FAQ concerning IFRS 16 – Lease (part 2)

Piotr STASZKIEWICZ
Audit Partner at RSM Poland

Last year we wrote a lot in our blog about the new IFRS 16 standard that significantly changes the concept behind considering contracts in terms of the necessity to disclose transactions in the lessee’s balance sheet.  We are going to continue on this topic, answering another batch of the most frequently asked questions concerning this standard.

10. We have signed over a dozen (operating) lease contracts to use delivery cars. Under the contractual terms and conditions, the cars cannot travel more than 5,000 km per month. Does the aforementioned limitation mean that the lease condition under IFRS 16 concerning the right to obtain substantially all economic benefits from the cars being used is not met?

Under IFRS 16, a contract is a lease if it conveys the right to control the use of an identified asset for a predefined period in exchange for consideration, and obtain economic benefits from it. We could state a contrario: if an asset is not identified, it is not a lease. The same could be said about the right to control or the lack of consideration. Therefore, if under the contract the conditions concerning the identified asset are met, namely (1) it can be explicitly or implicitly specified, and the lessor cannot have a substantive right of substitution and the lessee has the right to obtain substantially all economic benefits from the use of this asset (2) and the right to control the use of this asset (3), we are dealing with a lease according to IFRS 16.

What may seem problematic is the presence of contractual limitations, such as e.g. a ban on using the car abroad or a monthly limit of kilometres, etc. However, in most cases these are lessor’s protective measures that do not affect the lessee’s evaluation concerning the control of an asset (even within these limits). What is more, if we were to consider these limitations to be material and preventing the appropriate use of an asset, signing such a contract would have been surely reconsidered.

11. Under the car lease contracts signed by our company we often bear the costs of car maintenance service/MOT test. If all these costs are accounted for ‘under one entry’ in our monthly payments, can we measure the initial value of the right-of-use asset on the basis of the total of such payments recognized this way?

No. As a rule of thumb, lease and non-lease components must be separated. These additional services (like maintenance service for example) are not a lease component in itself, but only an addition, and should be separated and recognised as expenses every month separately from the depreciation of the right to use the car.

12. How can the value of the lease component be measured then?

In the simplest terms, one should determine the market value of the payment for the car lease independently from the maintenance service (1) and of the maintenance service itself (2). Knowing their proportion, we could determine what % of monthly payments made by the lessee should not be included in the initial measurement of the right-of-use asset.

13. How can comparable data in the report for 2019 be presented, assuming that as of 1.01.2019 we introduce the lease according to the provisions of IFRS 16?

It depends. Firstly, entities may apply the new standard just like any other new standards, with a full retrospective approach. Thus, assuming that you are going to apply IFRS 16 for the first time in 2019 and that you are presenting comparable data for one period (2018), under the retrospective approach you have to recognize contracts as at 1 January 2018 according to IFRS 16 as if the new standard has always been in force for you. The second option is to leave data under column 31.12.2018 unchanged in the financial statements for 2019, thus introducing the right-of-use assets only as of 1.01.2019, provided that as at 31.12.2018 operating or finance lease contracts were/will be recognised correctly (i.e. in line with IAS 17). An additional simplification is the possibility of refraining from the analysis of contract provisions in the light of IFRS 16, if within the meaning of IAS 17 it did not/will not meet the definition of a lease (either finance or operating) as at 31.12.2018.

14. And what if the contract is terminated? What to do with the asset value? Should it be written down?

Each and every amendment or termination of the contract has (or may have) accounting consequences and each case should be considered individually. The lessee shall be obliged to reassess the contractual terms and conditions, if there are any premises/circumstances indicating the need to change the input data. If the contract is terminated (cancelled), a given entity shall no longer account for the right-of-use assets. They shall not disclose any corresponding liabilities (future payments) unless otherwise provided for under the contract. If the contract is amended, you need to consider whether the right-of-use asset has been increased or reduced (e.g. reduction of the leased space). If the scope of the right-of-use asset has been increased (e.g. increase of the subject of the lease from 100 to 150 sq m), you have to determine whether you are dealing with a separate right to use this space of 50 sq m or not.

15. We have signed a foreign currency lease contract. What about the valuation as at the reporting date?

The recognised right-of-use assets shall not be adjusted for the valuation of currency liabilities related to the lease contract. Any differences resulting from the valuation shall be applied directly to the profit and loss account.

16. What about other variables, e.g. interest rates, on which lease payments depend? Do any changes thereof affect the profit and loss account directly, as well?

No. The interest rates and the index (e.g. inflation) adjusting the future payments and thus lease liabilities recognised as at the reporting date are a variable component and their fluctuations change the value of liabilities, as well as the right-of-use assets.

17. What should be adjusted if the car lease contract provides for a monthly limit of 3,000 km included in the lump sum, and every additional 100 km shall be invoiced separately at a rate of PLN XX? Do these additional payments increase the value of the assets?

Occasional additional costs resulting from exceeding the limit of kilometres travelled should be recognised directly as expenses. However, on the date of lease recognition and the first postings you have to ask yourself a question whether this limit will not be exceeded every month in fact. And if so, the actual value of the right to use the car should be determined not on the basis of the contractual lump sum only, but on the additional amount for the exceeded limit, as well, since it will happen often, every month. In this case you have to rely on your best knowledge, experience and judgement.

18. What is going to change in the case of a leaseback under the new standard?

Firstly, it seems essential to determine whether a sale of the asset has occurred within the meaning of IFRS 15. Then, the assets should be derecognised from the seller’s balance sheet. In the next step, we must compare the consideration for the sale with the market price: depending on whether the consideration for the sale is higher than the market value or not, we are dealing either with additional financing provided by the purchaser of the asset or prepayment of the lease payments. In the following stages, you calculate the value and make appropriate adjustments in the balance sheets of both parties. Obviously, if the asset is sold at fair value, and the consideration for the sale is the same as the seller’s book value, the entire calculation process is simple and boils down to posting these values in the books under appropriate entries.

As the above answers do not exhaust the topic of lease and IFRS 16, we encourage you to submit your doubts concerning the lease to the following email address: [email protected], so that we could extend the FAQ section dedicated to IFRS 16 together.