parent had entered into the lease directly.
4.7
Initial direct costs
Initial direct costs are incremental costs of obtaining a lease that would not have been
incurred if the lease had not been obtained, except for such costs incurred by a
manufacturer or dealer lessor in connection with a finance lease. [IFRS 16 Appendix A].
For lessors, initial direct costs, other than those incurred by manufacturer or dealer
lessors, are included in the initial measurement of the net investment in the lease and
reduce the amount of income recognised over the lease term. The interest rate implicit in
the lease is defined in such a way that the initial direct costs are included automatically in
the net investment in the lease and there is no need to add them separately. [IFRS 16.69].
IFRS 16 requires lessees to include their initial direct costs in their initial measurement of
the right-of-use asset. As noted above, initial direct costs are incremental costs that would
not have been incurred if the lease had not been obtained (e.g. commissions, certain
payments made to an existing lessee to incentivise that lessee to terminate its lease).
Lessees and lessors apply the same definition of initial direct costs. The requirements
under IFRS 16 for initial direct costs are consistent with the concept of incremental costs
in IFRS 15. Under IAS 17, initial direct costs are incremental costs that are directly
attributable to negotiating and arranging a lease, except for such costs incurred by
manufacturer or dealer lessors. The revised definition under IFRS 16 could result in some
changes in practice for lessors. Lessor’s initial direct costs will now also exclude costs
incurred regardless of whether the lease is obtained (e.g. certain legal advice).
4.7.1
Directly attributable costs other than initial direct costs incurred by
lessees
Certain costs associated with acquiring an asset within the scope of IAS 16 are required to be
capitalised upon initial recognition. See Chapter 18 at 4. However, IFRS 16 does not address
the accounting for lessees’ costs incurred directly attributable to bringing a right-of-use asset
to the location and condition necessary for it to be capable of operating in the manner
intended by management. To the extent that costs related to acquiring a right-of-use asset
are not subject to capitalisation under other IFRS (e.g. IAS 16), it remains to be seen in practice
whether they are charged to profit or loss when incurred or capitalised by analogy to IAS 16.
4.8 Economic
life
The economic life is either the period over which an asset is expected to be
economically usable by one or more users or the number of production or similar units
expected to be obtained from an asset by one or more users. [IFRS 16 Appendix A].
4.9 Fair
value
The fair value for the purposes of applying the lessor accounting requirements in
IFRS 16 is the amount for which an asset could be exchanged, or a liability settled,
between knowledgeable, willing parties in an arm’s length transaction. [IFRS 16 Appendix A].
The fair value definition for lessors has been carried forward from IAS 17.
Leases (IFRS 16) 1727
5 LESSEE
ACCOUNTING
5.1 Initial
recognition
At the commencement date, a lessee recognises a right-of-use asset and a lease liability.
[IFRS 16.22]. This applies to all leases unless the lessee elects the short-term lease and/or
lease of low-value asset recognition exemptions, discussed below. If an entity applies
the exemptions it must disclose that fact. [IFRS 16.60].
5.1.1 Short-term
leases
A short-term lease is a lease that, at the commencement date, has a lease term of
12 months or less. A lease that contains a purchase option is not a short-term lease.
[IFRS 16 Appendix A].
The short-term lease exemption can be made by class of underlying asset to which the
right of use relates. A class of underlying asset is a grouping of underlying assets of a
similar nature and use in an entity’s operations. [IFRS 16.8].
A lessee that makes this accounting policy election does not recognise a lease liability
or right-of-use asset on its balance sheet. Instead, the lessee recognises the lease
payments associated with those leases as an expense on either a straight-line basis over
the lease term or another systematic basis. The lessee applies another systematic basis
if that basis is more representative of the pattern of the lessee’s benefit. [IFRS 16.6].
When determining whether a lease qualifies as a short-term lease, a lessee evaluates the
lease term in the same manner as all other leases. That is, the lease term includes the
non-cancellable term of the lease, periods covered by an option to extend the lease if
the lessee is reasonably certain to exercise that option and periods covered by an option
to terminate the lease if the lessee is reasonably certain not to exercise that option. As
the determination is made at commencement date, a lease cannot be classified as short-
term if the lease term is subsequently reduced to less than 12 months. In addition, to
qualify as a short-term lease, the lease cannot include an option to purchase the
underlying asset.
A lease that qualifies as a short-term lease at the commencement is a new lease if there
is a lease modification or a change in a lessee’s assessment of the lease term (e.g. the
lessee exercises an option not previously included in the determination of the lease
term). [IFRS 16.7]. The new lease is evaluated to determine whether it qualifies for the
short-term exemption, similar to any other new lease.
The short-term lease accounting policy election is intended to reduce the cost and
complexity of applying IFRS 16. However, a lessee that makes the election must
make certain quantitative and qualitative disclosures about short-term leases
(see 5.8.2 below).
Once a lessee establishes a policy for a class of underlying assets, all future short-term
leases for that class are required to be accounted for in accordance with the lessee’s
policy. A lessee evaluates any potential change in its accounting policy in accordance
with IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors.
1728 Chapter 24
Example 24.16: Short-term lease
Scenario A
A lessee enters into a lease with a nine-month non-cancellable term with an option to extend the lease for
four months. The lease does not have a purchase option. At the lease commencement date, the lessee
concludes that it is reasonably certain to exercise the extension option because the monthly lease payments
during the extension period are significantly below market rates.
Analysis: The lease term is greater than 12 months i.e. 13 months. Therefore, the lessee may not account for
the lease as a short-term lease.
Scenario B
Assume the same facts as Scenario A except, at the lease commencement date, the lessee concludes that it is
not reasonably certain to exercise the extension option because the monthly lease payments during the
optional extension period are at what the lessee expects to be market rates and there are no other factors that
would make exercise of
the renewal option reasonably certain.
Analysis: The lease term is 12 months or less, i.e. nine months. Therefore, the lessee may (subject to its
accounting policy, by class of underlying asset) account for the lease under the short-term lease exemption,
i.e. it recognises lease payments as an expense on either a straight-line basis over the lease term or another
systematic basis and does not recognise a lease liability or right-of-use asset on its balance sheet, similar to
an operating lease under IAS 17.
5.1.2
Leases of low-value assets
Lessees can also make an election for leases of low-value assets, which can be made on
a lease-by-lease basis. [IFRS 16.8]. A lessee that makes this accounting policy election does
not recognise a lease liability or right-of-use asset on its statement of financial position.
Instead, the lessee recognises the lease payments associated with those leases as an
expense on either a straight-line basis over the lease term or another systematic basis.
The lessee applies another systematic basis if that basis is more representative of the
pattern of the lessee’s benefit. [IFRS 16.6].
A lessee assesses the value of an underlying asset based on the value of the asset when it is
new, regardless of the age of the asset being leased. [IFRS 16.B3]. The assessment of whether an
underlying asset is of low value is performed on an absolute basis. Leases of low-value assets
qualify for the exemption regardless of whether those leases are material to the lessee. The
assessment is not affected by the size, nature or circumstances of the lessee. Accordingly,
different lessees are expected to reach the same conclusion about whether a particular
underlying asset is of low-value. [IFRS 16.B4]. At the time of reaching its decisions about the
exemption, the IASB had in mind leases of underlying assets with a value, when new, of
US$5,000 or less. [IFRS 16.BC100]. Examples of low-value assets include desktop and laptop
computers, small items of office furniture, telephones and other low-value equipment
[IFRS 16.B8] and excludes cars because a new car would typically not be of low value. [IFRS 16.B6].
An underlying asset can only be of low-value if both:
• the lessee can benefit from use of the assets on their own, or together with, other
resources that are readily available to the lessee; and
• the underlying asset is not dependent on, or highly interrelated with, other assets.
[IFRS 16.B5].
Leases (IFRS 16) 1729
For example, an entity may lease a truck for use in its business and the lease includes
the use of the tyres attached to the truck. To use the tyres for their intended purpose,
they can only be used with the truck and therefore are dependent on, or highly
interrelated with the truck. Therefore the tyres would not qualify for the low-value
asset exemption.
A lease of an underlying asset does not qualify as a lease of a low-value asset if the nature
of the asset is such that, when new, the asset is typically not of low value. For example,
leases of cars would not qualify as leases of low-value assets because a new car would
typically not be of low value. [IFRS 16.B6].
An intermediate lessor who subleases, or expects to sublease an asset, cannot account
for the head lease as a lease of a low-value asset. [IFRS 16.B7].
5.2 Initial
measurement
5.2.1 Right-of-use
assets
At commencement date, a lessee measures the right-of-use asset at cost. [IFRS 16.23].
The cost of a right-of-use asset comprises:
• the amount of the initial measurement of the lease liability;
• any lease payments made at or before the commencement date, less any lease
incentives received;
• any initial direct costs incurred by the lessee; and
• an estimate of costs to be incurred by the lessee in dismantling and removing the
underlying asset, restoring the site on which it is located or restoring the underlying
asset to the condition required by the terms and conditions of the lease, unless
those costs are to produce inventories. The lessee incurs the obligation for those
costs either at the commencement date or as a consequence of having used the
underlying asset during a particular period. [IFRS 16.24].
A lessee recognises dismantling, removal and restoration costs above as part of the cost
of the right-of-use asset when it incurs an obligation for those costs. A lessee applies
IAS 2 – Inventories – to costs that are incurred during a particular period as a
consequence of having used the right-of-use asset to produce inventories during that
period. The obligations for such costs are recognised and measured applying IAS 37 –
Provisions, Contingent Liabilities and Contingent Assets. [IFRS 16.25].
5.2.2 Lease
liabilities
At the commencement date, a lessee measures the lease liability at the present value of
the lease payments that are not paid at that date. The lease payments are discounted
using the interest rate implicit in the lease, if that rate can be readily determined. If that
rate cannot be readily determined, the lessee uses the lessee’s incremental borrowing
rate. [IFRS 16.26].
1730 Chapter 24
At the commencement date, the lease payments included in the measurement of the
lease liability comprise the following payments for the right to use the underlying asset
during the lease term that are not paid at the commencement date:
• fixed payments (including in-substance fixed payments), less any lease incentives
receivable;
• variable lease payments that depend on an index or a rate, initially measured using
the index or rate as at the commencement date;
• amounts expected to be payable by the lessee under residual value guarantees;
• the exercise price of a purchase option if the lessee is reasonably certain to
exercise that option; and
• payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease. [IFRS 16.27].
5.3 Subsequent
measurement
5.3.1 Right-of-use
assets
After the commencement date, a lessee measures the right-of-use asset applying a cost
model, unless it applies either of the measurement models described in 5.3.1.B below.
[IFRS 16.29].
5.3.1.A Cost
model
To apply the cost model, the lessee measures the right-of-use asset at cost:
• less any accumulated depreciation and accumulated impairment losses; and
• adjusted for the remeasurement of the lease liability described in 5.4 below. [IFRS 16.30].
A lessee applies the depreciation requirements in IAS 16 in depreciating the right-of-
use asset, subject to the following requirements. [IFRS 16.31].
If the lease transfers ownership of the underlying asset to the lessee by the end of the
lease term or if the cost of the right-of-use asset reflects that the lessee will exercise a
purchase option, the lessee depreciates the right-of-use asset from the commencement
date to the end of the useful life of the underlying asset. Otherwise, the lessee
depreciates the right-of-use asset from the commencement date to the earlier of the
end of the useful life o
f the right-of-use asset or the end of the lease term. [IFRS 16.32].
Depreciation of the right-of-use asset is recognised in a manner consistent with existing
standards for property, plant and equipment. IAS 16 is not prescriptive about the
methods of depreciation, mentioning straight line, diminishing balance and units of
production as possibilities. The overriding requirement of IAS 16 is that the depreciation
charge reflects the pattern of consumption of the benefits the asset brings over its useful
life, and is applied consistently from period to period.
IAS 16 also requires that each part of an item of property, plant and equipment with a
cost that is significant in relation to the total cost of the item be depreciated separately.
An entity allocates the amount initially recognised with respect to an item of property,
plant and equipment to its significant parts and depreciates separately each such part.
For example, as noted in IAS 16, it may be appropriate to depreciate separately the
Leases (IFRS 16) 1731
airframe and engines of an aircraft. In many cases, the right-of-use asset will relate to
one underlying asset or significant part and so a component approach may not be
necessary. However, entities will need to assess whether it should be applied for right-
of-use assets that have significant parts with different useful economic lives.
A lessee applies IAS 36 – Impairment of Assets – to determine whether the right-of-
use asset is impaired and to account for any impairment loss identified. [IFRS 16.33].
5.3.1.B
Other measurement models
If a lessee applies the fair value model in IAS 40 – Investment Property – to its
investment property, the lessee also applies that fair value model to right-of-use assets
that meet the definition of investment property in IAS 40. [IFRS 16.34].
If right-of-use assets relate to a class of property, plant and equipment to which the
lessee applies the revaluation model in IAS 16, a lessee may elect to apply that
revaluation model to all of the right-of-use assets that relate to that class of property,
plant and equipment. [IFRS 16.35].
5.3.2 Lease
liabilities
After the commencement date, a lessee measures the lease liability by:
(a) increasing the carrying amount to reflect interest on the lease liability;
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