Liabilities and equity
IFRS 16 · Leases (lessee)
The right to use is an asset, the duty to pay is a debt; interest on the debt is a finance cost.
Draft: not yet reviewed by a teacher
Why it exists
Under the old IAS 17 a lessee could use aircraft, shops and vans for years while showing only a rent expense: the debt to the lessor stayed off the balance sheet, and companies that leased looked less indebted than companies that bought the same assets with a loan. IFRS 16 removed that difference: a lease is buying a right of use on instalments.
Key rules
- At the commencement date the lessee recognises a right-of-use asset and a lease liability. A lessee does not classify leases as finance or operating.
- Liability = the present value of the lease payments not yet paid at commencement, discounted at the rate implicit in the lease or, if that cannot be readily determined, at the lessee's incremental borrowing rate.
- Asset = the liability + payments made at or before commencement − lease incentives received + initial direct costs + estimated dismantling and restoration costs.
- Afterwards: interest on the liability is a finance cost (the financing category under IFRS 18) and the payments reduce the liability; the asset is depreciated over the shorter of the lease term and the useful life, or over the useful life if ownership transfers or a purchase option is reasonably certain to be exercised.
- Optional exemptions: short-term leases (12 months or less, no purchase option) and leases of assets that are low-value when new. Their payments are expensed on a straight-line basis over the lease term.
- Sale and leaseback where the transfer is a sale under IFRS 15: the right-of-use asset is the share of the previous carrying amount for the rights retained, and gain is recognised only on the rights transferred to the buyer. If it is not a sale, the asset stays and the cash received is a financial liability.
Examples
A courier company leases vans for 5 years: 250 thousand AZN a year in advance, rate 8%, four-year factor 3.312. Legal fees 12, incentive from the lessor 20, livery removal (provision) 10.
- Liability: 250 × 3.312 = 828
- Asset: 828 + 250 + 12 − 20 + 10 = 1,080; depreciation 1,080 / 5 = 216
- 2026 interest: 8% × 828 = 66; liability at 31 December 2026: 894
- Split: current 250, non-current 644
A building with a carrying amount of 2,400 is sold at its fair value of 4,000 and leased back; the present value of the payments is 1,200.
- Share retained: 1,200 / 4,000 = 30%
- Right-of-use asset: 30% × 2,400 = 720
- Gain: (4,000 − 2,400) × 70% = 1,120
- Entry: Dr Bank 4,000, Dr ROU 720 / Cr PPE 2,400, Cr Lease liability 1,200, Cr Gain 1,120
How it works
The liability table depends on when the payments fall:
- in arrears: opening balance + interest − payment = closing balance;
- in advance: opening balance − payment = the base, + interest = closing balance.
The current and non-current split (ACCA's approach): non-current is what is left after the next payment, without future interest. In arrears, that is the balance at the end of next year; in advance, it is the balance straight after next year's 1 January payment, and the current part is the whole next payment.