1. Overall Impact
Impact on Accounting:
IFRS 16 introduces a significant change in the accounting treatment of operating leases, finance leases, and other complex transactions such as sale and leaseback arrangements…
+ For lessees: the new standard eliminates the classification of leases as either operating leases or finance leases. Instead, nearly all leases are capitalized by recognizing a lease liability and a right-of-use asset on the balance sheet – accompanied by depreciation of the asset and interest expense on the lease liability.
+ For lessors: the standard requires lessors to classify each lease as either an operating lease or a finance lease. For finance leases: at the commencement of the lease, the lessor recognizes the asset held under the finance lease as a receivable at an amount equal to the net investment in the lease and recognizes finance income over the lease term based on a pattern reflecting a constant periodic rate of return on the net investment. For operating leases: the lessor recognizes lease payments as income on a straight-line basis.
Impact on Financial Ratios:
With the recognition of lease liabilities (including both long-term and short-term liabilities) and right-of-use assets, an entity’s current financial ratios may change upon applying the new standard. These changes may affect the entity’s financial ratios as well as the covenants of existing loan agreements.
The objective of IFRS 16 is to report information that faithfully represents lease transactions and provides a basis for users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. To meet this objective, lessees are required to recognize assets and liabilities arising from leases.
2. Key Issues to Note During Transition
| Content | IFRS | VAS |
| IFRS 16 – Leases (Effective from January 1, 2019) and VAS 6 – Leases | ||
| Lessee Accounting – Initial Recognition | At the commencement date (when the leased asset is ready for use), the lessee must recognize a right-of-use asset and a lease liability:
| Under VAS 6, an operating lessee only recognizes periodic lease payments as an expense. A finance lessee must recognize a finance lease asset and a finance lease liability. |
| Lessee Accounting – Subsequent Measurement | The right-of-use asset is measured using the cost model. The lease liability is measured by:
| No specific provisions apply for operating lessees. For finance lessees: the finance lease asset is depreciated, and the lease liability is accounted for using the amortized cost method. |
| New Definitions and Requirements under IFRS 16 | ||
| Scope | IFRS 16 applies to all lease contracts, including subleases, except for: (a) Leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources; (b) Leases of biological assets held by a lessee (see IAS 41 Agriculture); (c) Service concession arrangements (see IFRIC 12); (d) Rights held by a lessee under licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents, and copyrights within the scope of IAS 38 Intangible Assets; and (e) Intellectual property rights granted by a lessor (see IFRS 15 Revenue from Contracts with Customers). | |
| Exemptions | The following cases qualify for exemption from IFRS 16: (a) Leases with a lease term of 12 months or less and without a purchase option; (b) Leases where the underlying asset is of low value and is a new asset. | |
| First-time Application | IFRS 16 allows two retrospective methods for first-time application:
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| Determining the Discount Rate | The interest rate implicit in the lease is the discount rate that, at the commencement date, 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) the lessor’s initial direct costs. If the interest rate implicit in the lease cannot be readily determined, the discount rate shall be the lessee’s incremental borrowing rate at the commencement date. | |
| Reassessment | If there are indications of impairment of the leased asset, IAS 36 shall be applied to perform an impairment test on the right-of-use asset. | |
| Sale and Leaseback Transactions | IFRS 16 requires an assessment of the substance of the transactions – specifically, whether the “sale” qualifies under IFRS 15 – before determining the appropriate accounting treatment. | |
| Lease Modifications/Amendments | IFRS 16 requires an assessment of whether the modification or amendment results in the lessee having to account for the change as a separate lease. | |
3. Tasks to Be Performed
- The company needs to estimate the impact of the changes when applying IFRS 16 on the financial ratios currently used, including the conditions in debt covenants.
- Renegotiate lease contracts and identify key contract terms that may affect financial ratios if necessary.
