IFRS 16 : Leases Part 1

Question 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 16.1].

Answer 1

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. [IFRS 16.2].

Question 2

Scope of IFRS 16

IFRS 16 applies 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;

Answer 2

(d) Licences of intellectual property granted by a lessor within the scope of IFRS 15; 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. [IFRS 16.3].

A lessee may, but is not required to, apply IFRS 16 to leases of intangible assets other than those described in (e) above. [IFRS 16.4].

Question 3

Recognition exemptions

A lessee can elect not to apply the recognition requirements to:

(a) Short term leases; and
(b) Leases for which the underlying asset is of low value. [IFRS 16.5].

Answer 3

These recognition exemptions are discussed in further detail at Short-term leases and Leases of low-value assets below.

Question 4

Definitions

Answer 4

Commencement date of the lease (commencement

date)
- The date on which a lessor makes an underlying asset available for use by a lessee.

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.

Question 5

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.

Effective date of the modification
- The date when both parties agree to a lease modification.

Answer 5

Finance lease
- A lease that transfers substantially all the risks and rewards incidental(happening as a result of (an activity)) to ownership of an underlying asset.

Fixed payments
- Payments made by a lessee to a lessor for the right to use an underlying asset during the lease term, excluding variable lease payments.

Question 6

Gross investment in the lease
- The sum of:
• The lease payments receivable by a lessor under a finance lease; and
• Any unguaranteed residual value accruing to
the lessor.

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.

Answer 6

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.

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.

Question 7

Lease
- A contract, or part of a contract, that conveys(carry) the right to use an asset (the underlying asset) for a period of time in exchange for consideration.

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.

Lessor
- An entity that provides the right to use an underlying asset for a period of time in exchange for consideration.

Answer 7

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, of extending or shortening the contractual lease term).

Lessee
- An entity that obtains the right to use an
underlying asset for a period of time in exchange for consideration.

Question 8

Lease term
- The non-cancellable period for which a lessee has the right to use an underlying asset, 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.

Answer 8

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.

Net investment in the lease
- The gross investment in the lease discounted at the interest rate implicit in the lease.

Question 9

Operating lease
- A lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

Optional lease payments
- Payments to be 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.

Answer 9

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).

Residual value guarantee
- A guarantee made to a lessor by a party unrelated to the lessor that the value (or part of the value) of an underlying asset at the end of a lease will be at least
a specified amount.

Question 10

Right-of-use asset
- An asset that represents a lessee’s right to use an underlying asset for the lease term.

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.

Contract
- An agreement between two or more parties that creates enforceable rights and obligations.

Answer 10

Sublease
- A transaction for which an underlying asset is re-leased by a lessee (‘intermediate lessor’) to a third party, and the lease (‘head lease’) between the head lessor and the lessee remains in effect.

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.

Question 11

Unearned finance income

• The difference between:
  (a) The gross investment in the lease; and
  (b) The net investment 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.

Answer 11

Variable lease payments
- The portion of payments made by a lessee to a lessor for the right to use an underlying asset during the lease term that varies because of changes in facts
or circumstances occurring after the commencement date, other than the passage of time.

Useful life
- The period over which an asset is expected to be available for use by an entity; or the number of production or similar units expected to be obtained from an asset by an entity.

Question 12

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;
(c) The exercise price of a purchase option if the lessee is reasonably certain 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.

Answer 12

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 nonlease components.

Question 13

WHAT IS A LEASE?

Answer 13

WHAT IS A LEASE?

Question 14

IFRS 16 defines a lease as ‘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’. [IFRS 16 Appendix A].

The determination of whether an arrangement contains a lease is performed at the inception of the contract. [IFRS 16.9].

Answer 14

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 contracts conveys the right to direct the use of an identified asset may be challenging. We discuss this further at Determining whether an arrangement contains a lease below.

Question 15

Determining whether an arrangement contains
a lease 1

At inception of a contract, an entity assesses 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. [IFRS 16.9].
See Identified asset below for additional discussion
on identified assets.

Answer 15

A period of time may be described in terms of the amount of use of an identified asset (for example, the number of production units that an item of equipment will be used to produce). [IFRS 16.10].

Question 16

Determining whether an arrangement contains
a lease 2

To assess whether a contract conveys the right to control the use of an identified asset for a period of time, an entity assesses 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 (see Right to obtain substantially all of the economic benefits
from use of the identified asset below); and

(b) the right to direct the use of the identified asset (see Right to direct the use of the identified asset below). [IFRS 16.B9].

Answer 16

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. [IFRS 16.B10].

An entity assesses whether a contract contains a lease for each potential separate lease component.
[IFRS 16.B12]. See Identifying and separating lease and non-lease components of a contract below.

Question 17

Determining whether an arrangement contains
a lease - Joint arrangements 1

Entities often enter into joint arrangements (JOAs) with other entities for certain activities. For example, the exploration of oil and gas fields, or the development
of pharmaceutical products.

Answer 17

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;

Question 18

Determining whether an arrangement contains
a lease - Joint arrangements 2

• 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; and

Answer 18

• 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.

Question 19

Determining whether an arrangement contains
a lease - Joint arrangements 3

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.
[IFRS 16.B11].

Answer 19

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.

Question 20

Determining whether an arrangement contains
a lease - Joint arrangements 4

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.

Answer 20

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 nonphysically distinct portion of an underlying asset and, therefore, does not have the right to substantially all 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.

Question 21

Determining whether an arrangement contains
a lease - Joint arrangements 5

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.

Answer 21

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.

Question 22

Determining whether an arrangement contains
a lease - Joint arrangements 6

If the lead operator determines 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.

Answer 22

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 joint operating agreement, would be impacted by the individual facts and circumstances.

Question 23

Determining whether an arrangement contains
a lease - Joint arrangements 7

If there is a sublease with the 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.

Answer 23

However, if no sublease existed, the non-operators would recognise joint interest payables when incurred for their share of the costs incurred by the operator in respect of the leased asset.

Question 24

Determining whether an arrangement contains
a lease - Identified asset 1

An arrangement only contains a lease if there is an identified asset. 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. [IFRS 16.B13].

Example 24.1: Implicitly specified asset
Example 24.2: Identified asset – implicitly specified at the time the asset is made available for use by the customer

Answer 24

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. [IFRS 16.B20]

Question 25

Determining whether an arrangement contains a lease - Identified asset 2 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 whether these arrangements are identified assets. However, the FASB’s new standard 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).

Answer 25

As the IASB has stated that 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 similar arrangements. Example 24.3: Identified asset – physically distinct portion of a larger asset Example 24.4: Identified asset – capacity portion of an asset

Question 26

Determining whether an arrangement contains a lease - Identified asset 3 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.

Answer 26

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.

Question 27

Determining whether an arrangement contains a lease - Identified asset 4 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, that very long-term leases of land (e.g. 999 years) ; • 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; and

Answer 27

• 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.

Question 28

Determining whether an arrangement contains a lease - Substantive substitution rights 1 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). [IFRS 16 Appendix A]. A supplier’s right to substitute an asset is substantive when both of the following conditions are met :

Answer 28

• 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); and • 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). [IFRS 16.B14].

Question 29

Determining whether an arrangement contains a lease - Substantive substitution rights 2 The IASB indicated in the Basis for Conclusions to IFRS 16 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. [IFRS 16.BC113].

Answer 29

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. [IFRS 16.B15].

Question 30

Determining whether an arrangement contains a lease - Substantive substitution rights 3 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 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 :

Answer 30

* 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; and * 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. [IFRS 16.B16]

Question 31

Determining whether an arrangement contains a lease - Substantive substitution rights 4 The requirement that a substitution right must benefit the supplier economically in order to be substantive is a new concept. 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. [IFRS 16.BC113]. If an 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. [IFRS 16.B17]

Answer 31

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.

Question 32

Determining whether an arrangement contains a lease - Substantive substitution rights 5 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. [IFRS 16.B19]. 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.

Answer 32

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. [IFRS 16.B18]. Example 24.5: Substitution rights

Question 33

Determining whether an arrangement contains a lease - Right to obtain substantially all of the economic benefits from use of the identified asset 1 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. [IFRS 16.B21].

Answer 33

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. Economic benefits arising from construction or ownership of the identified asset (e.g. tax benefits related to excess tax depreciation and investment tax credits as discussed in IFRS 16.BC 118) 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.

Question 34

Determining whether an arrangement contains a lease - Right to obtain substantially all of the economic benefits from use of the identified asset 2 When assessing the right to obtain substantially all of the economic benefits from use of an asset, an entity considers the economic benefits that result from use of the asset within the defined scope of a customer’s right to use the asset. 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 considers only the economic benefits from use of the motor vehicle within that territory, and not beyond; or

Answer 34

(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 considers only the economic benefits from use of the motor vehicle for the permitted mileage, and not beyond. [IFRS 16.B22].

Question 35

Determining whether an arrangement contains a lease - Right to obtain substantially all of the economic benefits from use of the identified asset 3 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 are considered to be part of the economic benefits that the customer obtains from use of the asset.

Answer 35

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. [IFRS 16.B23].

Question 36

Determining whether an arrangement contains a lease - Right to direct the use of the identified asset 1 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; or • the relevant decisions about how and for what purpose an asset is used are predetermined; and

Answer 36

* the customer either 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 * 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. [IFRS 16.B24].

Question 37

Determining whether an arrangement contains a lease - Right to direct the use of the identified asset : How and for what purpose the asset is used 1 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. [IFRS 16.B25].

Answer 37

How and for what purpose an asset is used is a single concept (i.e. ‘how’ an asset is used is not assessed separately from ‘for what purpose’ an asset is used). [IFRS 16.BC120]. The IASB have indicated 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 implementing those decisions. [IFRS 16.BC120].

Question 38

Determining whether an arrangement contains a lease - Right to direct the use of the identified asset : How and for what purpose the asset is used 2 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);

Answer 38

(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); (c) rights to change where the output is produced (for example, to decide 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). [IFRS 16.B26].

Question 39

Determining whether an arrangement contains a lease - Right to direct the use of the identified asset : How and for what purpose the asset is used 3 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. [IFRS 16.B27].

Answer 39

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 at Relevant decisions about how and for what purpose the asset is used are predetermined 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.

Question 40

Determining whether an arrangement contains a lease - Right to direct the use of the identified asset : Relevant decisions about how and for what purpose the 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 design of the asset or by contractual restrictions on the use of the asset). This may occur when the customer and the supplier in negotiating the contract predetermined the most relevant decisions and those decisions cannot be changed. The IASB indicated that it would expect decisions about how and for what purpose an asset is used to be predetermined in few cases. [IFRS 16.BC121].

Answer 40

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; or • 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. [IFRS 16.B24].

Question 41

Determining whether an arrangement contains a lease - Right to direct the use of the identified asset : Specifying the output of an asset before the period of use As noted above, 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. [IFRS 16.B28]. In assessing whether a customer has the right to direct the use of an asset, an entity considers only rights to make decisions about the use of the asset during the period of use, unless how and for what purpose an asset is used is predetermined.

Answer 41

Consequently, unless the customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purposes the asset will be used throughout the period of use, an entity does 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 throughout the period of use. 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. [IFRS 16.B29].

Question 42

Determining whether an arrangement contains a lease - Right to direct the use of the identified asset : Protective rights 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.

Answer 42

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. [IFRS 16.B30]. Example 24.6: Right to direct the use of an asset

Question 43

Determining whether an arrangement contains a lease - Flowchart of the decision making process IFRS 16 contains a flowchart that depicts the decision making process for determining whether an arrangement contains a lease [IFRS 16.B31] and provides a summary of the discussion in Identified asset through Protective rights above. This has been reproduced below. (refer OneNote).

Answer 43

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.

Question 44

Determining whether an arrangement contains a lease - Reassessment of the contract An entity reassesses whether a contract is, or contains, a lease only if the terms and conditions of the contract are changed. [IFRS 16.11]. A change in the terms and conditions of a contract does not include the exercise of an option (e.g. a renewal option) or failure to exercise an option that is included in the contract.

Answer 44

no note

Question 45

Identifying and separating lease and non-lease components of a contract - Identifying and separating lease components of a contract 1 An entity accounts for each lease component within a contract as a lease separately from non-lease components of the contract, unless the entity (lessees only) applies the practical expedient in paragraph 15 of IFRS 16. [IFRS 16.12]. 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

Answer 45

(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. [IFRS 16.B32]. If one or both of these criteria are not met, the right to use multiple assets is considered a single lease component.

Question 46

Identifying and separating lease and non-lease components of a contract - Identifying and separating lease components of a contract 2 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

Answer 46

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. [IFRS 16.B33]. Example 24.7: Identifying and separating lease components

Question 47

Identifying and separating lease and non-lease components of a contract - Identifying and separating lease components of a contract 3 For contracts that involve the right to use land and land improvements (e.g. buildings), IFRS 16 requires a lessor to classify 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. [IFRS 16.B57]. 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.

Answer 47

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). [IFRS 16.B56]. 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 building as separate lease components. However, this would not necessarily be the case when an entity only leases part of the building.

Question 48

Identifying and separating lease and non-lease components of a contract - 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, unless the lessee applies the practical expedient as discussed at 3.2.2.B below. [IFRS 16.16]. 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).

Answer 48

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. [IFRS 16.B33]. However, if the lessor provides goods or services, such as maintenance, supply of utilities, including operating the underlying asset for the customer (e.g. vessel charter, aircraft wet lease), the contract would generally contain non-lease components.

Question 49

Identifying and separating lease and non-lease components of a contract - Identifying and separating lease from non-lease components of a contract : Lessee reimbursements 1 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 to the tenant (e.g. providing utilities or rubbish removal) are considered non-lease components because they provide the lessee with a service.

Answer 49

In some leases, a lessee may also 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).

Question 50

Identifying and separating lease and non-lease components of a contract - Identifying and separating lease from non-lease components of a contract : Lessee reimbursements 2 Under IFRS 16, such costs are not separate components of the contract because they do not represent payments for goods or services and are not considered to be part of the total consideration that is allocated to the separately identified components of the contract (i.e. the lease and nonlease components). Entities also need to evaluate whether such payments are fixed (or in-substance fixed) lease payments or variable lease payments.

Answer 50

Example 24.8: Activities that are not components of a lease contract

Question 51

Identifying and separating lease and non-lease components of a contract - Determining and allocating the consideration in the contract lessees : Determining the consideration in the contract IFRS 16 does not define ‘consideration’ in a contract, nor is ‘consideration’ defined in the IFRS Glossary.

Answer 51

However, we believe that the consideration in a contract for a lessee would include all the lease payments described at 4.5 below, as well as certain other consideration in the contract regardless of whether it is labelled as lease payments or payments for non-lease components of a contract, including other 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.

Question 52

Identifying and separating lease and non-lease components of a contract - Determining and allocating the consideration in the contract lessees : Allocating the consideration in the contract – lessees For a contract that contains a lease component and one or more additional lease or non lease components, a lessee allocates 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. [IFRS 16.13].

Answer 52

The relative stand-alone price of lease and non-lease components is 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 estimates the stand-alone price, maximising the use of observable information. [IFRS 16.14]. A contractually stated price may be the stand-alone price for a good or service but it is not presumed to be for accounting purposes. Example 24.9: Allocating contract consideration to lease and non-lease components – lessees

Question 53

Identifying and separating lease and non-lease components of a contract - Determining and allocating the consideration in the contract – lessors : Determining the consideration in the contract As discussed at 3.2.3.A above, 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: (a) lease payments as described at 4.5 below; (b) the following other payments not labelled in the contract as lease payments: (i) 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;

Answer 53

(ii) 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; and (iii) 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: (A) the lessor’s efforts to transfer one or more goods or services that are not leases; or (B) an outcome from transferring one or more goods or services that are not leases.

Question 54

Contract combinations An entity combines two or more contracts entered into at or near the same time with the same counterparty (or related parties of the counterparty), and accounts 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;

Answer 54

(b) the amount of consideration to be paid in one contract depends on the price or performance of the other contract; or (c) the rights to use underlying assets conveyed in the contracts (or some rights to use underlying assets conveyed in each of the contracts) form a single lease component. [IFRS 16.B2]. The IASB developed these criteria to address concerns that separately accounting for multiple contracts may not result in a faithful representation of the combined transaction. [IFRS 16.BC130-132].

Question 55

KEY CONCEPTS

Answer 55

Inception date of the lease (inception date) IFRS 16 requires customers and suppliers to determine whether a contract is a lease at inception of the lease. The inception date 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. [IFRS 16 Appendix A]. The underlying asset is the asset that is subject to a lease, for which the right to use that asset has been provided by a lessor to a lessee. [IFRS 16 Appendix A].

Question 56

Commencement date of the lease The commencement date of the lease is the date on which the lessor makes an underlying asset available for use by a lessee. [IFRS 16 Appendix A]. 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).

Answer 56

If a lessee 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 lease of low-value asset exemption discussed below) 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.

Question 57

Lessee involvement with the underlying asset before the commencement date 1 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. [IFRS 16.B43].

Answer 57

If a 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. [IFRS 16.B44].

Question 58

Lessee involvement with the underlying asset before the commencement date 2 A 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. [IFRS 16.B45].

Answer 58

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 SALE AND LEASEBACK TRANSACTIONS below. [IFRS 16.B46].

Question 59

Lessee involvement with the underlying asset before the commencement date 3 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.

Answer 59

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. [IFRS 16.B47].

Question 60

Lease term and purchase options 1 An entity determines the lease term as the non-cancellable period of the lease, together with both: • 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. [IFRS 16.18].

Answer 60

Purchase options are assessed in the same way as options to extend or terminate the lease. The IASB indicated 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. [IFRS 16.BC173]. The lease term begins at the commencement date and includes any rent-free periods provided to the lessee by the lessor. [IFRS 16.B36].

Question 61

Lease term and purchase options 2 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. [IFRS 16.19, IFRS 16.B37].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.

Answer 61

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).

Question 62

Lease term and purchase options 3 (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; (c) costs relating to the termination of the lease, such as negotiation costs, 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;

Answer 62

(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 (i.e. when the option can be exercised only if one or more conditions are met), and the likelihood that those conditions will exist. [IFRS 16.B37].

Question 63

Lease term and purchase options 4 The longer the period from commencement of the lease 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.

Answer 63

The further into the future that the option exercise 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. For example, the difference between the option purchase 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.

Question 64

Lease term and purchase options 5 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.

Answer 64

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.

Question 65

Lease term and purchase options 6 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 (see below), an entity assumes that the lessee is reasonably certain to exercise the option to extend the lease, or not to exercise the option to terminate the lease. [IFRS 16.B38].

Answer 65

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. [IFRS 16.B39].

Question 66

Lease term and purchase options 7 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.

Answer 66

For example, if a 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 considers the economic reasons for that past practice in assessing whether it is reasonably certain to exercise an option on leases of those assets. [IFRS 16.B40].

Question 67

Lease term and purchase options 8 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.

Answer 67

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 Example 24.11, Scenario C. Example 24.11: Determining the lease term

Question 68

Lease term and purchase options - Cancellable leases In determining the lease term and assessing the length of the non-cancellable period of a lease, an entity applies the definition of a contract and determines the period for which the contract is enforceable. A lease is no longer enforceable when the lessee and the lessor each has the right to terminate the lease without permission from the other party with no more than an insignificant penalty. [IFRS 16.B34].

Answer 68

Any non-cancellable periods (by the lessee and lessor) in contracts that meet the definition of a lease are considered part of the lease term. IFRS 16 further provides that, 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. [IFRS 16.B35]. Example 24.12: Cancellable leases

Question 69

Lease term and purchase options - Reassessment of lease term and purchase options lessees 1 After lease commencement, IFRS 16 requires lessees to monitor leases for significant changes that could trigger a change in the lease term. A lessee reassesses 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 :

Answer 69

(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. [IFRS 16.20].

Question 70

Lease term and purchase options - Reassessment of lease term and purchase options lessees 2 Examples of significant events or changes in circumstances that would trigger a reassessment 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; (b) a significant modification to, or customisation of, the underlying asset that was not anticipated at the commencement date;

Answer 70

(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). [IFRS 16.B41].

Question 71

Lease term and purchase options - Reassessment of lease term and purchase options lessees 3 An entity revises 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;

Answer 71

(c) 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 (d) an event occurs that contractually prohibits the lessee from exercising an option previously included in the entity’s determination of the lease term. [IFRS 16.21].

Question 72

Lease term and purchase options - Reassessment of lease term and purchase options lessees 4 As a 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.

Answer 72

Additionally, if the reassessment of lease term or the exercise of a purchase option results in a change, lessees 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, a lessee would recognise any remaining amount in profit or loss. See Reassessment of the lease liability below.

Question 73

Lease term and purchase options - Reassessment of lease term and purchase options – lessors IFRS 16 requires a lessor to revise the lease term to account for a 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.

Answer 73

no note

Question 74

Lease payments 1 Lease payments are 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;

Answer 74

(c) the exercise price of a purchase option if the lessee is reasonably certain 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.

Question 75

Lease payments 2 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.

Answer 75

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. [IFRS 16 Appendix A].

Question 76

Lease payments - In-substance fixed lease payments 1 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:

Answer 76

(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;

Question 77

Lease payments - In-substance fixed lease payments 2 (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 considers the realistic set of payments to be lease payments; or

Answer 77

(c) there is more than one realistic set of payments that a lessee could make, but it must make at least one of those sets of payments. In this case, an entity considers the set of payments that aggregates to the lowest amount (on a discounted basis) to be lease payments. [IFRS 16.B42].

Question 78

Lease payments - Lease incentives Lease incentives are defined as ‘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’. [IFRS 16 Appendix A]. A lease agreement with a lessor might include incentives for the lessee to sign the lease, such as an up-front 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. [IFRS 16.24(b)].

Answer 78

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). [IFRS 16.27(a)]. 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. [IFRS 16.70(a)]. 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.

Question 79

Lease payments - Variable lease payments that depend on an index or rate Variable lease payments that depend on an index or a rate include, for example, payments linked to a consumer price index, payments linked to a benchmark interest rate (such as LIBOR) or payments that vary to reflect changes in market rental rates. [IFRS 16.28]. 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).

Answer 79

The IASB indicated in the Basis for Conclusions 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. [IFRS 16.BC165]. 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. [IFRS 16.42(b)]. Example 24.13: Variable lease payment that depends on an index or rate

Question 80

Lease payments - 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. See Lease term and purchase options above.

Answer 80

Lease payments - 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.

Question 81

Lease payments - 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 unconditional 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. [IFRS 16.BC170]. 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. [IFRS 16.42(a)]. Example 24.14: Residual value guarantee included in lease payments

Answer 81

Lease payments - Amounts payable under 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. [IFRS 16.70(c)]. This amount included in lease payments is different to that for a lessee which only includes the amount expected to be payable. See Amounts expected to be payable under residual value guarantees – lessees only above.

Question 82

Lease payments - Amounts not included in lease payments – lessees only Variable lease payments that do not depend on an index or rate and are not in-substance fixed (see In-substance fixed lease payments above), 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.

Answer 82

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. [IFRS 16.38(b)].

Question 83

Lease payments - 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 Remeasurement of lease liabilities - Lessee below). 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. [IFRS 16.39].

Answer 83

Lease payments - 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. See Lease modifications - Lessor below.

Question 84

Discount rates 1 Discount rates are used to determine the present value of the lease payments which are used to determine lease classification and to measure a lessor’s net investment in the lease and a lessee’s lease liability. The discount rate for lessors is the interest rate implicit in the lease, which is defined as the rate 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. [IFRS 16 Appendix A].

Answer 84

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.

Question 85

Discount rates 2 For lessees, lease payments are 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 uses the incremental borrowing rate. [IFRS 16.26]. 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.

Answer 85

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 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. [IFRS 16 Appendix A].

Question 86

Discount rates 3 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.

Answer 86

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. 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 below.

Question 87

Initial direct costs 1 Initial direct costs are 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. [IFRS 16 Appendix A].

Answer 87

For lessors, 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 and there is no need to add them separately. [IFRS 16.69]

Question 88

Initial direct costs 2 IFRS 16 requires lessees to include their initial direct costs in their initial measurement of the right-of-use asset. As noted above, 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.

Answer 88

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. The revised definition under IFRS 16 could result in some changes in practice for lessors. Lessor’s initial direct costs will now also exclude costs incurred regardless of whether the lease is obtained (e.g. certain legal advice).

Question 89

Initial direct costs - Directly attributable costs other than initial direct costs incurred by lessees 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.

Answer 89

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.

Question 90

Economic life The economic life is 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. [IFRS 16 Appendix A].

Answer 90

Fair value The fair value for the purposes of applying the lessor accounting requirements in IFRS 16 is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. [IFRS 16 Appendix A].

Question 91

LESSEE ACCOUNTING

Answer 91

LESSEE ACCOUNTING

Question 92

Initial recognition At the commencement date, a lessee recognises a right-of-use asset and a lease liability. [IFRS 16.22]. This applies to all leases unless the lessee elects the short-term lease and/or lease of low-value asset recognition exemptions, discussed below.

Answer 92

If an entity applies the exemptions it must disclose that fact. [IFRS 16.60].

Question 93

Initial recognition - Short-term leases 1 A short-term lease is 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. [IFRS 16 Appendix A]. 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. [IFRS 16.8].

Answer 93

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 applies another systematic basis if that basis is more representative of the pattern of the lessee’s benefit. [IFRS 16.6].

Question 94

Initial recognition - Short-term leases 2 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. 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.

Answer 94

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.

Question 95

Initial recognition - Short-term leases 3 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). [IFRS 16.7]. The new lease is evaluated to determine whether it qualifies for the short-term exemption, similar to any other new lease.

Answer 95

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

Question 96

Initial recognition - Short-term leases 4 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.

Answer 96

Example 24.16: Short-term lease

Question 97

Initial recognition - Leases of low-value assets 1 Lessees can also make an election for leases of low-value assets, which can be made on a lease-by-lease basis. [IFRS 16.8]. A lessee that makes this accounting policy 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.

Answer 97

The lessee applies another systematic basis if that basis is more representative of the pattern of the lessee’s benefit. [IFRS 16.6]

Question 98

Initial recognition - Leases of low-value assets 2 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. [IFRS 16.B3]. 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. [IFRS 16.B4]

Answer 98

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. [IFRS 16.BC100]. Examples of low-value assets include desktop and laptop computers, small items of office furniture, telephones and other low-value equipment [IFRS 16.B8] and excludes cars because a new car would typically not be of low value. [IFRS 16.B6].

Question 99

Initial recognition - Leases of low-value assets 3 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; and • the underlying asset is not dependent on, or highly interrelated with, other assets. [IFRS 16.B5].

Answer 99

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 therefore are dependent on, or highly interrelated with the truck. Therefore the tyres would not qualify for the low-value asset exemption.

Question 100

Initial recognition - Leases of low-value assets 4 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. [IFRS 16.B6].

Answer 100

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. [IFRS 16.B7].

Question 101

Initial measurement - Right-of-use assets 1 At commencement date, a lessee measures the right-of-use asset at cost. [IFRS 16.23]. The cost of a right-of-use asset comprises: • the amount of the initial measurement of the lease liability; • any lease payments made at or before the commencement date, less any lease incentives received;

Answer 101

* any initial direct costs incurred by the lessee; and * 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 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. [IFRS 16.24].

Question 102

Initial measurement - Right-of-use assets 2 A lessee recognises dismantling, removal and restoration costs above 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.

Answer 102

The obligations for such costs are recognised and measured applying IAS 37 – Provisions, Contingent Liabilities and Contingent Assets. [IFRS 16.25].

Question 103

Initial measurement - Lease liabilities 1 At the commencement date, a lessee measures the lease liability at the present value of the lease payments that are not paid at that date. The lease payments are discounted using the interest rate implicit in the lease, if that rate can be readily determined.

Answer 103

If that rate cannot be readily determined, the lessee uses the lessee’s incremental borrowing rate. [IFRS 16.26].

Question 104

Initial measurement - Lease liabilities 2 At the commencement date, the lease payments included in the measurement of the lease liability comprise (consist of) the following payments for the right to use the underlying asset during the lease term that are not paid at the commencement date: • fixed payments (including in-substance fixed payments), less any lease incentives receivable; • variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date;

Answer 104

* amounts expected to be payable by the lessee under residual value guarantees; * the exercise price of a purchase option if the lessee is reasonably certain to exercise that option; and * payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease. [IFRS 16.27].

Question 105

Subsequent measurement - Right-of-use assets After the commencement date, a lessee measures the right-of-use asset applying a cost model, unless it applies either of the measurement models described in Other measurement models below. [IFRS 16.29].

Answer 105

no note

Question 106

Subsequent measurement - Right-of-use assets : Cost model 1 To apply the cost model, the lessee measures the right-of-use asset at cost: • less any accumulated depreciation and accumulated impairment losses; and • adjusted for the remeasurement of the lease liability described in Remeasurement of lease liabilities below. [IFRS 16.30]. A lessee applies the depreciation requirements in IAS 16 in depreciating the right-of use asset, subject to the following requirements. [IFRS 16.31].

Answer 106

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. [IFRS 16.32].

Question 107

Subsequent measurement - Right-of-use assets : Cost model 2 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.

Answer 107

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.

Question 108

Subsequent measurement - Right-of-use assets : Cost model 3 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 be depreciated separately. An entity allocates the amount initially recognised with respect to an item of property, plant and equipment to its significant parts and depreciates separately each such part

Answer 108

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-ofuse asset is impaired and to account for any impairment loss identified. [IFRS 16.33].

Question 109

Subsequent measurement - Right-of-use assets : Other measurement models If a lessee applies the fair value model in IAS 40 – Investment Property – to its investment property, the lessee also applies that fair value model to right-of-use assets that meet the definition of investment property in IAS 40. [IFRS 16.34].

Answer 109

``` 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. [IFRS 16.35]. ```

Question 110

Subsequent measurement - Lease liabilities After the commencement date, a lessee measures 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 (c) remeasuring the carrying amount to reflect any reassessment or lease modifications specified, or to reflect revised in-substance fixed lease payments. [IFRS 16.36].

Answer 110

Interest on the lease liability in each period during the lease term is 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 at commencement, unless a reassessment requiring a change in the discount rate has been triggered. [IFRS 16.37].

Question 111

Subsequent measurement - Expense recognition 1 After the commencement date, the lessee recognises depreciation and impairment of the right-of-use asset in profit or loss, unless depreciation is permitted to be capitalised (e.g. to inventory) under other IFRS (or the lessee applies the fair value model described in at Other measurement models above).

Answer 111

A lessee also recognises in profit or loss, unless the costs are included in the carrying amount of another asset applying other IFRS, 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. [IFRS 16.38]

Question 112

Subsequent measurement - Expense recognition 2 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, the interest expense decreases as cash payments are made during the lease term and the lease liability decreases.

Answer 112

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. This expense pattern is consistent with the subsequent measurement of finance leases under IAS 17.

Question 113

Subsequent measurement - Expense recognition 3 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.

Answer 113

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. See Impairment of right-of-use assets below for additional discussion of impairment of right-of-use assets.

Question 114

Remeasurement of lease liabilities 1 After the commencement date, a lessee remeasures the lease liability to reflect changes to the lease payments. A lessee recognises the amount of the remeasurement of the lease liability as an adjustment to the right-of-use asset.

Answer 114

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. [IFRS 16.39].

Question 115

Remeasurement of lease liabilities 2 A lessee remeasures the lease liability by discounting the revised lease payments using a revised discount rate, if: (a) there is a change in the lease term. A lessee determines 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 in the context of a purchase option. A lessee determines the revised lease payments to reflect the change in amounts payable under the purchase option. [IFRS 16.40].

Answer 115

The lessee determines 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. [IFRS 16.41].

Question 116

Remeasurement of lease liabilities 3 A lessee remeasures the lease liability by discounting the revised lease payments, if: (a) there is a change in the amounts expected to be payable under a residual value guarantee. A lessee determines the revised lease payments to reflect the change in amounts expected to be payable under the residual value guarantee;

Answer 116

(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 remeasures the lease liability to reflect those revised lease payments only when there is a change in the cash flows (i.e. when the adjustment to the lease payments takes effect). A lessee determines the revised lease payments for the remainder of the lease term based on the revised contractual payments. [IFRS 16.42].

Question 117

Remeasurement of lease liabilities 4 In applying the paragraph above, a lessee uses an unchanged discount rate, unless the change in lease payments results from a change in floating interest rates. In that case, the lessee uses a revised discount rate that reflects changes in the interest rate. [IFRS 16.43]

Answer 117

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.

Question 118

Remeasurement of lease liabilities 5 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.

Answer 118

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. Example: Remeasuring the lease liability (change in lease term) Emile Woolf for Remeasurement of lease liabilities

Question 119

Lease modifications 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 (for example, adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term). [IFRS 16 Appendix A]. If a lease is modified, the modified contract is evaluated to determine whether it is or contains a lease (see Determining whether an arrangement contains a lease above).

Answer 119

If a lease continues to exist, the lease modification can result in: • a separate lease; or • a change in the accounting for the existing lease (i.e. not 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 (see Remeasurement of lease liabilities above).

Question 120

Lease modifications - Determining whether a lease modification results in a separate lease A lessee accounts for a lease modification as a separate 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; and • the consideration for the lease increases commensurate with the stand-alone price for the increase in scope and any adjustments to that stand-alone price reflect the circumstances of the particular contract. [IFRS 16.44].

Answer 120

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. If either of the conditions are not met, the modified lease is not accounted for as a separate lease (see Lessee accounting for a modification that does not result in a separate lease below).

Question 121

Lease modifications - Lessee accounting for a modification that does not result in a separate lease 1 For a lease modification that is not accounted for as a separate lease, at the effective date of the lease modification the lessee: (a) allocates the consideration in the modified contract; (b) determines the lease term of the modified lease; and (c) remeasures the lease liability by discounting the revised lease payments 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. [IFRS 16.45].

Answer 121

For a lease modification that is not accounted for as a separate lease, the lessee accounts 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 recognises in profit or loss any gain or loss relating to the partial or full termination of the lease; or (b) making a corresponding adjustment to the right-of-use asset for all other lease modifications. [IFRS 16.46]

Question 122

Lease modifications - Lessee accounting for a modification that does not result in a separate lease 2 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.

Answer 122

• 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 existing lease component and non-lease component and remeasure the lease liability at the date both parties agreed to the modification (the beginning of year 8).

Question 123

Lease modifications - Lessee accounting for a modification that does not result in a separate lease 3 • If the modification results in a separate lease component, the lessee will allocate the consideration in the modified contract to each existing and new lease and nonlease component 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).

Answer 123

• 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). *See Example Emile

Question 124

Other lessee matters - Impairment of right-of- use assets 1 A lessee applies IAS 36 to determine whether the right-of-use asset is impaired and to account for any impairment loss identified. [IFRS 16.33]. 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 of which the asset is a part – the CGU).

Answer 124

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.

Question 125

Other lessee matters - Impairment of right-of- use assets 2 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.

Answer 125

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.

Question 126

Other lessee matters - 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.

Answer 126

The IASB acknowledged in the Basis for Conclusions 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. [IFRS 16.BC199].

Question 127

Other lessee matters - Income tax accounting IFRS 16 could affect lessees’ accounting for income taxes. For lessees, IFRS 16 requires recognition of lease-related assets and liabilities that are not on the balance sheet under today’s accounting (i.e. amounts related to leases that are operating leases under IAS 17) and could change the measurement of other lease-related assets and liabilities.

Answer 127

These changes affect certain aspects of accounting for income taxes such as the following: (a) recognition and measurement of deferred tax assets and liabilities; and (b) assessment of the recoverability of deferred tax assets.

Question 128

Presentation 1 A lessee presents either in the statement of financial position, or discloses 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: (i) includes 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) discloses which line items in the statement of financial position include those right-of-use assets;

Answer 128

(b) lease liabilities separately from other liabilities. If the lessee does not present lease liabilities separately in the statement of financial position, the lessee discloses which line items in the statement of financial position include those liabilities. [IFRS 16.47].

Question 129

Presentation 2 The requirement above does not apply to right-of-use assets that meet the definition of investment property, which is presented in the statement of financial position as investment property. [IFRS 16.48]. 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.

Answer 129

In the statement of profit or loss and other comprehensive income, a lessee presents 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. [IFRS 16.49].

Question 130

Presentation 3 In the statement of cash flows, a lessee classifies: (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; and

Answer 130

(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. [IFRS 16.50].

Question 131

Presentation - Statement of financial position Right-of-use assets presented either: • separately from other assets (e.g. owned assets); or • 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.

Answer 131

Lease liabilities presented either: • separately from other liabilities; or • together with other liabilities with disclosure of the balance sheet line items that include lease liabilities and their amounts.

Question 132

Presentation - 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).

Answer 132

Interest expense on the lease liability is a component of finance costs.

Question 133

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.

Answer 133

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.

Question 134

Disclosure - Disclosure objective 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. [IFRS 16.51].

Answer 134

A lessee discloses information about its leases for which it is a lessee in a single note or separate section in its financial statements. However, a lessee need not duplicate information that is already presented elsewhere in the financial statements, provided that the information is incorporated by cross-reference in the single note or separate section about leases. [IFRS 16.52].

Question 135

Disclosure - Disclosures of assets, liabilities, expenses and cash flow 1 IFRS 16 paragraph 53 includes the following disclosure requirements for lessees, for the reporting period: (a) depreciation charge for right-of-use assets by class of underlying asset; (b) interest expense on lease liabilities; (c) the expense relating to short-term leases. 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. This expense does not include the expense relating to short-term leases of low-value assets included in paragraph (c) above;

Answer 135

(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. [IFRS 16.53].

Question 136

Disclosure - Disclosures of assets, liabilities, expenses and cash flow 2 A lessee provides the disclosures specified in paragraph 53, as shown above, in a 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. [IFRS 16.54].

Answer 136

A lessee discloses the amount of its lease commitments for short-term leases 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) above relates. [IFRS 16.55].

Question 137

Disclosure - Disclosures of assets, liabilities, expenses and cash flow 3 If right-of-use assets meet the definition of investment property, a lessee applies 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) above, for those right-of-use assets. [IFRS 16.56].

Answer 137

``` If a lessee measures right-of-use assets at revalued amounts applying IAS 16, the lessee discloses the information required by paragraph 77 of IAS 16 for those right-of-use assets. [IFRS 16.57]. Those disclosures include the effective date of the revaluation, whether an independent valuer was involved, the carrying amount of the class of asset that would have been recognised under the cost model and the revaluation surplus. ```

Question 138

Disclosure - Disclosures of assets, liabilities, expenses and cash flow IFRS 16 requires disclosure of the total cash outflow for leases. [IFRS 16.53(g)].It does not explicitly state that leases of low-value assets and short-term leases are excluded.

Answer 138

Therefore, we believe the cash outflows related to those leases should be included in the disclosure.