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Liabilities & leases · IFRS 16

IFRS 16 Leases

Summary, key points, exam traps and a worked example — written for ICAP, ACCA, ICAI, CIMA and ICAEW students.

On this page
  1. Status & recent changes
  2. Objective
  3. Scope
  4. Key definitions
  5. Recognition & measurement
  6. Key disclosures
  7. Common exam traps
  8. Worked example
  9. Related standards
  10. Practise MCQs

Status & recent changes

  • Amendments effective from 1 January 2024 specify how a seller-lessee measures the lease liability in a sale and leaseback so that it does not recognise a gain relating to the right of use it retains.

Objective

Sets out how lessees and lessors recognise, measure, present and disclose leases, with a single on-balance-sheet model for lessees.

Scope

  • All leases, including subleases, except leases to explore for or use minerals and similar resources, biological assets within IAS 41, service concession arrangements, certain licences of intellectual property, and some rights under licensing agreements.

Key definitions

Lease
A contract, or part of one, that conveys the right to control the use of an identified asset for a period in exchange for consideration.
Lease term
The non-cancellable period plus periods covered by extension options the lessee is reasonably certain to exercise and termination options it is reasonably certain not to exercise.
Right-of-use asset
An asset representing the lessee's right to use the underlying asset for the lease term.
Short-term lease
A lease of 12 months or less at commencement with no purchase option.

Recognition & measurement

Lessee

  • At commencement recognise a right-of-use asset and a lease liability, unless the optional exemptions for short-term leases or low-value assets are used (payments then expensed, usually straight-line).
  • Lease liability = present value of lease payments not yet paid, discounted at the rate implicit in the lease, or the lessee's incremental borrowing rate if that cannot be readily determined.
  • Lease payments include fixed payments (less incentives receivable), variable payments that depend on an index or rate, expected residual value guarantee payments, a purchase option price if reasonably certain to be exercised, and termination penalties where the term reflects termination.
  • Right-of-use asset = initial lease liability + payments made at or before commencement − incentives received + initial direct costs + estimated dismantling/restoration costs.
  • Subsequently: depreciate the right-of-use asset (over the shorter of lease term and useful life, unless ownership transfers) and unwind the liability using the effective interest method.
  • Remeasure the liability for changes in lease term, purchase option assessment, residual value guarantees or index-linked payments, adjusting the right-of-use asset.

Lessor

  • Classify each lease as a finance lease (substantially all risks and rewards of ownership transfer) or an operating lease.
  • Finance lease: derecognise the asset and recognise a receivable at the net investment in the lease; earn finance income over the term.
  • Operating lease: keep the asset and recognise lease income, normally straight-line.

Sale and leaseback

  • If the transfer is a sale under IFRS 15, the seller-lessee measures the right-of-use asset at the proportion of the previous carrying amount relating to the right of use retained, and recognises a gain or loss only on the rights transferred to the buyer-lessor.
  • If it is not a sale, the seller keeps the asset and accounts for the proceeds as a financial liability under IFRS 9.

Key disclosures

  • Lessee: depreciation by class, interest on lease liabilities, short-term and low-value lease expense, variable payments, total cash outflow, additions and carrying amounts of right-of-use assets, and a maturity analysis.
  • Lessor: selling profit or loss, finance income, operating lease income, and maturity analyses of payments receivable.

Common exam traps

  • Payments in advance (at commencement) are not included in the lease liability, but are added to the right-of-use asset.
  • Split the lease liability into current and non-current portions.
  • Interest on the liability is a finance cost; depreciation of the right-of-use asset is an operating expense.
  • Variable payments linked to sales or usage are expensed as incurred, not included in the liability.

Worked example: Lessee: initial and Year 1 measurement

Scenario. A lessee leases a machine for 5 years, paying $10,000 annually in arrears. The rate implicit in the lease is 8%. There are no initial direct costs or incentives.

  1. Lease liability = 10,000 × 3.9927 (5-year annuity at 8%) = $39,927; right-of-use asset also $39,927.
  2. Year 1 interest = 39,927 × 8% = $3,194.
  3. Closing liability = 39,927 + 3,194 − 10,000 = $33,121.
  4. Depreciation = 39,927 ÷ 5 = $7,985.

Answer: Year 1 expense = $3,194 interest + $7,985 depreciation; liability $33,121 at the year end.

Practise MCQs on this standard

Test your understanding of IFRS 16 with free chapter-wise MCQs and explanations in these question banks.

CAF-1 Financial Accounting and ReportingICAP CAFACCA FA Financial AccountingACCAACCA FR Financial ReportingACCACAF-6 Corporate ReportingICAP CAFCIMA BA3 Fundamentals of Financial AccountingCIMA Certificate in Business AccountingICAEW AF Accounting FundamentalsICAEW ACA Certificate LevelCA Inter P1 Advanced AccountingICAI CA Intermediate

ICAI CA Intermediate examines Indian Accounting Standards, which are based on but can differ from IFRS. Check your syllabus.

Read the official IFRS 16 text on ifrs.org