The objective of IFRS 16 is to report information that (a) faithfully represents lease transactions and (b) provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.

To meet that objective, a lessee should recognise assets and liabilities arising from a lease.

IFRS 16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value.

A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.

A lessee measures right-of-use assets similarly to other non-financial assets (such as property, plant and equipment) and lease liabilities similarly to other financial liabilities.

As a consequence, a lessee recognises depreciation of the right-of-use asset and interest on the lease liability.

The depreciation would usually be on a straight-line basis.

In the statement of cash flows, a lessee separates the total amount of cash paid into principal (presented within financing activities) and interest (presented within either operating or financing activities) in accordance with IAS 7.

Assets and liabilities arising from a lease are initially measured on a present value basis.

The measurement includes non-cancellable lease payments (including inflation-linked payments), and also includes payments to be made in optional periods if the lessee is reasonably certain to exercise an option to extend the lease, or not to exercise an option to terminate the lease.

The initial lease asset equals the lease liability in most cases.

The lease asset is the right to use the underlying asset and is presented in the statement of financial position either as part of property, plant and equipment or as its own line item.

IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17. Accordingly, a lessor continues to classify its leases as operating leases or finance leases, and to account for those two types of leases differently.

The new standard will have a far-reaching impact on certain sectors, particularly retail, construction, utilities and transport.

Andrew Marshall, senior technical partner at KPMG said: ‘The retail sector is going to be significantly impacted by the new IFRS on leases, IFRS 16.

‘This is quite simply because the most significant assets they use in their business are the stores from which they operate and these assets are often leased on medium to long-term operating leases.’

The issues retailers will face are those common to all leases, namely:

• bringing on balance sheet the right of use asset and the lease liability, being the discounted future cash flows, significantly increasing the asset base and the debt and hence gearing on the balance sheet;
• substituting the IAS 17 straight line operating lease charge with the IFRS 16 straight line depreciation of the right of use asset and declining interest charge (the effective interest charge reduces as the lease liability reduces);
• consequently, a higher earnings before interest, tax, depreciation and amortisation (EBITDA), as depreciation and interest are excluded, whereas the old operating lease charge was not; and
• the end of the sale and leaseback regime as a way of reducing debt.

IFRS 16 replaces IAS 17 Leases effective 1 January 2019. IFRS 16 has the following transition provisions:

• existing finance leases: continue to be treated as finance leases; and
• existing operating leases: option for full or limited retrospective restatement to reflect the requirements of IFRS 16.

Report by Sara White

Read our series of IFRS 16 sector transition reports for useful tips and advice

Go to Croner-i Tax and Accounting to read IFRS 16 transition