IFRS 16 Transition Series for Lessees – Example 1

George Azih IFRS 16, Lease Accounting Transition

How to transition from an operating lease under current IAS 17 to the single lessee accounting model – a finance lease using the cumulative effect approach?

In today’s blog post, we will provide a detailed example of the cumulative effect approach or modified retrospective method with the accounting entries that illustrate the transition impact of IFRS 16.

Helpful Tip: Under the cumulative effect approach, a lessee does not restate comparative information.

Key Differences for Lessees with Leases previously classified as Operating Leases


IAS 17

IFRS 16

Off-Balance Sheet Accounting Treatment

Assets and Liabilities on the Balance Sheet

Single Lease Rent Expense

Depreciation and Interest on the Income Statement


Here are the steps under the IFRS 16 transition for an operating lease from current IAS 17 to IFRS 16 for lessee accounting.

Step 1: Calculate present value of remaining payments over remaining lease term discounted using the incremental borrowing rate on transition. (This is the lease liability)

Step 2: Determine the right-of-use asset on a lease by lease basis using 1 of 2 options explained below.

Step 3: Adjust the right-of-use assert for impairment under IAS 36 if applicable.

 

Let’s explain the steps with an example. Consider the following scenario:

Commencement date:

January 1, 2015

Lease Term:

10 years

Payments (paid in arrears):

$10,000/year

Incremental Borrowing Rate (on transition):

6%

 

Step 1: Calculate present value of remaining payments over remaining lease term discounted using the incremental borrowing rate on transition. (This is the lease liability)

Get the Present Value Test Now To Follow Along

The lease liability amortization schedule of remaining payments is as follows:

IFRS 16 for lessee example 1 table 3

To see my blog on how to calculate the present value of the remaining lease payments, click here.

The remaining payments of $60,000 less the total interest expense of $10,827 equals a lease liability on transition of $49,173.

Note: Comparative period information does not change in this scenario.

 

Step 2: Determine the right-of-use asset amount on a lease-by-lease basis using 1 of 2 options.

 

Option 1 – Calculate the ROU asset beginning from the lease commencement date using a discount rate based on the lessee's incremental borrowing rate at the date of initial application

The following is the straight-line amortization schedule for the lease in this scenario since commencement:

IFRS 16 transition for lessee example 1 table 4
To see my blog on how to calculate the present value of the right-of-use asset since the commencement date,
click here. 

Using Option 1, the lessee takes the cumulative beginning balance or carrying amount of $44,161 which has been discounted at 6% to determine the right-of-use asset amount.

The cumulative entry to make in January 2019 using Option 1 would be:

DR Right-of-Use Asset 44,161

DR Equity 5,012

                                        CR Lease Liability 49,173

 

Option 2 - Amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments recognized immediately before the effective date.

Using Option 2, the lessee makes the right-of-use asset as an amount equal to the lease liability of $49,173 determined in Step 1.

The cumulative entry to make in January 2019 using Option 2 would be:

DR Right-of-Use Asset 49,173

                                                CR Lease Liability 49,173

Step 3: Adjust the right-of-use assert for impairment under IAS 36 if applicable.  

In this scenario, there was no impairment indicators noted per IAS 36.

If you have any questions, please leave a comment below, or email us directly at info@LeaseQuery.com.

 

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