Lease Identification

Introduction

Now that we have discussed the answer to “Why IFRS 16” and a bit of “How to IFRS 16”, we will continue down the narrow, bendy road of lease accounting. If you missed it – here is the link to the introduction of our guide to IFRS 16 for leases.

Like all things in life, before you start with a project, specifically one that hinges on compliance (IFRS), you first check and then double check if you really need to do it, right?

No one would want to start with the complex standard of IFRS 16 if you could’ve have evaded it from the start. So, a good starting point for any accounting transaction, is to ensure that you fall within the scope and recognition criteria for leases.

In this guide, we will quickly look at three easy questions to ask before accounting for a lease. Then work through a flowchart that helps you to make your decision logically to account for a lease or not. Lastly, we will go through the rules that IFRS 16 allows you to simplify your lease accounting.

Just keep in the back of your mind, that any contract may contain a lease, because there is no requirement that it must be in a separate contract.

Definition

IFRS 16 changed the definition of a lease which made it more clear on how to apply the definition to any contract. Initially for some companies on implementation of IFRS 16 for leases, this resulted in a few more leases they had to recognize.

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 makes, 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.

There are three questions to ask if a contract meets the criteria of a lease:

1. 1. Is there an identifiable asset (Do you know specifically which asset you will use)?
   2. Do you have the right to control the asset with both of the following? 
      1. 1. Right to direct the use of the asset; and
         2. Obtain the benefits from using the asset; and
   3. Are there any substitution rights for the asset?

This will help guide you in your decision if the contract is a lease. Something that helps, is to make sure you know which asset is uniquely yours.

If ever you are in doubt on any of these three aspects, the standard goes into a lot of detail to help guide you. Please see the standard references to look at for more detail:

1. 1. Identifiable asset [IFRS 16.B13]
   2. Right to control [IFRS 16.B9-B10; B21-B30]
   3. Substitution rights [IFRS 16.B14-B20]

Lease Identification Flowchart

The flowchart below gives guidance in making an insightful assessment of whether a contract is, or contains, a lease:

Recognition Exemptions

You are probably thinking why you should go through all of this if you have short-term leases, or lease of such small value that it has no impact on your financial statements?

Fortunately, the standard provides relieve for low value and short-term leases. These leases may just be expensed through the income statement and you will not have to apply the “full scope” of IFRS 16 for leases.

Of course, there are specific rules for this exemption, otherwise everyone would exempt their leases.

Short-term leases are those that will start and finish within 12 months. It makes sense to exclude it, because the impact of a one-year IFRS 16 lease will be the same as just expensing it.

Similarly, low value leases (typically less than $5,000) would also not have a significant impact and is exempt. [IFRS 16.BC98-BC104]

Closing

Our hope is that after this guide, with the three question to ask, you know what to look out for and eliminate any contract not under IFRS 16. Perhaps you are lucky and can apply the exemptions available.

With large, distributed teams, you want to ensure that your teams are only spending their time on contracts that are in the full scope of IFRS 16. That is why Rubli clients have a built in a ‘Lease checklist’, with the support of IFRS 16 to help you manage your lease accounting.

Once you have established that you need to account for your lease in terms of IFRS 16, you need to perform the ‘initial measurement’ where you calculate the value to bring on to the balance sheet. In the next guide we will discuss how to calculate the starting value of the lease liability and asset.