IFRS 16 Lessor Accounting DESCRIBES that lessors account for finance leases by initially de-recognizing the asset and recognizing a receivable for the net investment in the lease. Initial direct costs (other than those incurred by a Manufacturer/(Dealer) lessor) are INCLUDED in the ‘Net Investment in the Lease’.
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IFRS 16 Lessor Accounting – Background
Lessors continue to CLASSIFY leases as ‘Operating’ or ‘Finance’, with IFRS 16’s approach to lessor accounting substantially unchanged from its predecessor, IAS 17.
IFRS 16 was ISSUED in January 2016 and applies to annual reporting periods beginning on or after 1 January 2019.
IFRS 16 Lessor Accounting – Classification of Lease
A lessor CLASSIFIES the lease either as a Finance Lease or an Operating Lease.
| A Lease is a Finance Lease If: |
|---|
| – Ownership is transferred to the lessee by the end of the lease term; |
| – Option to purchase the asset at price < Fair Value of asset at the end of the lease; |
| – Lease term > Major Part of the economic life of the asset (75% or more); |
| – Present Value of lease payments > Fair Value of the asset at the commencement of the lease (90% or more); OR |
| – Lease asset is of specialized nature. |
| Other Indicators: |
| – If the lessee can cancel the lease, the lessor’s losses are to be borne by the lessee; |
| – Gain/Loss on account of fluctuation of residual value accrues to the lessee; |
| – Lessee can continue the lease for a secondary period at rent < Market Rent. |
1. Finance Lease
At the Commencement of the Lease, the lessor accounts for the ‘Finance Lease’ as:
| Debit: Lease Receivable (Net Investment in Finance Lease) [- Lease payments not paid at the ‘Commencement’; AND – Un-guaranteed residual value (UGRV)] Discounted at Interest Rate Implicit in the Lease | Credit: Property, Plant, and Equipment (PPE) |
| Credit: Initial Direct Cost (Borne by the lessor) | |
| Credit: Gain on Sale of PPE (Debit if Loss) | |
2. Operating Lease
The lessor accounts for the ‘Operating Lease’ in the following manner:
| Continue to RECOGNIZE the underlying asset. |
| Any initial direct costs incurred in obtaining the lease are CAPITALIZED and AMORTIZED over the lease term. |
| RECOGNIZE the lease income over the lease term on straight-line basis (or another Systematic basis). |
Manufacturer/(Dealer) Lessor
A ‘Finance Lease’ of an asset by a Manufacturer/(Dealer) Lessor gives rise to the following two incomes:
| Finance Lease Income Over the Lease Term – If an artificially low rate of interest is charged by manufacturer/dealer lessor, selling profit is restricted to that which would apply if a market rate of interest were charged. This is done by discounting future lease payments using the market interest rate. | Selling Profit or Loss – Sales revenue is recognized at lower of: (a) Fair Value of the underlying asset; and (b) Present Value of lease payments, discounted at the Market Rate of Interest. – Cost of Sale is recognized at the carrying amount of the asset less the present value of un-guaranteed residual value (if any). |
| Any costs INCURRED in connection with obtaining the lease are charged to Profit and Loss (P&L) at the commencement date. |
Lease of Land and Building
| Separate Classification |
|---|
| [Land has Indefinite Economic Life] |
| Land | Building |
|---|---|
| – Account for as ‘Operating Lease‘ unless title passes to the lessee at the end of the lease term. | – Account for as ‘Finance Lease‘ or ‘Operating Lease‘. |
| Allocation of lease payments on the basis of the proportion of the fair value of land and building. |
Synopsis
Under IFRS 16, Lessors are required to classify leases as EITHER ‘Operating’ or ‘Finance’ based on the extent to which the risks and rewards associated with the underlying asset are transferred to the lessee.
IFRS 16 Lessor Accounting a Concept which STATES that for ‘Operating Leases’, Lessors continue to recognize lease income on a straight line basis over the lease term. In ‘Finance Leases’, Lessors recognize a portion of the net investment in the lease as finance income and the remaining portion as a reduction of the carrying amount of the underlying asset.
Chartered Accountant – ICAP
Bachelor of Accounting (Honours) – AeU, Malaysia