Example of IFRS 16 Leases
Introduction
IFRS 16 leases become effective for annual reporting periods starting on or after 1 January 2019 and fully replace IAS 17. So, any company as the lessee that use IFRS as its accounting standards is required to review its existing operating lease to make either full or limited retrospective restatement in order to comply with requirements of the new standard, IFRS 16. For the existing financial leases, it will be treated the same.
The company as a lessee is required to recognize lease payments (whole payments in lease contract) as assets and liabilities for all leases that have the term longer than 12 months. The exception is only for those leases that have insignificant value.
The company needs to initially recognize the value of lease assets and liabilities as the present value of the lease payments. The company can present the leased asset in the statement of financial position as part of the PPE or on its own line item, e.g. as right-of-use assets.
The lease assets or right-of-use assets will need to be depreciated using straight-line depreciation method while on the lease liabilities side, interest expense will be recognized. The cash payment for lease will be split into two parts, in which one part is to deduct lease liabilities (Dr. lease liabilities) and another one is interest expense (Dr. interest expense)
Accounting Entry for Lease
The accounting entry for lease are as follow:
Initial recognition:
| Account | Debit | Credit |
|---|---|---|
| Right-of-use assets | 000 | |
| Lease Liabilities | 000 |
Lease depreciation:
| Account | Debit | Credit |
|---|---|---|
| Lease depreciation expense | 000 | |
| Accumulated depreciation – lease | 000 |
Lease payment:
| Account | Debit | Credit |
|---|---|---|
| Lease liabilities | 000 | |
| Interest expense | 000 | |
| Cash | 000 |
First time adoption:
For the first time adoption which the company has existing operating lease, the adjustment will need to be made to the equity account. In this case, the accounting entry would be:
| Account | Debit | Credit |
|---|---|---|
| Right-of-use assets | 000 | |
| Retained earnings (equity) | 000 | |
| Lease Liabilities | 000 |
Example 1: Lease accounting in IFRS 16
The company has rented an office with 5 years and the payment of $120,000 is at the end of each year. Assuming the interest rate is 6% per annum.
How to account for the lease following IFRS 16?
Solution:
Initial measurement
With the interest rate of 6%, we can calculate the discount factor using the formula of 1/(1+r) ^n, we got the result as below:
| Year | Discount Factor |
|---|---|
| Y1 | 0.9434 |
| Y2 | 0.8900 |
| Y3 | 0.8396 |
| Y4 | 0.7921 |
| Y5 | 0.7473 |
Then we can calculate the present value of lease payment as below table:
| Year | Lease payment | Discount Factor | Present Value |
|---|---|---|---|
| Y1 | 120,000 | 0.9434 | 113,208 |
| Y2 | 120,000 | 0.8900 | 106,800 |
| Y3 | 120,000 | 0.8396 | 100,754 |
| Y4 | 120,000 | 0.7921 | 95,051 |
| Y5 | 120,000 | 0.7473 | 89,671 |
| Total | 600,000 | 505,484 |
Hence, we can record the accounting entry of lease assets and liabilities as follow:
| Account | Debit | Credit |
|---|---|---|
| Right-of-use assets | 505,484 | |
| Lease Liabilities | 505,484 |
Depreciation of lease asset
At the end of each year, we need to depreciate the right-of-use assets with the straight-line depreciation method.
Depreciation = 505,484 / 5 = 101,097
We get the result as below:
| Year | Beginning balance | Depreciation | Ending balance |
|---|---|---|---|
| Y1 | 505,484 | 101,097 | 404,387 |
| Y2 | 404,387 | 101,097 | 303,290 |
| Y3 | 303,290 | 101,097 | 202,193 |
| Y4 | 202,193 | 101,097 | 101,097 |
| Y5 | 101,097 | 101,097 | 0 |
| Total | 505,484 |
Hence, we can record the accounting entry of depreciation each year as below:
| Account | Debit | Credit |
|---|---|---|
| Lease depreciation expense | 101,097 | |
| Accumulated depreciation – lease | 101,097 |
Lease payment and lease liabilities:
We also need to account for lease payment and the interest expense from lease liabilities at the end of each year.
With the 6% annual interest, interest expense on first-year = 505,484 * 6% = 30,329 and the following years is as in table below:
| Year | Beginning balance | Lease payment | Interest expense | Lease liabilities | Ending balance |
|---|---|---|---|---|---|
| Y1 | 505,484 | (120,000) | 30,329 | (89,671) | 415,813 |
| Y2 | 415,813 | (120,000) | 24,949 | (95,051) | 320,761 |
| Y3 | 320,761 | (120,000) | 19,246 | (100,754) | 220,007 |
| Y4 | 220,007 | (120,000) | 13,200 | (106,800) | 113,208 |
| Y5 | 113,208 | (120,000) | 6,792 | (113,208) | 0 |
Hence, we can record the accounting entry in the first year as below:
| Account | Debit | Credit |
|---|---|---|
| Lease liabilities | 89,671 | |
| Interest expense | 30,329 | |
| Cash | 120,000 |
—————————————
Example 2: First adoption of IFRS 16 with an existing operating lease
The company has rented an office with 5 years and the payment $120,000 is at the end of each year. The lease contract started on 1 January 2017 and the lease was recognized as operating lease since then.
The company has just followed IFRS 16 on 1 January 2019. Assuming the interest rate is 6% per annum.
How to account for the lease following IFRS 16 on 1 January 2019?
Solution:
In this example, our initial measurement will be a little different from the first example as equity adjustment will be required. This is due to changing accounting standards to IFRS 16 in 2019 will require retrospective restatement to meet the requirement.
In this case, we need to determine the present value of the leased asset in 2017 then depreciate it to determine the carrying value on 1 January 2019 when we start using IFRS 16.
Determine lease assets at 1 January 2019:
The result of the present value of lease payment with 6% interest rate is as follow:
| Year | Lease payment | Discount Factor | Present Value |
|---|---|---|---|
| 2017 | 120,000 | 0.9434 | 113,208 |
| 2018 | 120,000 | 0.8900 | 106,800 |
| 2019 | 120,000 | 0.8396 | 100,754 |
| 2020 | 120,000 | 0.7921 | 95,051 |
| 2021 | 120,000 | 0.7473 | 89,671 |
| Total | 600,000 | 505,484 |
The result of depreciation is as follow:
| Year | Beginning balance | Depreciation | Ending balance |
|---|---|---|---|
| 2017 | 505,484 | 101,097 | 404,387 |
| 2018 | 404,387 | 101,097 | 303,290 |
| 2019 | 303,290 | 101,097 | 202,193 |
| 2020 | 202,193 | 101,097 | 101,097 |
| 2021 | 101,097 | 101,097 | 0 |
| Total | 505,484 |
So, the value of lease assets at 1 January 2019 = 303,290
Now, we can start with lease liabilities.
Determine lease liabilities at 1 January 2019:
We have already paid for 2 years since the lease started in 2017 so our lease liabilities are the remaining amount of 3 years payment.
So, we can calculate the present value of the 3 years lease payment as follow:
| Year | Lease payment | Present value |
|---|---|---|
| 2019 | 120,000 | 113,208 |
| 2020 | 120,000 | 106,800 |
| 2021 | 120,000 | 100,754 |
| Total | 360,000 | 320,761 |
So, the value of lease liabilities at 1 January 2019 = 320,761
Adjust the difference:
Now we have lease assets of 303,290 and lease liabilities of 320,761 then
We have the difference of (320,761 – 303,290) = 17,471 which requires the equity adjustment
So, we can record the accounting entry as follow:
| Account | Debit | Credit |
|---|---|---|
| Right-of-use assets | 303,290 | |
| Retained earnings (equity) | 17,471 | |
| Lease Liabilities | 320,761 |
And the remaining years until 2021:
| Year | Beginning balance | Lease payment | Interest expense | Lease liabilities | Ending balance |
|---|---|---|---|---|---|
| 2019 | 320,761 | (120,000) | 19,246 | (100,754) | 220,007 |
| 2020 | 220,007 | (120,000) | 13,200 | (106,800) | 113,208 |
| 2021 | 113,208 | (120,000) | 6,792 | (113,208) | 0 |
| Total | (360,000) | 39,239 | (320,761) |