IFRS 16 Leases

Operating Lease

A lease is an agreement whereby the lessor (the legal owner of an asset) conveys to the lessee (the user of the asset) the right to use an asset for an agreed period of time in return for a payment or series of payments.

So, Lessee will recognise a right of use asset and an associated liability at the inception of the lease.

Accounting for leases in the financial statements of lessees

FRS 16 requires that the ‘right of use asset’ and the lease liability should initially be measured at the present value of the minimum lease payments. The discount rate used to determine present value should be the rate of interest implicit in the lease.

Recording the asset

The ‘right of use asset (ROUA)’ would include the following amounts, where relevant:

• Any payments made to the lessor at, or before, the commencement date of the lease, less any lease incentives received.
• Any initial direct costs incurred by the lessee.
• An estimate of any costs to be incurred by the lessee in dismantling and removing the underlying asset, or restoring the site on which it is located

Depreciation

·         The ROUA is subsequently depreciated. Depreciation is over the shorter of the useful life of the asset and the lease term, unless the title to the asset transfers at the end of the lease term, in which case depreciation is over the useful life.

(For example, If asset’s useful life is 10 years but contract is for 5 years, The ROUA will be depreciated for 5 years)

Lease liability

The lease liability is effectively treated as a financial liability which is measured at amortised cost, using the rate of interest implicit in the lease as the effective interest rate.

Case Study

For use of Showroom/Shop/Floor entered for 3 years agreement. Lease payment/rent payment per month $500. To obtain the lease, the lessee incurred initial direct costs of $100. Cash in hand $ 20,000 as Capital.

Workout

The interest rate (ROI) implicit in the lease is 10% per annum. The present value of the lease payments is $16,413 as:

Present Value of Minimum lease payment
Year	Annual Rent	PV@10%
2019	6,000	6,000
2020	6,000	5,455
2021	6,000	4,959
	Right of Use Asset	16,413

The carrying amount of the right of use asset after these entries is $16,513 ($16,413 + $100) and consequently the annual depreciation charge will be $5,504.33 ($16,513 x 1/3).

The lease liability will be measured using amortised cost principles as:

Amortization Cost Schedule
Year	Opening Balance (Lease Liability)	Rental Amount	Interest	Decrease Lease Liability	Closing Balance (Lease Liability)
2019	16,413	6,000	1,041.32	4,959	11,455
2020	11,455	6,000	545.45	5,455	6,000
2021	6,000	6,000	(0.00)	6,000	-

Financial Presentation

Statement of Profit or Loss and Other Comprehensive Income
For the period ended
		Dec-19	Dec-20	Dec-21
Depreciation		5,504	5,504	5,505
Finance cost-Interest		1,041	545	-
		6,546	6,050	5,505

Statement of Financial Position
As on
		Dec 30, 2019	Dec 30, 2020	Dec 30, 2021
ASSETS
Right of use assets		11,009	5,504	-
Cash in hand		13,900	7,900	1,900
	Total Assets	24,909	13,404	1,900
EQUITY  AND LIABILITIES
Equity		20,000	20,000	20,000
Retained Earnings C/F			(6,546)	(12,595)
-Current Year		(6,546)	(6,050)	(5,505)
liabilities:
Lease liability		11,455	6,000	-
	Total equity and liabilities	24,909	13,405	1,900