At Rubli, our journey through the intricate landscape of IFRS 16 accounting has equipped us with a wealth of experience and insights. Drawing from our extensive work with clients, we understand the nuanced challenges and opportunities IFRS 16 presents, specifically for lessees.
In a previous guide, we covered the IFRS 16 standard & IFRS 16 lease accounting holistically while in this guide we will share our collective knowledge on lessee accounting processes under IFRS 16, highlighting the strategic importance of leases, and demonstrating how to manage lessee accounting entries effectively.
Our goal is to empower financial managers and accountants with the knowledge and tools to master IFRS 16 leases confidently. Our IFRS 16 software is also a valuable solution for companies looking to streamline IFRS 16 lease accounting
Key takeaways:
- IFRS 16 Transforms Lease Accounting: Mandates balance sheet reporting for nearly all lessee leases, significantly altering financial statements and metrics.
- Transition from IAS 17 to IFRS 16: Enhances transparency and combats off-balance-sheet financing, offering a clearer picture of lease transactions.
- Compliance Challenges for Lessees: Adoption of IFRS 16 introduces systemic changes, affecting tax implications, financial performance, and strategic decisions.
- Scope and Application Insights: Critical for lessees to grasp IFRS 16’s scope, including specific exclusions, for precise compliance and reporting.
Table of Contents
Introduction to IFRS 16 Lessee Accounting
The advent of IFRS 16 marked a significant transformation in how lessees report their finances.
Transitioning from the old International Accounting Standard, IAS 17 for leases, IFRS 16 introduces a unified approach to lease classification and reporting for lessees, ensuring greater transparency across financial statements.
This shift has fundamentally changed how leases are recognised, measured, and presented, especially for those previously classified under operating leases.
Understanding the Role of Lessees under IFRS 16
Under IFRS 16, lessees face new obligations and responsibilities that fundamentally alter their approach to lease accounting.
The standard eliminates the traditional operating lease classification model, requiring lessees to recognise nearly all leases on the balance sheet as liabilities, with corresponding right-of-use assets. This is the same concept as the ‘finance lease’ classification of IAS 17, where leases are treated as asset purchases with corresponding liabilities.”
This transition, affecting annual reporting periods beginning on or after January 1, 2019, aims to provide a more accurate depiction of a lessee’s financial obligations and resources. In the past, lease contracts were only disclosed on the notes as part of commitments if the lease was classified as an operating lease (which happened most of the time).
The change which IFRS 16 brings for the lessees will increase their responsibility to ensure that leases are now fully reflected in the financial statements (not limited to a note). Lessees must carefully assess each lease to determine its impact on their financial statements, considering factors such as the lease term, payments, and the asset’s value.
Key Objectives of IFRS 16 for Lessees
IFRS 16 aims to enhance transparency and comparability in financial reporting by ensuring that lessees account for lease transactions in a consistent manner. The primary goal is to provide a clearer picture of a company’s financial position which is achieved by eliminating off-balance sheet accounting for lessees.
Eliminating leases that are off-balance sheet (i.e., leases with no balances recognised) is performed by recognising lease liabilities and right-of-use assets for all contracts. This increased visibility into leasing activities enables better decision-making by stakeholders and reflects the true economic reality of a company’s financial situation, improving comparability across entities.
The objective continues by influencing the solvency and liquidity position of the company as non-current assets are recognised, but the lease liability is sufficiently divided into current (lease payments in the next 12 months) and non-current (any lease payments after 12 months).
Impact of IFRS 16 on Lessee's Financial Reporting
The implementation of IFRS 16 has a profound impact on a lessees’ balance sheet and income statement. By bringing lease obligations onto the balance sheet, lessees report higher liabilities and assets, potentially altering debt ratios and other key financial metrics. This change can affect loan covenants, borrowing costs, and investment decisions.
Furthermore, the single lessee lease classification accounting model alters income statement reporting, as the ‘lease expense’ that was recognised with operating leases was removed. Instead, the lease will result in the depreciation of right-of-use assets and interest on lease liabilities, which may lead to a front-loaded pattern of expense recognition. This differs significantly from the straight-line expense profile of operating leases, which aimed at recognising an equally distributed lease expense across the period of the lease. These changes necessitate a thorough review and potential reassessment of financial strategies to align with the new reporting requirements.
Another consideration with the recognition of a right-of-use asset is that the asset’s cost will be accounted for under IAS 16 (Property, plant, and equipment). This will result in the assessment of impairment expenses when there is an indicator. For a deeper understanding of how these changes interact with financial reporting and impairments, consider exploring our IAS 36 impairments post.
Types of IFRS 16 Leases: Considerations for Lessees
Under IFRS 16 for the lessee, leases are primarily recognised without the distinction between finance and operating leases for lessees. The standard mandates that lessees recognise nearly all leases on the balance sheet, reflecting both the lease liability and the corresponding right-of-use asset.
However, in the business world, the term ‘finance leases’ (as the old standard would define it) is still being used as well as the term for ‘operating leases’ (called exempt leases under IFRS 16). This classification process is crucial, as it impacts the lessee’s financial statements and the disclosure of lease liabilities and leased assets.
Exploring Finance Leases under IFRS 16 Lessee Accounting
Finance leases under IFRS 16 are characterised by the transfer of substantially all the risks and rewards incidental to ownership/control of the leased asset to the lessee. The classification criteria include:
- If there is a purchase option/transfer of ownership at the end of the lease
- Comparing the lease period to the useful life of the asset.
Lessees, however, must recognise most leases on the balance sheet (as if they were finance leases), recording a right-of-use asset and a lease liability. Luckily there is a practical expedient included in the standard to help with leases that won’t have a big impact on the company’s financial statements (see Short-term and Low-value Leases).
This accounting treatment affects the lessee’s financial statements significantly, as it requires the recognition of depreciation expense for the asset and interest on the lease liability, impacting both the balance sheet and income statement. The payment of the lease will then be accounted for as capital repayments of the liability recognised. For detailed methodologies on calculating lease liability, explore our post on the different ways to calculate the lease liability.
Lessee Accounting for Short-term & Low-value Asset Leases under IFRS 16
IFRS 16 offers simplifications for short-term and low-value asset leases, allowing lessees not to recognise right-of-use assets and lease liabilities on the balance sheet.
Instead, lessees can recognise the lease payments of the leased asset as an expense on a straight-line basis over the lease term.
There are some criteria to comply with before a lease can be classified as an exempt lease:
- Short-term lease: The lease contract is shorter than 12 months.
- Low-value lease: To conclude if the asset is of low value, you should consider what the value would have been if it was a new asset purchase. IFRS gives guidance and suggests that a threshold of $5,000 may be used, but companies would have to apply their own judgement.
This simplified approach benefits lessees by reducing administrative burden and complexity in financial reporting, making it easier to manage and report leases of lesser significance or value, without significantly impacting the presentation of a lessee’s financial position.
Please note that you are allowed to consider each identifiable asset separately for the Low-Value lease consideration.
Detailed Overview: IFRS 16 Lessee Lease Accounting Process
The lease accounting process under IFRS 16 is integral to ensuring transparency and accuracy in financial reporting for lessees.
It requires meticulous attention to detail at every stage, from identifying leases to recognising and measuring them on the balance sheet. This guide delves into the critical steps of the IFRS 16 lessee accounting cycle, highlighting their importance in maintaining compliance and enhancing financial clarity.
We’ll delve into each of these stages in this section, explaining their significance and how they reshape lease accounting.
The IFRS 16 Lease accounting stages are:
Identification of Lease Assets and Liabilities for Lessees
Under IFRS 16, lessees must identify assets and liabilities arising from leases.
The IFRS 16 standard gives the following definition:
“A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration”.
In other words, if you pay to use an asset for some time, it is a lease.
A common error that someone new to IFRS 16 might make is to think that a finance loan from the bank to buy a vehicle falls within the scope of IFRS 16. Remember that, contractually, in a lease, the asset remains the property of the lessor (the owner). With a finance loan, there is a change in ownership.
We cover the criteria that dictate when IFRS 16 applies to a contract holistically in our IFRS 16 guide, however, in terms of lessees, here are the important considerations to make this determination:
- There is an identifiable asset: This means the lease includes a specific asset, which can be explicitly identified in the contract or implicitly through the lease’s nature.
- You have the right to control the asset: This involves having both the right to direct how the asset is used and the ability to gain economic benefits from its use.
- Substitution rights: The lessor’s right to substitute the asset is restricted, ensuring the lessee has exclusive use of the asset throughout the lease term.
- Lease Term: Encompasses the fixed lease period and any extension or termination options likely to be exercised.
- Lease Payments: Defined in the contract, for the right to control the asset during the lease.
- No Transfer of Ownership: The asset remains the lessor’s property, differentiating leases from finance purchases.
Initial Recognition and Measurement of Lease Assets and Liabilities
Upon lease commencement, lessees recognise right-of-use assets and lease liabilities on the balance sheet.
The initial measurement of the lease liability includes the present value of lease payments, discounted by the lease’s discount rate. The lease liability value is added to the value of the right-of-use asset, which might be impact by payments other than lease payments. Both these balances are recognised on the statement of financial position.
Lease Liability
The lease liability is simply calculated as the present value of the expected payments you will make after the lease started. If you are unsure what is meant by “present value”, this is the current worth of all future payments, calculated by applying a discount rate to reflect their reduced value in today’s terms.
This is often referred to as “time value of money”. If you use Excel a lot, this is generally calculated using the “PV” or “NPV” formula. If you are still unsure, numerous resources on the internet will be able to help you.
If you are familiar with Excel, this is usually calculated using these formulas:
Present Value (PV)
The Present Value (PV) formula calculates the current value of future cash flows by discounting them at a specific rate, reflecting the time value of money. This concept is crucial in IFRS 16 for determining the lease liability by converting future lease payments into their present worth, using either the lessee’s incremental borrowing rate or the lease’s implicit interest rate.
The formula for calculating present value in Excel is =PV(rate, nper, pmt, [fv], [type].
NPV (Net Present Value):
The NPV formula calculates the net present value of future cash flows by discounting them back to the present value using a constant discount rate. It assumes that cash flows occur at regular intervals (e.g., monthly, annually) and that each period between cash flows is equal. This makes NPV particularly suitable for situations where different cash flows are generated at consistent intervals.
The formula for calculating present value in Excel is =NPV(discount rate, series of cash flow).
XNPV (Net Present Value):
The XNPV formula, on the other hand, provides a more flexible approach by allowing for cash flows that don’t necessarily occur at regular intervals. It takes into account the exact dates of each cash flow, making it more accurate for situations where cash flows occur at irregular intervals.
The XNPV formula is =XNPV(discount_rate, cash_flows, dates).
In our related post on calculating lease liability, we explore the logic and best use cases for applying these calculations while unpacking any margin for error, which can be solved by relying on our IFRS 16 tool.
The Lease liability is influenced by the following:
Discount Rate
A key input to the present value calculation and the standard says to first consider the rate implicit in the lease, but should you not know this (which is usually the case), you can use the lessees’ incremental borrowing rate (IBR).
- Rate implicit in the Lease – In this case, you need to know what the value of the asset is and then you calculate the interest rate that equals that value.
- Lessees’ incremental borrow rate (IBR) – This is just a fancy way to say what rate a bank would charge if you had to take a similar type of loan from them.
A nice thing to remember is that you are allowed to use a single discount rate to a portfolio of leases if the IBR is used. In other words, you can apply one rate for all your vehicles, because it is in one asset class.
Lease Payments
The standard goes into a lot of detail which payments should be included, but in practice, it is fairly obvious what to include and what not to include:
- Any fixed (or as good as fixed) payments gets included.
- Any payments that you are reasonably certain you’ll make, should be included (termination penalties, residual value guarantees, purchase options)
- Variable payments are excluded (expensed as incurred)
- Payments made before commencements are excluded, but included in the asset calculation.
A question that often arises is what to do with escalating payments and the answer is quite simple:
- If the escalation is fixed (for instance 5% annually), you include that in the calculation;
- If the escalation is linked to an index (such as inflation), you simply pretend it isn’t linked to anything and use the current payment for the lease, until it changes (remeasure it).
Lease Term
The lease liability calculation will be impacted by the lease term, which is often directly from the contract. This is the period that the asset will be used for. The standard defines this as the “non-cancellable period of a lease”.
There are a lot of factors to consider if the contract has a bit more clauses than standard contracts and in particular renewal clauses. If you are reasonably certain that the contract will be renewed, then you include the expected payments of the extension in the calculation.
Other factors to consider is if you plan to terminate the contract early in which case the termination penalty should be included (if applicable). Your lease liability calculation will start on the commencement date (when you start using the asset), so any rent-free periods have to be included in the lease term.
In summary, you use all the payments that you are reasonably certain you’ll make by taking renewal and termination options into account. This requires judgement and will be assessed based on your company’s accounting policies for IFRS 16.
Right-of-use Asset
Upon establishing a lease liability, lessees under IFRS 16 concurrently recognise a corresponding asset, known as the right-of-use asset. Typically, this asset’s initial value mirrors the lease liability, adjusted for any pre-lease commencement payments or receipts.
The composition of the right-of-use asset’s initial value includes:
- The lease liability balance
- Adjustment for any pre-commencement lease payments.
- Addition of initial direct costs.
- Inclusion of estimated dismantling or restoration costs, as per IAS 37 requirements.
- Deduction of lease incentives received.
Useful life considerations
Determining the useful life of right-of-use assets is crucial, generally aligning with the lease term. However, the potential exercise of a purchase option necessitates a reassessment, extending the useful life to reflect the anticipated duration of use beyond the lease term.
Subsequent Measurement and Reassessment for Lessees
Subsequent measurement involves depreciating the right-of-use asset over the lease term and accruing interest on the lease liability. This approach ensures that the lease’s impact on the lessee’s financial statements reflects the use of the asset over time and the cost of financing the lease. Reassessments are required if there are changes in lease terms or assessments of the lease term, which are called modifications and remeasurements, impacting the lease liability and, consequently, the right-of-use asset (more on this later).
From the subsequent measurement you will note the significant income statement impact because the lease expense (usually included in operating expenses) is now included as part of depreciation and interest expense.
There is no impact over the lifetime of the lease, compared to IAS 17, however the interest charge will be more in the early stages of the lease and diminish over time and depreciation is the same amount each period.
Depreciation of the Leased Asset
In the realm of IFRS 16, lessees must account for right-of-use assets by depreciating them over the lease term. This process reflects the asset’s consumption and its diminishing value over time, a fundamental aspect of lessee accounting under this standard.
The straight-line method is the norm for depreciating right-of-use assets, attributing an even expense rate throughout the lease duration. This approach aligns with IFRS 16’s objective to provide clarity and consistency in how leased assets are represented in lessees’ financial statements.
While IFRS 16 primarily guides this depreciation, it’s essential to note that in specific scenarios, such as subleases, the accounting treatment might slightly vary. However, the principle remains that depreciation must capture the economic reality of the asset’s use under the lease agreement.
Accounting entries for depreciation remain straightforward, with a monthly or yearly debit to the depreciation expense and a corresponding credit to accumulated depreciation. At the lease’s conclusion, any remaining book value of the right-of-use asset is cleared against its accumulated depreciation.
It’s also important to remember that the asset’s impairment considerations, as outlined in IAS 36, apply to right-of-use assets. Lessees should assess these assets for impairment if there is an indicator, to ensure their carrying amount does not exceed the recoverable amount, adjusting depreciation as necessary to reflect any impairment losses.
Interest Expenses for Lessee Leases
For lessees under IFRS 16, managing lease liabilities involves recording periodic interest and lease payment journals. An amortisation schedule is typically employed to facilitate this, offering a clear view of how each lease contributes to the financial statements over time. This methodical approach ensures accuracy in reporting the impact of leases on both the income statement and the balance sheet for each accounting period.
The interest recognised will start when the lease commences (when control of the asset is obtained). Interest is recognised each period on the remaining balance of the lease, determined by the rate you used when discounting the lease payments to the present value.
Remember that the interest to use will remain the same, unless if there is a modification/remeasurement that required a new discount rate to be used. Let’s explore this further.
Lease Modifications and Reassessment for Lessees
Up to this point in this guide we have discussed how to account for the lease contract, ignoring the fact that it may and can change. Should the contract terms change, the lease payments change or your accounting assessments change (like the lease term and exercising of options), then you would have to load modification or a remeasurement.
Any contractual change will usually require you to account for it as a modification. Any cash flow changes or estimate reassessments will be accounted for as a remeasurement.
In both types of changes, you will determine the updated lease payments, consider the appropriate discount rate to use and recalculate the present value. You will compare the new present value with the current lease liability and this ‘lease difference’ will be your adjustment. In most cases, you’ll adjust the asset by the same amount, except in a few scenarios. More on that below.
The Rubli IFRS 16 lease accounting tool has a step-by-step guide that helps you make the correct adjustments to your leases.
Remeasurements
Remeasurements in lease accounting under IFRS 16 are triggered by specific events, such as changes in lease terms, payment adjustments due to index changes, or the reassessment of purchase or termination options. The effective date of any remeasurement aligns with the date of the triggering event.
In this remeasurement, the new lease payments are discounted by a rate (see below guidance), to a new present value of the lease payments
- Updated Discount Rate: Applied when lease terms change, including extensions, reductions, or decisions to purchase the leased asset, particularly when payments are influenced by prevailing interest rates, aligning with IFRS 9.
- Original Discount Rate: Used for adjustments in estimates, like residual value guarantees, or for lease payments tied to another index.
The difference between the new present value and the current lease liability balance will be a required adjustment.
Adjustments to the lease liability are mirrored in the right-of-use asset’s carrying amount. A decrease in lease liability that results in an asset reduction beyond its carrying amount is recognised in profit and loss, ensuring the asset’s value is not negative.
Modifications: Navigating Contract Changes
Lease modifications necessitate a reevaluation of lease components under IFRS 16. Depending on the nature of the modification, this could lead to remeasuring the lease liability or recognising a new lease component. Key modification scenarios include:
- Scope Increase: For instance, adding more leased space, where the payment adjustment is proportional to the asset increase. This scenario typically leads to the recognition of a new lease component, without impacting profit and loss.
- Scope Decrease: Reductions in leased space or term require a lease liability remeasurement, with a corresponding adjustment to the right-of-use asset and potential profit and loss implications.
- Other Changes: Modifications not covered by the above categories also prompt a lease liability remeasurement, with the current discount rate applied to these adjustments.
Modifications always involve the current discount rate, distinguishing them from some remeasurement scenarios that might retain the original rate.
For detailed insights into handling lease modifications, refer to modifications in our comprehensive IFRS 16 training.
Practical IFRS 16 Lessee Accounting Example
Consider a lessee entering a five-year lease for office space, with a fixed annual lease payment of 100,000 at the end of the period and using the lessee’s incremental borrowing rate of 7.93%. An initial direct cost for lease negotiation is also incurred at 25,000. The lessee recognises the right-of-use asset and lease liability in year 1, applies subsequently measuring to the right-of-use asset for depreciation and interest expense on the liability balance.
The initial measurement calculation of the lease will be 400 000, which will be added to the right-of-use asset. The total right-of-use asset balance will be 425 000, as the initial direct costs will be added to the value of the asset. Thereafter the lease payments and interest expense will impact the lease liability balance and the depreciation will decrease the right-of-use asset balance.
The initial measurement journals will be as follows:
Initial lease liability measurement
| Heading 1 | Heading 2 |
|---|---|
| Debit - Right-of-use Asset Cost | 400 000 |
| Credit - Lease Liability | (400 000) |
Initial direct lease costs
| Heading 1 | Heading 2 |
|---|---|
| Debit - Right-of-use Asset Cost | 25 000 |
| Credit - Bank | (25 000) |
The subsequent measurement journals will be as follows:
Periodic depreciation Journals (each year)
| Heading 1 | Heading 2 |
|---|---|
| Debit – Depreciation Expense | 85 000 |
| Credit – Right-of-use asset - Accumulated Depreciation | (85 000) |
Journal for the interest (Year 1)
| Heading 1 | Heading 2 |
|---|---|
| Debit – Interest Expense | 31 723 |
| Credit – Lease Liability | (31 723) |
Lease Payment Journals (each year):
| Heading 1 | Heading 2 |
|---|---|
| Debit – Lease liability | 100 000 |
| Credit – Bank (Lease payment) | (100 000) |
Termination Journals (end of the lease):
| Heading 1 | Heading 2 |
|---|---|
| Debit – Right-of-use Asset - Accumulated Depreciation | 425 000 |
| Credit -Right-of-use Asset – Cost | (425 000) |
At the end of Year 3, a lease contract modification is negotiated which extends the lease by two years, requiring a remeasurement of the lease liability and asset. At the date of the change the lessee’s IBR is 8.16% and there is no change in the lease payments.
The new lease liability is calculated at 330 000 and the lease liability balance at the end of year 3 is 178 496. This results in a lease liability difference of 151 504. The lease liability and the right-of-use asset will increase by this amount.
The modification journal will be as follows:
Recognising the increase in the lease liability and right-of-use asset cost
| Heading 1 | Heading 2 |
|---|---|
| Debit – Right-of-use Asset - Accumulated Depreciation | 425 000 |
| Credit -Right-of-use Asset – Cost | (425 000) |
This practical example highlights the ongoing nature of lease accounting under IFRS 16, from initial recognition through modifications and reassessments. For further insights and tools to navigate the IFRS 16 accounting process, learn more about our IFRS 16 lease accounting tool and explore IFRS 16 Software: Everything You Need To Know.
Financial Statement Disclosure Requirements for Lessees and Their Impact
IFRS 16 introduces comprehensive disclosure requirements for lessees, aiming to enhance the transparency and comparability of financial statements. These disclosures significantly influence financial statement analysis, providing deeper insights into a lessee’s financial obligations and resource utilisation related to leasing activities.
Lessee Disclosure Requirements under IFRS 16
IFRS 16 requires lessees to provide very specific information in an extremely detailed manner. If you thought that correctly accounting for all your leases,and including their changes, was a challenge, then welcome to the next level.
Your IFRS 16 lease accounting disclosures should contain both quantitative and qualitative disclosure requirements (read more about this in the following link IFRS 16 Disclosure). The objective of these disclosures is to give enough information for users of your financial statements to understand the impact of your lease portfolio.
Challenges with IFRS 16 disclosures include combining all your lease data and schedules, disclosing aggregated future lease payments, current year lease changes, etc.
IFRS 16.47-60 provides a checklist that you can follow when drafting your financial statements. Usually the following disclosures are seen, as a minimum for IFRS 16:
Statement of Financial Position Disclosure
- Non-current assets
- Current Lease Liabilities
- Non-current Lease Liabilities
Statement of Comprehensive Income
This can either be disclosed in the statement of comprehensive income or in a note, but the user of the financial statements should at least see the following disclosed separately:
- Depreciation expense of right-of-use assets
- Interest expense of lease liabilities
- Profit/loss impacts as a result of lease changes.
- Short-term and low-value lease expenses
- Variable Lease payments recognised in Profit/Loss
Statement of Cash Flows
- Cash flows from Operating activities - Interest Paid
- Cash flows from Financing activities - Repayment of lease liabilities
Accounting Policies (Qualitative)
- Right-of-use Assets accounting policies and depreciation method
- Lease Liabilities calculation method and modification methods including the judgements for the incremental borrowing rate and lease terms.
Notes to the financial statements
- Lease Liabilities movement schedule
- Lease Liabilities Maturity Analysis
- Finance cost on Lease Liabilities
- Lease Commitments
Impact of IFRS 16 Disclosures on Lessee's Financial Analysis
The enhanced disclosure requirements under IFRS 16 bring about a significant impact on financial statement analysis from a lessee’s perspective.
By providing detailed information on lease liabilities and right-of-use assets, lessees offer investors, analysts, and other stakeholders a more transparent view of their financial health. This new level of transparency can influence perceptions of a lessee’s leverage and long-term financial commitments, impacting investment decisions and the valuation of the company.
Comparing IFRS 16 and IAS 17 Disclosures from a Lessee's Perspective
Transitioning from IAS 17 to IFRS 16, lessees encounter a shift in disclosure requirements that fundamentally change how leases are reported on the balance sheet. Unlike IAS 17, which distinguished between finance and operating leases for lessees, IFRS 16 requires lessees to report most leases on the balance sheet, increasing the need for detailed disclosures.
This shift poses specific challenges for lessees, as they must adjust to the new reporting standards and ensure clarity in their financial communications. The International Accounting Standards Board has guided these changes, aiming to provide a more accurate representation of a lessee’s financial obligations. For a comprehensive understanding of the introduction and rationale behind IFRS 16, refer to the IFRS 16 guide.
IFRS 16 and Tax Considerations for Lessees
The implementation of IFRS 16 introduces significant tax considerations for lessees, fundamentally altering how lease accounting impacts their tax accounting procedures.
This section explores the specific tax implications arising from the accounting changes under IFRS 16, providing lessees with a clearer understanding of their tax liabilities and planning strategies.
Please note that the discussion will be from the general tax considerations, and you should still consult your local tax practitioner’s advice and guidance.
Lease Payments and Tax Deductibility for Lessees
Under IFRS 16, lease payments are accounted for differently to the tax treatment, influencing your tax treatment. While the principle of tax deductibility for lease-related expenses remains, the approach may vary across jurisdictions.
From a taxation perspective, the lease payment will be deductible as a lease expense, because the tax authorities will look through the IFRS 16 accounting and recognise the cash payment only.
Consider IFRS 16, there is no lease payment expense (as this is recognised against the Lease Liability), but accounting will recognise depreciation expense and interest expense.
Although the two perspectives will result in a close similarity in the profit on loss of your company, it will still have an impact on your tax payable to your tax authority. This timing and amount difference will result in deferred tax calculations that are required.
Evaluating the Tax Implications of Lease Capitalisation Under IFRS 16 for Lessees
With the capitalisation of leases mandated by IFRS 16, lessees face new tax accounting consequences. The shift from operating to finance lease accounting means that what were once off-balance sheet transactions now directly affect the lessee’s tax accounting liabilities.
The tax authority will not recognise either the right-of-use asset recognised in your financial statements or the lease liability. In conjunction with the timing difference in your profit and loss statement, this will cause further deferred tax consequences.
Impact of IFRS 16 on Corporate Income Tax Calculations for Lessees
IFRS 16 influences corporate income tax calculations by changing how lease expenses are recognised. Adjustments to taxable income will be required because there is no lease expense recognised and ‘non-taxable’ depreciation and interest.
As a result, the profit before corporate income tax calculation will be calculated by starting with the accounting profit before taxation and adjusting it for:
- Deduct: Lease Expenses (Cash payments)
- Adding: Right-of-use Asset Depreciation
- Adding: Lease Liability Interest expense
Reconciliation of Accounting Profit to Taxable Income for Lessees Under IFRS 16
Lessee must reconcile accounting profit with taxable income and accounting for IFRS 16 with the differences in lease expense recognition for accounting and tax purposes. As explained above, this process involves adjusting the corporate income tax for ‘non-taxable’ expenses. Such reconciliations are essential for lessees to accurately report their tax liabilities, highlighting the need for a thorough understanding of the tax implications of lease accounting adjustments.
Tools and Technology for Managing Lessee Accounting under IFRS 16
Navigating the complexities of lessee accounting under IFRS 16 necessitates the use of appropriate tools and technology. From manual methods like Excel spreadsheets to sophisticated, IFRS 16-specific software solutions, the range of tools available can significantly impact the efficiency and accuracy of lease accounting practices.
For an in-depth exploration of these solutions, including the benefits of cloud-based software, explore our guide on IFRS 16 Software and considerations for choosing IFRS 16 software.
IFRS 16 Lessee Accounting Using Excel
Excel remains a popular tool for managing lessee accounting, especially for organisations with a manageable number of leases or those opting for a lease-by-lease analysis. Excel templates designed for IFRS 16 can help in calculating lease liabilities and right-of-use asset depreciation, providing a cost-effective solution for smaller enterprises.
However, the manual nature of Excel increases the risk of errors and lacks the sophisticated features of dedicated IFRS 16 software, such as automatic updates to reflect lease modifications or reassessments. While Excel can be a good starting point, its limitations become apparent as the volume and complexity of leases grow.
IFRS 16 Software for Streamlining Lessee Accounting
For organisations managing a significant lease portfolio, dedicated IFRS 16 software offers numerous advantages. These software solutions are designed to automate the calculation of lease liabilities and right-of-use asset depreciation, streamline data management, and ensure compliance with IFRS 16.
Features such as automatic lease modification handling, comprehensive reporting capabilities, and integration with financial systems can greatly reduce manual workloads and the potential for error.
By leveraging IFRS 16 software, lessees can achieve a higher level of accuracy and efficiency in their lease accounting practices, ensuring compliance and freeing up valuable resources for strategic analysis and decision-making. For more information on how our solutions can help, explore Rubli’s IFRS 16 software, and contact us for a demo.
Final Thoughts on IFRS 16 Lessee Accounting
This guide has traversed the intricate landscape of IFRS 16 lessee accounting, shedding light on its profound implications for lessees’ financial reporting, tax considerations, and the necessary tools for compliance. The shift to IFRS 16 has redefined lease accounting and set a new standard for transparency and accountability in financial statements. As we look to the future, ongoing developments and enhancements in both regulatory frameworks and technology promise to further refine lessee accounting practices.
Lessees must stay informed and adaptable to navigate these changes successfully. We offer comprehensive resources, tools and support tailored to IFRS 16, including our IFRS 16 training content, our IFRS 16 guides within our blog, and our own IFRS 16 lease accounting software that helps lessees and lessors streamline IFRS 16 lease accounting.
You can contact us for a demo to see how our solution can support your lease accounting journey.
