International Financial Reporting Standard 16

International Financial Reporting Standard 16 (IFRS 16), titled Leases, is an International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) that establishes the principles for the recognition, measurement, presentation, and disclosure of leases. The standard requires lessees to recognize most lease arrangements on the balance sheet by recording a right-of-use asset and a corresponding lease liability. IFRS 16 introduced a single lessee accounting model, replacing the previous distinction between operating leases and finance leases for lessees. The standard became effective for annual reporting periods beginning on or after 1 January 2019.

History

Prior to IFRS 16, lease accounting under IFRS was governed primarily by International Accounting Standard 17 (Leases), which classified leases as either operating leases or finance leases.

The distinction was criticized because many long-term lease obligations remained off the balance sheet under operating lease accounting, reducing the transparency and comparability of financial statements.

In response, the International Accounting Standards Board (IASB) undertook a comprehensive project to improve lease accounting. IFRS 16 was issued in January 2016 and replaced IAS 17 and several related interpretations for annual reporting periods beginning on or after 1 January 2019.

Objective

The objective of IFRS 16 is to establish principles for reporting useful information about leases so that users of financial statements can assess:

the effect of leases on an entity's financial position;
financial performance;
cash flows.

The standard seeks to improve transparency by recognizing lease obligations on the balance sheet.

Scope

IFRS 16 applies to most lease contracts except those relating to:

biological assets held under leases;
service concession arrangements;
licenses of intellectual property granted by a lessor;
certain rights held under licensing agreements for items such as films, patents, and copyrights.

The standard applies to both lessees and lessors, although the accounting requirements differ.

Definition of a lease

Under IFRS 16, a contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

Control generally exists when the customer has:

the right to obtain substantially all economic benefits from the use of the asset; and
the right to direct the use of the asset.

Lessee accounting

IFRS 16 introduced a single accounting model for lessees.

At the commencement date of a lease, the lessee generally recognizes:

a right-of-use asset; and
a lease liability.

The lease liability is initially measured at the present value of future lease payments, while the right-of-use asset is initially measured at cost.

Subsequently:

the lease liability is reduced as lease payments are made and increased by interest;
the right-of-use asset is depreciated over the lease term or useful life, as appropriate.

Lessor accounting

Lessor accounting under IFRS 16 remains broadly consistent with the previous requirements of IAS 17.

Lessors classify leases as either:

finance leases; or
operating leases.

The accounting treatment depends on whether substantially all the risks and rewards incidental to ownership are transferred to the lessee.

Recognition exemptions

IFRS 16 permits lessees not to recognize certain leases on the balance sheet.

Exemptions are available for:

short-term leases with lease terms of twelve months or less; and
leases of low-value assets.

Lease payments relating to these leases are generally recognized as expenses over the lease term.

Measurement

The initial measurement of the lease liability is generally based on:

fixed lease payments;
variable lease payments dependent on an index or rate;
expected residual value guarantees;
exercise price of purchase options, where applicable.

The right-of-use asset generally includes:

the initial lease liability;
initial direct costs;
lease payments made before commencement;
estimated restoration obligations.

Disclosure requirements

IFRS 16 requires entities to disclose information including:

depreciation of right-of-use assets;
interest expense on lease liabilities;
maturity analysis of lease liabilities;
variable lease payments;
lease commitments;
qualitative information regarding leasing activities.

These disclosures improve users' understanding of an entity's leasing arrangements.

Relationship with previous standards

Standard	Subject	Status
International Accounting Standard 17	Leases	Replaced by IFRS 16
International Financial Reporting Standard 16	Leases	Current standard

Although lessor accounting remained largely unchanged, IFRS 16 fundamentally revised lessee accounting by introducing a single recognition model.

Advantages

IFRS 16 provides several benefits.

These include:

greater transparency;
improved comparability among entities;
recognition of lease obligations on the balance sheet;
enhanced financial reporting;
more complete information for investors and creditors.

The standard reduces the use of off-balance-sheet financing for lease obligations.

Challenges

Implementation of IFRS 16 may involve:

identifying lease components within contracts;
estimating lease terms;
determining appropriate discount rates;
accounting for lease modifications;
collecting data for existing lease portfolios.

Entities with extensive leasing activities may require significant system and process changes.

Impact

International Financial Reporting Standard 16 significantly changed lease accounting by requiring most leases to be recognized on the balance sheet by lessees. The standard enhanced the transparency, comparability, and completeness of financial reporting by providing users with better information regarding lease obligations and the assets controlled through leasing arrangements. IFRS 16 has had a substantial impact on industries with significant leasing activities, including aviation, retail, transportation, telecommunications, and real estate.