Leases A guide to IFRS 16 June 2016 This guide contains general information only, and none of Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively, the “Deloitte Network”) is, by means of this guide, rendering professional advice or services. Before making any decision or taking any action that might affect your finances or your business, you should consult a qualified professional adviser. No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person who relies on this guide. © 2016. For information, contact Deloitte Touche Tohmatsu Limited. Extracts from International Financial Reporting Standards and other International Accounting Standards Board material are reproduced with the permission of the IFRS Foundation. Leases | A guide to IFRS 16 Foreword This guide is intended to assist preparers and users of financial statements to understand the impact of IFRS 16 Leases, issued in January 2016 and effective for accounting periods beginning on or after 1 January 2019. We begin with a high-level executive summary of the new requirements, followed by a specific focus on the important issues and choices available for entities on transition to the new Standard. Our detailed guide covers the requirements of the new Standard, supplemented by interpretations and examples to give clarity to those requirements, and pointers regarding practical issues that are likely to arise. In the appendices, we provide: • a summary of the important illustrative examples accompanying IFRS 16 dealing with the identification of leases; • convenient checklists for IFRS 16’s presentation and disclosure requirements (separately for lessees and lessors); and • a brief comparison with US Generally Accepted Accounting Principles (US GAAP). We trust that you will find this guide informative and a useful reference source. Within the detailed guide, paragraphs that represent the authors’ interpretations, material drawn from the IASB’s Basis of Conclusions on IFRS 16, and examples other than those cited in IFRSs are highlighted by green shading. 1 Leases | A guide to IFRS 16 Contents Executive summary 3 Dealing with transition 5 Detailed guide 9 Appendices Appendix 1 Illustrative examples – identification of a lease 97 Appendix 2 Presentation and disclosure checklist – lessees 102 Appendix 3 Disclosure checklist – lessors 107 Appendix 4 Comparison with US GAAP 109 2 Leases | A guide to IFRS 16 Executive summary IFRS 16 Leases was issued by the IASB in For lessees, the picture is fundamentally • a shift in lease expense classification January 2016. It will replace IAS 17 Leases different and IFRS 16 can be expected to from operating expenses to financing for reporting periods beginning on or after have a significant impact, particularly for costs and amortisation (i.e. moving 1 January 2019. It can be applied before entities that have previously kept a large below metrics such as operating profit, that date by entities that also apply IFRS 15 proportion of their financing ‘off-balance EBITDA or EBIT). There are some Revenue from Contracts with Customers. sheet’ in the form of operating leases. This exceptions: any variable lease payments operating lease-style accounting treatment not included in the initial measurement IFRS 16 sets out a comprehensive model is no longer available, except for short-term of the lease liability are classified as for the identification of lease arrangements leases (lease term 12 months or less) and operating expenses, as are the expenses and their treatment in the financial leases of low-value assets (‘low value’ is associated with short-term and low- statements of both lessees and lessors. not specifically defined but the IASB has value asset leases for which recognition IFRS 16 applies a control model for the indicated that it has in mind assets with a exemptions are applied; and identification of leases, distinguishing value, when new, in the order of magnitude • for entities that present cash flows between leases and service contracts on of US$5,000 or less). related to interest on leases as financing the basis of whether there is an identified flows, a shift of the payments previously asset controlled by the customer. While, for All other leases within the scope of IFRS associated with operating leases to the the majority of contracts, the classification 16 are required to be brought on-balance financing category (unless they change under the new Standard as either a lease sheet by lessees – recognising a ‘right-of- their policy regarding presentation or a service contract may not be different use’ asset and the related lease liability of interest cash flows). Cash from to the classification under the IAS 17 ‘risks at commencement of the lease, with operations and financing activity outflows and rewards’ model, divergence may subsequent accounting generally similar to will both increase for these entities. emerge, for example, when the pricing of the finance lease model under IAS 17. the contract was a significant consideration A number of aspects of the application under IAS 17. Importantly, both lessors How these new requirements affect a of IFRS 16 will require the exercise of and lessees are entitled to ‘grandfather’ lessee’s financial statements will obviously judgement – particularly in respect of the assessments regarding whether a contract depend on the mix of lease agreements in definition of a lease and the assessment existing at the date of initial application of place, and also on which of the Standard’s of the lease term. Entities will also need IFRS 16 contains a lease so that entities are exceptions and practical expedients are to take time to consider whether to avail not required to incur the costs of detailed applied. However, the expectation for of practical expedients and recognition reassessments. lessees will be: exemptions (including, in particular, reliefs available on transition, as discussed in One of the most notable aspects of • an increase in recognised assets and detail in the next section of this guide). IFRS 16 is that the lessee and lessor liabilities (right-of-use assets and liabilities accounting models are asymmetrical. recognised other than for short-term In addition, there are important business While the IASB has retained IAS 17’s leases and leases of low-value assets); considerations – including whether finance lease/operating lease distinction changes are needed to systems and • more lease expenses recognised in for lessors (and carried into IFRS 16 the processes (e.g. to track leases individually the early periods of a lease, and less in related requirements virtually intact), the or at a portfolio level, or to accumulate the later periods (‘front-loaded’ finance distinction is no longer relevant for lessees. the information needed for disclosures); charge on lease liability versus straight- any potential tax impacts (if the treatment line expense under IAS 17’s operating For lessors, the changes introduced by IFRS of a lease for tax purposes is based on lease approach); 16 are not significant and, except in respect its treatment in the financial statements); of subleases, a lessor is not required to and the impact of changes in the amounts make any adjustments on transition for reported on key metrics, debt covenants leases in which it is a lessor. Additional and management compensation. requirements have been introduced for subleases and lease modifications, and lessor disclosure requirements have been expanded. 3 Leases | A guide to IFRS 16 IFRS 16 Key judgements, policy choices and exemptions Detailed guide reference Judgement: Identifying a lease will sometimes require a Identifying a lease significant amount of judgement based on the elements (section 3) of the definition of a lease Judgement: Determining whether it is reasonably Lease term certain that an extension or termination option will be (section 5) exercised Judgement: Identifying the appropriate rate to discount Discount rate the lease payments may involve significant judgement (section 7.4.2.2) Exemption: Exemptions may be taken for short-term Recognition leases (by class of asset) or low-value asset leases (section 7.2) (lease-by-lease basis) Policy choice: Requirements of IFRS 16 can be applied Application to portfolios to a portfolio of similar leases provided that such (section 1.3) aggregation is not expected to have a material effect Policy choice: Lessee may elect not to separate non- Components lease components from lease components by class of (section 4) asset Policy choice: Lessee may, but is not required to, apply Scope IFRS 16 to leases of intangible assets (section 2) Policy choice: The transition choices available are: Transition full retrospective approach or cumulative catch-up (section 11) approach, definition of a lease – choice to grandfather all or none, initial direct costs in measurement of right- of-use asset – choice lease-by-lease, and other practical expedients on transition 4 Leases | A guide to IFRS 16 Dealing with transition Although IFRS 16 is not mandatorily Readiness assessment Data gathering and systems readiness effective until periods commencing on A readiness assessment is a good way Compiling all of the data necessary for or after 1 January 2019, for many entities to gauge the scale of the challenge reporting under IFRS 16, and ensuring that the scale of the challenge ahead means ahead and to identify which aspects of it is robust, may take considerable time and that they will be starting to think