Determining the Lease Liability
The accounting for the lease is largely similar to how finance leases are currently treated under AASB 117, with the lease liability being measured at the present value of the lease payments, discounted at the interest rate implicit in the lease. The following payments are included in the lease:
- Fixed payments
- Variable lease payments that depend on an index or rate, for example rental payments that are indexed to the consumer price index, or RBA Reserve rate.
- Any amounts payable under a residual value guarantee
- Any exercise price of an option that is reasonably certain to be exercised (see above).
- Any lease incentives receivable are deducted from the payments
Variable lease payments (for example, rent for a retail store based on a percentage of turnover) are not considered part of the lease liability, and are expensed as they fall due.
Once the lease liability has been determined, it is recognised at the inception of the lease, together with a “right-of-use asset” for the same value.
Over the lease term, the lessee will recognise two expenses
- Interest on the lease liability, based on the interest rate implicit in the lease
- Depreciation on the right-of-use asset, based on the shorter of the lease term and the asset’s useful life
The effect of this is that there is no rent expense recognised in the financial statements any more, only interest and depreciation. This is likely to impact key metrics such as EBITDA and interest cover.
Example 6 – Example of Lease Accounting
A distribution company rents a warehouse for $25,000 per year for a lease term of six years from 1 January 2020 (paid on 1 January each year). The interest rate implicit in the lease is 9%.
Currently, a rental expense of $25,000 would be recognised for each year.
Under AASB 16, the following would be recognised:
From the final line, showing the total expense recognised in the income statement, being both depreciation and interest, we can see that the effect of AASB 16 is to “front-load” the recognition of expense, rather than recognising it on a straight-line basis.
There are two exemptions from the requirements of AASB 16 set out above.
- Leases of less than 12 months in duration
- “Low-value” leases. While this is not formally defined, the Board’s basis for conclusions indicated that leases of less than USD 5,000 would generally be considered low value
In both cases, these leases would be treated in a similar manner to how operating leases are currently recognised, with the cost of the lease being recognised on a straight-line basis over the lease term.
The lessor accounting model under IFRS 16 is largely unchanged from the existing requirements in IAS 17. The lessor is still required to apply the same principles as under IAS 17 to distinguish between finance leases and operating leases, and apply the relevant accounting requirements accordingly. However, IFRS 16 requires enhanced disclosure from lessors in relation to risk exposure.
Learn more on the new lease accounting;