’s Disclosure Initiative, the Standardindicates that a lessee should provideadditional quantitative and qualitativeinformation if it is necessary to meet thedisclosure objective. The Standard indicatesthat the information provided must berelevant for the users of the entity’s financialstatements and should help users tounderstand the most relevant implicationsderived from its leases, including forexample, the flexibility provided by leases;restrictions imposed by leases; sensitivity onkey variables; exposure to additional risksand deviations from industry practices.

The Standard significantly expands thecurrent disclosure requirements about leases.The required quantitative disclosurerequirements include:

l depreciation charge for right-of-useassets by class of underlying asset;

l interest expense on lease liabilities;

l the expense relating to short-term leases;

l the expense relating to leases of low-value assets;

l the expense relating to variable leasepayments not included in themeasurement of lease liabilities;

l income from subleasing right-of-useassets;

l total cash outflow for leases;

l additions to right-of-use assets;

l gains or losses arising from sale andleaseback transactions; and

l the carrying amount of right-of-useassets at the end of the reporting period,by class of underlying asset.

In addition, a lessee is required to disclose amaturity analysis of lease liabilities(separately from other financial liabilities) inaccordance with IFRS 7, “FinancialInstruments: Disclosures.”

Accounting for Leases inFinancial Statements ofLessors

The Standard maintains substantially thelessor accounting requirements in “IAS 17,Leases.”

The Standard requires a lessor to classify alease either as an operating lease or a financelease.

A finance lease is a lease that transferssubstantially all the risks and rewardsincidental to ownership. The Standardincludes examples of situations that will leada lease to be considered a finance lease.

Finance leases: A lessor is required torecognize at the commencement date assetsheld under a finance lease in its Statement offinancial position and present them as areceivable at an amount equal to the netinvestment in the lease.

The net investment in the lease will bemeasured as the sum of both of thefollowing:

a) the lease receivable measured at thepresent value of the lease payments; and

b) the residual asset, measured at thepresent value of any residual value accruingto the lessor.

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Subsequently, a lessor is required torecognize finance income over the leaseterm, based on a pattern reflecting a constantperiodic rate of return on the lessor’s netinvestment in the lease.

Operating leases: A lessor is required torecognise lease payments from operatingleases as income on either a straight-linebasis or another systematic basis. Anothersystematic basis should be applied if thatbasis is more representative of the pattern inwhich benefit from the use of the underlyingasset is diminished.

A lessor is required to present underlyingassets subject to operating leases in itsstatement of financial position according tothe nature of the underlying asset.

Similarly to the requirements for lessees, theStandard includes a disclosure objective forlessors. The objective is to discloseinformation in the notes that, together withthe information provided in the statement offinancial position, statement of profit or lossand statement of cash flows, gives a basis forusers of financial statements to assess theeffect that leases have on the financialposition, financial performance and cashflows of the lessor.

Sale and LeasebackTransactions

The Standard includes guidance on sale andleaseback transactions applicable to both theseller-lessee and buyer-lessor. The treatmentof such transactions depends on whether thetransfer of the asset in question meets thecriteria of IFRS 15, “Revenue fromContracts with Customers” for recognition asa sale.

If these criteria are met:

l the seller-lessee recognizes a right-of-useasset calculated as the proportion of theasset’s previous carrying amount relatingto the right-of-use it has retained (as aresult, a gain or loss on disposal isrecognized only to the extent that rightsof use have transferred to the buyer-lessor); and.

l the buyer-lessor accounts for thepurchase of the underlying asset underapplicable Standards (for example, IAS16 for a purchase of property, plant andequipment) and the lease under IFRS16’s lessor accounting model.

If the sale proceeds do not reflect the fairvalue of the asset, or if the lease paymentsare not at a market rate, adjustments aremade to reflect a prepayment of leasepayments or additional financing provided bythe buyer-lessor.

If the criteria are not met:

l the seller-lessee continues to recognizethe underlying asset and recognizes afinancial liability in respect of the salesproceeds received; and

l the buyer-lessor recognizes a financialasset in respect of the payment made.

Both parties then account for the financialinstrument in accordance with IFRS 9,“Financial Instruments” (or, if that standardhas not yet been applied, IAS 39, “FinancialInstruments: Recognition andMeasurement”).

Effective Date and TransitionThe standard is applicable for annualreporting periods beginning on or after 1January 2019. Earlier application ispermitted for entities that apply IFRS 15,“Revenue from Contracts with Customers” ator before the date of initial application of thisStandard.

The Standard provides specific transitionrequirements to:

l the definition of a lease (permitting theconclusion reached under IAS 17 andIFRIC 4 Determining whether anArrangement contains a Lease to becarried forward in respect of contractsentered into prior to the date of initialapplication of IFRS 16);

l the measurement of right-of-use assetsand lease liabilities (providing relieffrom full retrospective calculation ofthese balances);

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l sale and leaseback transactions beforethe date of the initial application(requiring accounting based on theconclusion on whether the transactionwas a sale and operating leaseback or asale and finance leaseback reached underIAS 17); and

l amounts previously recognized inrelation to business combinations(requiring any asset or liability inrelation to favorable or unfavorableterms of operating leases to bederecognized and the carrying amount ofthe associated right-of-use asset adjustedby a corresponding amount).

A lessee can apply this Standard either by afull retrospective approach or a modifiedretrospective approach. If the latter approachis selected, an entity is not required to restatethe comparative information and thecumulative effect of initially applying thisStandard must be presented as an adjustmentto the opening balance of retained earnings(or other component of equity asappropriate).

Implementing the New LeaseStandard

The IASB set the effective date on 1 January2019 with the consideration of the time andcost that will be involved in implementingthe new Standard. This time allows entitiesto consider the effects of IFRS 16 forexample in respect of:

l changes needed to its systems andprocesses; for example to track leasesindividually or at portfolio level and toperform calculations;

l judgments required particularly inrespect of the definition of a lease and inthe assessment of the lease term;

l any potential tax impacts if the treatmentof a lease for tax purposes is based on itstreatment in financial statements;

l the impact of the Standard on keymetrics, debt covenants and managementcompensation; and

l additional information that entities mayneed to gather to make the requireddisclosures.

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