20 IFRS 16 Leases

Question 1

What is a lease

Answer 1

A lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration

Question 2

What is a lessor

Answer 2

The lessor is the ‘entity that provides the right to use an underlying asset in exchange for consideration.’

Question 3

What is a lessee

Answer 3

The lessee is the ‘entity that obtains the right to use an underlying asset in exchange for consideration.’

Question 4

What is a right of use asset

Answer 4

A right-of-use asset ‘is an asset that represents the lessee’s rights to use an underlying asset for the lease term

Question 5

IFRS16 requires lessees to recognise…

Answer 5

Assets and liabilities in relation to the rights and obligations created by the leases.

Question 6

What is commercial substance

Answer 6

Commercial substance reflects the financial reality of the transaction

Question 7

What is legal form

Answer 7

Legal form is the legal reality of the transaction

Question 8

Why was there a change from IAS 17 Leases to IFRS 16 Leases

Answer 8

• If you didn’t capitalise and only expenses you would be understating the assets and liabilities as you just run it as an expense through the P&L
• Boosts greeting in this case as getting benefits (revenue) without considering the assets that generated it
  o Now treated same as if you took out a loan to buy it
• However, it is still a net benefit to the company of putting it on the books as asset value will exceed liability, but still affects gearing just better BS
• Creates a more faithful representation
  o Substance over form

Question 9

What is the relationship between substance over form and IFRS 16

Answer 9

• IFRS 16 defines a lease using economic substance rather than legal form, i.e. a contract does not legally have to be a lease to be accounted for as a lease.
• When an asset is leased there is a difference between the legal form of that transaction and its commercial substance

Question 10

How does IFRS 16 classify leases

Answer 10

Lessees are required to recognise assets and liabilities in relation to the rights and obligations created by leases

Question 11

How do you identify a lease

Answer 11

A contract conveying the right to control an asset over a period of time in exchange for payment (consideration).

Question 12

What is the right to control

Answer 12

Obtain substantially all economic benefits from the asset
Right to direct the asset’s usage

Question 13

How does IFRS 16 relate to off balance sheet financing

Answer 13

• IFRS 16 seeks to prevent off-balance sheet financing
• i.e., funding/refinancing of an entity’s activities in such a way that some/all of the finance is not shown on the SFP

Question 14

Why would you want to use off balance sheet financing

Answer 14

• To satisfy users of FS, e.g. investors, analysts
• To stay within loan covenants imposed by lenders
• There may be an expectation of a rights issue when gearing is high.
• A rights issue would reduce gearing (as equity is increased) but have a negative impact on the share price

Question 15

What is a residual value guarantee

Answer 15

When the lessor is guaranteed that the asset at the end of the lease term will not be worth less than a specified amount.

Question 16

How are short life or low value assets treated

Answer 16

Their treatment is simplified:
* Recognise lease payments in SPL on a straight-line basis
* No lease liability or right-of-use asset is recognised.
Just expense to P&L not recognise