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PRACTICAL IFRS 16 TRAINING

Table Of Contents

1IFRS 16 Overview

2Lease Identification

3Initial Measurement

4Subsequent Measurement

5Modifications and Remeasurements

6Presentation and Disclosure


IFRS 16 OVERVIEW


INTRODUCTION TO IFRS 16

Welcome to Rubli's practical IFRS 16 guide!

At first glance, IFRS 16 for leases seems like a complex standard. We believe it
is because the standard includes rules for every type of scenario and many
iterations of the same topic, viewed from different angles.

Our guide will look at the fundamentals of IFRS 16 with a focus on the common
use cases. We'll also provide extra insights from experience gained in numerous
IFRS 16 implementations and supporting our clients.

Before we roll up our sleeves and get into the thick of things, let's take a
quick detour and talk about why IFRS 16 was introduced. It will help you
understand the logic of some of the rules, while grasping a few concepts.

Imagine that you have a company that needs a lot of vehicles to operate. You
probably don't have the money to buy all the vehicles.
So, you have two other options:

 * You can either go to a bank and take out a loan and buy the vehicle or;
 * You can agree to use a vehicle in exchange for a monthly cost (leasing it).

If you were to buy the vehicle, you will have the cost of the vehicle as an
asset, the loan as a liability with monthly loan payments. On the income
statement side, there will be depreciation of the vehicle and interest cost.

Now before IFRS 16, if you leased your vehicles, you would only have the lease
expense with no impact on the balance sheet.

You can see that although the operations would be the same for this company, it
would be very difficult to compare two companies solely on their balance sheets
and income statement.

In effect companies could easily hide onerous lease commitments from their
balance sheet.
Even well-known ratios such as ‘return on assets' would be distorted, because
well, you show no asset with a lease, so this ratio will look much better than
it should.

So, in short, IFRS 16 is mitigating off-balance sheet accounting while
increasing comparability.


IFRS 16 OVERVIEW

Now to get back to your lease accounting journey.
IFRS 16 in brief, has the following main topics for both the lessee (MAKING
payments) and the lessor (RECEIVING payments).

There is a lease contract, where an asset may be used for a period of time in
exchange for money (the consideration). This results in a lessee-lessor
relationship with a lease liability and right-of-use asset for the lessee and a
lease receivable for the lessor.


1. LEASE CONTRACT CONSIDERATIONS

The first step is to determine if IFRS 16 is applicable in a contract. The
standard goes into a lot of detail whether IFRS 16 is applicable or not.

The standard now includes a new definition for a lease to guide you with your
decision. This inclusion in the standard was purposefully done because some
people will draft a contract to mitigate a lease contract and side-step the
standard. So now companies must consider any contract and if there is any
indication if it contains a lease contract.

There are various considerations and a lot of guidance provided by IFRS 16 lease
accounting, but that's only applicable when contract terms start getting
‘creative'.

If you are looking for more detail on lease identification and if this is a
lease contract, the next guide in the training looks at this in detail.

This guide also includes a flowchart to help you to determine if the contract
contains a lease.
The Rubli lease tool includes a "Lease checklist" to determine if a contract
contains a lease as per IFRS 16, with the guidance and related paragraph
references included. It is a good step to take before a new lease is loaded and
accounted for.


2. LESSEE ACCOUNTING

For the person making the payment - The Lessee, there is no longer any
classification of a lease and it will be accounted for as a finance lease (don't
worry if you are unfamiliar with this term).
This will lead to the recognition of a lease liability, which is the discounted
lease payments from the contract and the recognition of a right-of-use asset
(usually at the same value).

As the lessee, the accounting of IFRS 16 for a lease is mimicking the accounting
treatment of a loan. So as the lessee, you are creating a hypothetical loan (the
lease liability), with a similar interest rate that the bank would have given
you.

The lease liability is amortized over the lease period, which means it will be
increased by the interest and reduced by the lease payments. Similarly, your
asset will be depreciated over the lease period.

Practical observations
You may think that IFRS 16 is changing the profit of a company, however, it is
actually just shifting the expenses slightly compared to the normal lease
expense. The two income statement lines (depreciation and interest expense) will
be equal to total lease payments over the lifetime of the lease.

The timing difference of the expense generally relates to interest expense that
will decrease over the term of the lease (because the outstanding balance is
being paid-off), while the depreciation remains fixed. So, the bulk of the
"lease" expense is recognized in the early years.

This table below shows this graphically for a 5-year lease:

Year Depreciation Interest Expense Total IFRS 16 expense "Lease" Expense
Difference 1 82 004 28 701 110 705 100 000 10 705 2 82 004 23 710 105 714 100
000 5 714 3 82 004 18 370 100 374 100 000 374 4 82 004 12 656 94 660 100 000 (5
340) 5 82 004 6 542 88 546 100 000 (11 454) 410 012 89 980 500 000 500 000 -

Recognizing a larger portion of the expense earlier in the term of the lease
doesn't have a big impact, since it averages out on a lease portfolio. Simply
put, some leases are nearing their term end and others would only start now and
because of this mix, the expense holistically is fairly the same each year.

The major effect of IFRS 16 is the creation of a liability and asset at the
start of the lease period.


3. LESSOR ACCOUNTING

The lessor accounting for IFRS 16 did not change a lot from the old standard IAS
17. You would still have to perform the assessment of the lease classification.

The classification can be either a finance lease or an operating lease and that
usually depends on how long the asset will be used, compared to its useful life.

A lease where the asset will either be owned by the lessee at the end of the
lease or the value thereof at the end, will almost have been diminished, will be
a finance lease. This is usually the case with a vehicle lease, because you
would use a vehicle for a period and then when it is ‘old' you would get a new
one for your business.

A finance lease will have a gross lease receivable (sum of all the lease
payments) and unearned finance income (the interest to be received during the
entire lease period).
The net amount of these two is referred to as the net lease receivable, which is
the difference between the gross lease receivable and unearned finance income.
This also happens to equal the present value of the lease payments.

With a finance lease it is seen as a "transfer" or disposal of the asset, so any
depreciation would stop on commencement (start date) of the lease. In exchange
for the asset value, the net lease receivable is recognized.

On the other hand, an operating lease is when the asset will not be leased for
too long, compared to its useful life. This can be a medium-term property lease
for 5 years for example, because a building can be used for much longer than
that.

In this case, the asset is not derecognized, and so the depreciation will
continue to be recognized. The lease payments will be recognized as rental
income over the period of the lease.

Practical observations
The same will apply for the lessor as the lessee regarding the fact that over
the lease period, there will be no difference in the income statement, only a
slight timing difference.
The total lease payments received during the lease period will equal the finance
income and the cost savings of not having to recognize the depreciation expense.
In contrast to the lessee side, the balance sheet impact is minimal.

Regarding the operating lease, if the leased asset is property, you would
probably have to consider if IAS 40 - Investment property is applicable.


CLOSING

IFRS 16 definitely had an impact on the balance sheet for the lessee, but it
will show a more comparable version of financial statements between companies,
without having too much of an impact on the income statement.

The requirements of IFRS 16 can be cumbersome and tedious, with complex
considerations and numerous moving parts on large everchanging lease portfolios.

In the next guide of the training, we'll look at lease identification and how to
determine if your contract should be accounted for in terms of IFRS 16.

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