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 in various posts the main aspects of the accounting model for lessees, and last time we looked at some of the mechanics of making the transition to the new standard. As we discussed, entities can choose to adopt IFRS 16 retrospectively, recognizing the cumulative effect of initially applying the standard at the date of initial application. We left off before addressing how an entity recognizes and measures the initial right-of-use asset in that situation. So here’s what IFRS 16 has to say about that:
“The lessee shall choose, on a lease-by-lease basis, to measure that right-of-use asset at either:
- (i) its carrying amount as if the Standard had been applied since the commencement date, but discounted using the lessee’s incremental borrowing rate at the date of initial application; or
- (ii) an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease recognized in the statement of financial position immediately before the date of initial application.”
The second of these approaches will often increase lease-related costs artificially in the years immediately following transition to IFRS 16 (because the depreciation charge would typically be higher than if IFRS 16 had always been applied). On the other hand, it will often be easier and more cost-effective than any other method. Unable to find a single way through these conflicting merits, the IASB decided to allow a choice. It expects issuers “to select the less costly option only for leases for which the costs of applying a more accurate transition approach outweigh the benefit of achieving a ‘correct’ post-transition income statement. The IASB expects this to apply to leases that are high in volume but low in value but not to leases such as long-term leases of property or large equipment.”
The issuer will usually also apply IAS 36 Impairment of Assets to right-of-use assets at the date of initial application, thus possibly measuring an impairment loss at that date. As an alternative to performing an impairment review, it may rely on its assessment of whether leases are onerous, applying IAS 37 immediately before the date of initial application. If a lessee chooses this practical expedient, it adjusts the right-of-use asset at the date of initial application by the amount of any provision for onerous leases it recognizes in the statement of financial position immediately before the date of initial application. The IASB regarded this as a reasonable practical expedient, given that if an entity identifies an onerous operating lease liability applying IAS 37, this likely reflects impairment of the right-of-use asset.
An issuer isn’t required to make any adjustments on transition for leases for which the underlying asset is of low value (and which are accounted for as discussed here). All the lessee has to do there is to apply the standard from the date of initial application (which may not mean doing too much at all). Also, a lessee may elect not to apply the standard to leases for which the lease term ends within twelve months of the date of initial application, accounting for these as short term leases – the IASB says it expects this short-cut to provide a significant cost saving.
Another practical expedient: the issuer may exclude initial direct costs when it measures the right-of-use asset at the date of initial application; as discussed here, it normally treats these as part of that asset’s initial cost. The IASB says it doesn’t expect this concession to have a significant impact on reported information. And bending a little on its neurotic fear of ever using hindsight, the IASB decided to allow a lessee to use hindsight on transition, such as in determining the lease term for a contract containing options to extend or terminate the lease. In this case, it thinks using hindsight “will result in useful information,” as well as of course being somewhat simpler.
An issuer taking a “cumulative catch up” approach to adopting IFRS 16 will make most of the IAS 8-type disclosures you’d expect in such situations, as well as the following specific items (interesting to muse on the likely utility of these):
- (a) the weighted average lessee’s incremental borrowing rate applied to lease liabilities recognized in the statement of financial position at the date of initial application; and
- (b) an explanation of any difference between:
- (i) operating lease commitments disclosed applying IAS 17 at the end of the annual reporting period immediately preceding the date of initial application, discounted using the incremental borrowing rate at the date of initial application…; and
- (ii) lease liabilities recognized in the statement of financial position at the date of initial application.
The issuer also discloses any practical expedients it may have applied. These, of course, are in addition to all the other ongoing IFRS 16 disclosures, which we’ll discuss in a future post. That is, if anyone is still with me after ploughing through the above…
The opinions expressed are solely those of the author