Issues arising in applying the IFRS 16.5 concession that an issuer not apply its requirements to leases for which “the underlying asset is of low value…”
We previously discussed this here, providing some of the IASB’s underlying thinking:
- “…many lessees expressed concerns about the costs of applying the requirements of IFRS 16 to leases that are large in number but low in value. They suggested that such an exercise would require a significant amount of effort with potentially little effect on reported information.
- In the light of these concerns, the IASB decided to provide a recognition exemption for leases of low-value assets…..
- In developing the exemption, the IASB attempted to provide substantive relief to preparers while retaining the benefits of the requirements in IFRS 16 for users of financial statements. The IASB intended the exemption to apply to leases for which the underlying asset, when new, is of low value (such as leases of tablet and personal computers, small items of office furniture and telephones). At the time of reaching decisions about the exemption in 2015, the IASB had in mind leases of underlying assets with a value, when new, in the order of magnitude of US$5,000 or less. A lease will not qualify for the exemption if the nature of the underlying asset is such that, when new, its value is typically not low. The IASB also decided that the outcome of the assessment of whether an underlying asset is of low value should not be affected by the size, nature, or circumstances of the lessee—ie the exemption is based on the value, when new, of the asset being leased; it is not based on the size or nature of the entity that leases the asset.
Against that backdrop, here’s a fact pattern recently discussed by CPA Canada’s IFRS Discussion Group:
- An entity has the following leases:
- Leases of buildings;
- Leases of vehicles (each individual asset is worth significantly more than US$5,000 when new);
- Leases of office furniture (each individual asset is worth CAD$7,000 (US$5,300) when new); and
- Leases of IT equipment such as a lease arrangement for 100 laptops (each individual laptop is worth CAD$1,000 when new, for a total lease value of CAD$100,000).
The group discussed which of these items are eligible for the exemption, setting out various possibilities. You might take the view that it encompasses the office furniture and the IT equipment: the comment that the IASB “had in mind…an order of magnitude of US$5,000 or less” doesn’t in itself set out a bright line test, and so a few hundred dollars here or there shouldn’t matter. Alternatively, you might think it is a bright line test, thus limiting the exemption to the IT equipment. There’s another intertwining issue. The standard says an underlying asset can only be of low value if it’s not highly dependent on, or highly interrelated with, other assets. In this case, as far as we can tell from the fact pattern, each piece of furniture or equipment can be used individually, and so that’s not a worry. On the other hand, as the laptops are all covered by a single arrangement, you might think the focus should be on the total assets under that one lease arrangement: if so, the aggregate value of CAD$100,000 would take the exemption off the table for those items. If you add all of that up, maybe nothing in this scenario qualifies as low-value.
Fortunately for all of us, a “substantial majority” of the group’s members thought that the leases of the office equipment and IT equipment should all qualify for the exemption, taking the view that the reference to US$5,000 doesn’t constitute a bright line test, and that broader materiality considerations may come into play. The group threw in a couple of interesting points:
- Some Group members observed that in practice, entities leverage their existing asset capitalization policy in determining what constitutes low-value leased assets. However, a point was made that by not recognizing a leased asset, there is also a potential for understating the entity’s liabilities as well. This effect on the entity’s financial position is different compared to the decision for not capitalizing items of property, plant and equipment. Therefore, entities should make sure the effect of not recognizing low-value leased assets is considered from both asset and liability perspectives as there could be covenant and financial liquidity implications.
- In addition, entities are required to disclose the expense relating to leases of low-value assets, so it is important to have a system in place to track this data. A representative of the Canadian Securities Administrators noted that this disclosure is an important indicator as to how judgment is applied in determining what the entity considers to be low value.
Personally, I wish that this kind of issue wasn’t necessary; that we could just trust the system to apply materiality considerations in a qualitatively and quantitatively astute manner, and basically to avoid ever getting wrapped up in accounting machinations that aren’t worth doing. The IASB considered that approach, but concluded that “the exemption would provide substantial cost relief to many lessees (and, in particular, smaller entities) by removing the burden of justifying that such leases would not be material in the aggregate.” That’s probably true, but the discussion group’s choice of this topic seems to suggest some smaller issuers have had to struggle with the burden of justifying that US$5,000 doesn’t constitute a bright line. Which may have been only marginally better…
The opinions expressed are solely those of the author