Course: IFRS 16 - Leases

Simplified Tutorial on IFRS 16 (with Case Study and Practice Questions)

Objective
This course simplifies the key principles of IFRS 16, which governs the recognition, measurement, presentation, and disclosure of leases. By the end of this lesson, learners will understand how to apply IFRS 16, including real-life applications through a practical case study.

Lesson Outline

1. Introduction to IFRS 16

• Definition: IFRS 16 establishes principles for the accounting of leases, requiring lessees to recognize most leases on their balance sheet as assets and liabilities.
• Purpose: Ensures transparency by eliminating off-balance-sheet lease reporting and providing a clearer picture of an entity's financial commitments.

2. Key Concepts in IFRS 16

• What is a Lease?
  A lease is a contract that gives the right to control the use of an asset for a specific period in exchange for payment.

• Scope: Applies to all leases except:

  • Leases to explore for or use minerals, oil, and natural gas.
  • Licenses of intellectual property.
  • Service concession arrangements.

• Recognition and Measurement for Lessees
  Under IFRS 16, lessees must recognize:

  1. A Right-of-Use Asset (ROU): Represents the lessee's right to use the leased asset.
  2. A Lease Liability: Represents the lessee’s obligation to make lease payments.

• Exemptions:

  • Short-term leases (less than 12 months).
  • Low-value assets (e.g., office furniture).

3. Accounting Treatment for Lessees

• Initial Recognition:
  • The Right-of-Use Asset is initially measured at the cost, including lease payments and any initial direct costs.
  • The Lease Liability is measured as the present value of future lease payments.
• Subsequent Measurement:
  • The ROU asset is depreciated over the lease term.
  • The lease liability is reduced as payments are made and adjusted for interest.

4. Accounting Treatment for Lessors

• Finance Leases: The lessor recognizes a lease receivable and derecognizes the underlying asset.
• Operating Leases: The lessor keeps the leased asset on the balance sheet and recognizes lease income on a straight-line basis.

5. Presentation and Disclosure

• Presentation:
  • ROU assets are presented as part of property, plant, and equipment.
  • Lease liabilities are classified as financial liabilities.
• Disclosure: Entities must provide details about the nature, timing, and amount of lease payments, assumptions used, and any risks related to lease contracts.

Case Study: Hello Bae Tech Ltd.

Background
Hello Bae Tech Ltd. enters into a 5-year lease agreement on January 1, 2024, for office space. The annual lease payment is $100,000, payable at the start of each year. The company incurs an initial direct cost of $5,000. The lease interest rate is 5%.

Applying IFRS 16

1. Initial Recognition

   • Calculate the present value of lease payments:
     • PV of lease payments = $100,000 × [1 + 1/(1.05) + 1/(1.05)^2 + 1/(1.05)^3 + 1/(1.05)^4] = $432,949.
   • Recognize:
     • Right-of-Use Asset = $432,949 + $5,000 = $437,949.
     • Lease Liability = $432,949.

2. Subsequent Measurement

   • Depreciation of ROU Asset: $437,949 ÷ 5 years = $87,590 per year.
   • Interest Expense on Lease Liability: Year 1 = $432,949 × 5% = $21,647.
   • Lease Liability Reduction: Year 1 payment = $100,000 - $21,647 = $78,353.

3. Financial Statement Impact

   • Balance Sheet:
     • Year 1:
       • ROU Asset = $437,949 - $87,590 = $350,359.
       • Lease Liability = $432,949 - $78,353 = $354,596.
   • Profit or Loss:
     • Depreciation = $87,590.
     • Interest Expense = $21,647.

Benefits of IFRS 16

• Transparency: Improves comparability by eliminating off-balance-sheet leases.
• Clarity: Provides a clearer view of an entity’s financial health.
• Stakeholder Trust: Boosts confidence in financial disclosures.

Conclusion

IFRS 16 has significantly changed how leases are accounted for, primarily by requiring lessees to recognize leases on their balance sheets. Through understanding and applying IFRS 16 principles, companies like Hello Bae Tech Ltd. can ensure accurate and transparent financial reporting of lease transactions.

IFRS 16 Practice Quiz

1. What is the primary focus of IFRS 16?

Revenue recognition
Accounting for leases
Financial instruments
Consolidation of financial statements

2. What does the Right-of-Use Asset represent?

The cost of the leased asset
The profit from the lease
The lessee's right to use the leased asset
The payments made by the lessee

3. Which of the following is excluded from IFRS 16's scope?

Short-term leases
Leases of intellectual property
Low-value leases
Both (b) and (c)

4. How is the Lease Liability initially measured?

At fair value
At the present value of future lease payments
At the historical cost
At net realizable value

5. What is the main objective of IFRS 16?

To improve transparency in lease reporting
To calculate tax liabilities
To measure the fair value of assets
To assess goodwill impairment