Lease Accounting

Lease Accounting

Accounting of leases under IFRS 16
Lease accounting is the method of recording and reporting on all of the leased property, equipment, and other non-owned assets that a business or other organization holds. Generally, these contracts are categorized as either operating leases or finance leases.

Under the latest lease accounting standards —IFRS 16, these leases and similar contracts must now be accounted for as assets and liabilities on the balance sheet.

Accounting by lessees Accounting by lessors
For a contract that is or contains a lease a lessee is required to recognize at the commencement date of a lease
· A right-of-use asset; and
· A lease liability.
Lessors should classify each lease as an operating lease or a finance lease. And account for those two leases differently

IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17.

The lease liability needs to be discounted using
· The implicit rate of interest in the lease; or
· If the implicit rate of interest in the lease cannot be readily determined, the lessee’s incremental borrowing rate.

Changes in a company’s balance sheet (Lessees)
Exemption from recognizing asset and liability-IFRS 16 does not require a company to recognize
Assets and liabilities for
(a) Short-term leases-leases of 12 months or less, and
(b) Lease of low-value assets such as a lease of a personal computer.

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Changes in company’s income statement
Companies having material off balance leases, IFRS 16 changes the nature of expenses related to those leases. IFRS 16 replaces typical straight-line operating lease expense for those leases which apply IAS 17 with a depreciation charge for lease assets and an interest expense on lease liabilities. This change helps in   aligning the lease expense treatment for all leases. Although, the depreciation is charged evenly, the interest expense reduces over the life of the lease as lease payments are made. This results in reducing a total expense as an individual lease matures. The difference in the recognition of expense between IFRS 16 and IAS 17 is expected to be insignificant for many companies which are holding a portfolio of leases that start and end in different reporting periods.

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Implications on cash flows
Changes in accounting requirements does not change amount of cash transferred between the parties to a lease. Therefore IFRS 16 will not have any effect on the total amount of cash flows. However, IFRS 16 have an effect on the presentation of cash flows related to previous off balance sheet leases. Because of IFRS 16 operating cash outflows will get reduce, with a corresponding increase in financing cash outflows, compared to the amounts reported by applying IAS 17. This is because, by applying IAS 17, companies presented cash outflows on previous off balance sheet leases as operating activities. On the other hand, applying IFRS 16, principal repayments on all lease liabilities are included within financing activities. Interest payments can also be included within financing activities applying IFRS 16.

Journal Entries

Initial recognition
Debit Right-of-use asset
Credit Lease liability (in the amount of the PV of lease payments)

Subsequent measurement
Right-of-use asset
Debit Profit or loss – Depreciation charge
Credit Accumulated depreciation of right-of-use asset

Lease liability
Debit Profit or loss – Interest expense
Credit Lease liability

The lease payments made are recognized as a reduction of the lease liability:
Debit Lease liability
Credit Bank account (cash)

At AJSH, we assist our clients in accounting, bookkeeping, preparation of financial statements, transition from AS to IFRS. If you have any questions regarding treatment of lease transactions and its implication, kindly click here.