To account for leases under IFRS 16, the entity should follow the principles and rules of accounting for leases, which are the principles and rules that govern the recognition, measurement, and disclosure of leases in the financial statements.
IFRS 16 is the International Financial Reporting Standard that applies to leases. IFRS 16 replaces the previous leases standard, IAS 17, and introduces a single, on-balance sheet model for lessees. Under IFRS 16, lessees are required to recognize a right-of-use asset and a lease liability for all leases, except for short-term and low-value leases.
The key steps in accounting for leases under IFRS 16 are as follows:
- Identify the lease: The first step in accounting for leases under IFRS 16 is to identify the lease. A lease is a contract that conveys the right to use an asset for a specified period of time in exchange for consideration. A lease is classified as a finance lease or an operating lease based on the nature of the underlying asset and the extent to which the risks and rewards of ownership of the asset are transferred to the lessee.
- Measure the right-of-use asset and the lease liability: The second step in accounting for leases under IFRS 16 is to measure the right-of-use asset and the lease liability. The right-of-use asset is measured at the present value of the lease payments, discounted at the lessee’s incremental borrowing rate. The lease liability is measured at the present value of the lease payments, discounted at the lessee’s incremental borrowing rate, plus any lease incentives received by the lessee.
- Recognize the right-of-use asset and the lease liability in the balance sheet: The third step in accounting for leases under IFRS 16 is to recognize the right-of-use asset and the lease liability in the balance sheet. The right-of-use asset is recognized as a non-current asset, and the lease liability is recognized as a non-current liability. The right-of-use asset and the lease liability are recognized at the commencement date of the lease.
The right of use asset has to be depreciated over the lease term. At each year end the value of the remaining asset should be compared to the lease liability to assess for any impairment.
The business may have coded rental/lease payments to the rent nominal in the p&l. This needs to be reclassified to reducing the lease liability. Instead the p&l will show the lease interest payable for the year.
The lease term is generally used for the calculations, unless there is a break clause at the option of the lessee etc.
There is an exemption available for short leases such as 1 year lease/tenancy agreements.