As we discussed here, the IASB has issued IFRS 16 Leases, effective for annual reporting periods beginning on or after January 1, 2019.
We’ve already covered the main aspects of the accounting model for lessees. Here now is what the standard has to say about presentation:
- A lessee shall either present in the statement of financial position, or disclose 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 shall:
- (i) include 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) disclose which line items in the statement of financial position include those right-of-use assets.
- (b) lease liabilities separately from other liabilities. If the lessee does not present lease liabilities separately in the statement of financial position, the lessee shall disclose which line items in the statement of financial position include those liabilities.
- The (above requirement) does not apply to right-of-use assets that meet the definition of investment property, which shall be presented in the statement of financial position as investment property.
- In the statement of profit or loss and other comprehensive income, a lessee shall present 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.
- In the statement of cash flows, a lessee shall classify:
- (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
- (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.
The underlying thinking here is probably fairly self-evident. On the one hand, a lessee often uses owned assets and leased assets for the same purpose and derives similar economic benefits from both. At the same time: “the IASB noted that there are differences between a right-of-use asset and an owned asset, and that users of financial statements may want to know the carrying amount of each separately. For example, right-of-use assets may be viewed as being (a) less risky than owned assets, because a right-of-use asset may not embed residual asset risk; or (b) more risky than owned assets, because the lessee may need to replace the right-of-use asset at the end of the lease term, but may not be able to secure a similar rate for the replacement lease.” Likewise: “Although a lease liability shares many common characteristics with other financial liabilities, a lease liability is contractually related to a corresponding asset and often has features, such as options and variable lease payments, that differ from those typically found in other liabilities.”
Although some respondents to the IASB’s exposure drafts expressed support for recognizing a single lease-related expense, the IASB concluded among other things that recognizing interest on lease liabilities separately from depreciation of right-of-use assets would “create greater comparability in the income statement between entities that borrow to buy assets and those that lease similar assets. Separating interest and depreciation would also provide coherency between the lessee’s balance sheet and income statement (ie the interest expense would correspond to the lease liabilities presented as financial liabilities, and depreciation would correspond to the right-of-use assets presented as non-financial assets). This coherency is important for some analyses, such as calculating return on capital employed and some leverage ratios.”
The requirements for the cash flow statement flow from the view that it would be misleading to portray payments there in a way that differs from the income statement. In summary then, the presentation requirements result: “in a lessee accounting for a lease consistently in the balance sheet, income statement and statement of cash flows. For example, a lessee (a) measures and presents the lease liability similarly to other financial liabilities; (b) recognizes and presents interest relating to that liability in a similar manner to interest on other financial liabilities; and (c) presents cash paid relating to interest on lease liabilities similarly to interest on other financial liabilities.”
Among other things, for companies with material operating leases, IFRS 16 will result in higher EBITDA (in its strict definition) than IAS 17, because EBITDA applying IAS 17 includes the entire operating lease expense from such leases, and under IFRS 16 it doesn’t. Also, IFRS 16 is expected to reduce operating cash outflows, with a corresponding increase in financing cash outflows, compared to the amounts reported applying IAS 17. It’ll take years, of course, to assess whether all of this makes a measurable impact on the quality of capital allocation decisions…
The opinions expressed are solely those of the author