What is IFRS 16? Definition and example

What is IFRS 16?

Under IFRS 16, a contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration (paragraph 9). Offices, warehouses, vehicles, equipment and land can all be leased. For lessees, IFRS 16 introduced a single accounting model: at the start of a lease, the lessee recognises a right-of-use asset and a lease liability (paragraph 22).

Two exemptions are optional (paragraphs 5 and 6). A short-term lease, 12 months or less at commencement with no purchase option, can be expensed, with the choice made by class of asset. A lease of a low-value asset can be expensed lease by lease; the value is judged when the asset is new, so tablets, personal computers, small office furniture and telephones can qualify, but cars do not (paragraphs B3 to B8). This page covers lessees; lessors follow other requirements in the standard.

How does a lessee apply IFRS 16?

1. Identify the lease and its termConfirm the contract conveys control of an identified asset. The lease term is the non-cancellable period plus extension options the lessee is reasonably certain to use, and periods after a termination option it is reasonably certain not to use.
2. Measure the lease liabilityThe present value of the lease payments not yet paid, discounted at the rate implicit in the lease or, if that cannot be readily determined, the lessee’s incremental borrowing rate (paragraph 26).
3. Measure the right-of-use assetThe lease liability, plus payments made at or before commencement less incentives received, initial direct costs and estimated restoration costs (paragraph 24).
4. Run it each periodCharge interest on the liability and reduce it by the payments. Depreciate the right-of-use asset, usually over the shorter of the lease term and the asset’s useful life (paragraphs 31 and 32).
5. Present itShow interest on the lease liability separately from depreciation of the right-of-use asset (paragraph 49).

What does IFRS 16 look like in numbers?

Why does IFRS 16 matter for finance teams in the GCC?

In Saudi Arabia, SOCPA applies international standards to companies listed on the financial market from financial statements starting 1 January 2017, and to other entities from periods beginning 1 January 2018, so most leases of offices, warehouses, vehicles and land sit on the balance sheet for companies on full IFRS. Because the lease cost moves into depreciation and interest, EBITDA rises and so do reported liabilities, which matters when bank covenants or bonuses use those figures. Rent paid in advance is part of the right-of-use asset, not a prepaid expense, unless an exemption applies.

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