Written by: Musa M.

Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

IFRS 16: LEASES

(Issued in January 2016. Effective for annual periods reporting periods beginning on or
after 1 January 2019. The IAS 17 is no longer apply)

Objective of IFRS 16 leases

Is to specify the principle for recognition, measurement, presentation
and disclosure of leases.
• It prescribes the accounting treatment of leased assets in the financial
statements of lessees and lessors.

The Scope of IFRS 16

IFRS 16 applies to all leases (including subleases) except for:
1. Leases to explore for or use of minirals, oil, natural gas and similar
resourse
2. Leases of biological asset (IAS 41)
3. Intellectual property licenses granted by a lessor (IFRS 15)
4. Service concession arrangements (IFRIC 12)
5. Right held by a lessee under licensing agreements (for an items such
as films, videos, manuscript, patent and copyright e.t.c.) – (IAS 38)

Background
• A lease is a way of obtaining a use of an asset, such as a machine,
without purchasing it outright. The company that owns the asset (the
lessor) allows another party (the lessee) to use the asset for a specified
period of time in return for a series of rental payments.

• Classification of leases
- A finance lease is a lease that transfers substantially all the risks and
rewards incidental to ownership of an asset to the lessee.

- An operating lease is a lease other than a finance lease.

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

➢ Risks may be represented by the possibility of losses from:

o idle capacity;
o technological obsolescence;
o Variations in returns caused by changes in economic conditions.

➢ Rewards may be represented by the expectation of;

o profitable use of the asset over its economic life;
o gains from increases in value or profits on disposal.

• Asset: The Conceptual Framework defines asset as a present

economic resource controlled by the entity as result of past events
- An economic resource is a right that has the potential to produce
economic benefits
o Right: can take many forms including the right to receive
cash, exchange resources on favorable terms, right over
physical objects and right to use intellectual property

- Control: is the ability to obtain economic benefits from the asset,

and to restrict the ability of others to obtain the same benefits from
the same items.

• Conceptually speaking, all classes of leases both finance and

operating lease, meet the above definition.

• IAS 17 did not provide for the recognition in lessees’ statement of

financial position of material assets and liabilities arising from
operating leases.

• IFRS 16 removes the finance lease, operating lease distinction for

lessees. The new rules require a lessee to recognize all leases on its
statement of financial position (with certain exceptions).

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

• IFRS 16 does not change how lessors should account for leases.
Lessors still must classify leases as either finance leases or operating
leases and account for them accordingly in the same way as before.

Definition and explanations of some terms

❖ 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.

• NB: The entity is required to identify only the component(s) that

contain a lease and apply IFRS 16 on those component(s).

❖ Inception date of the lease: is the earlier of the date of the lease
agreement and the date of commitment by the parties to the principal
terms and conditions of the lease.

• This is where the parties to the lease contract commit to the terms
of the contract.

• As at this date:
- Contracts must be assessed to find out if they are a lease or if
they contain a lease.
- A lessor must identify the type of lease in a contract (i.e whether
it is finance or operating lease).

❖ Commencement date of a lease: is the date on which a lessor

makes an underlying asset available for use by a lessee.

• This is the date that a lessee starts to use the asset or, at least, is
entitled to start to use the asset.

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

• It is the date of initial recognition of the lease (i.e. the recognition

of the assets, liabilities, income or expenses resulting from the
lease, as appropriate).

❖ Lease term: is the non-cancellable period for which a lessee has the
right to use an underlying asset, together with both:

a) Periods covered by an option to extend the lease if the lessee is

reasonably certain to exercise that option; and
b) Periods covered by an option to terminate the lease if the lessee is
reasonably certain not to exercise that option.

❖ Lease payments: is the payments made by a lessee to a lessor

relating to the right to use an underlying asset during the lease term,
comprising the following:

a) Fixed payments less any lease incentives, if any;

b) Variable lease payments that depend on an index or a rate;
c) The exercise price of a purchase option if the lessee is reasonably
certain to exercise that option; and
d) Payments of penalties for terminating the lease, if the lease term
reflects the lessee exercising an option to terminate the lease.
e)
i. For the lessee, lease payments also include amounts expected to
be payable by the lessee under residual value guarantees.

ii. For the lessor, lease payments also include any residual value
guarantees provided to the lessor by the lessee, a party related to
the lessee or a third party unrelated to the lessor that is
financially capable of discharging the obligations under the
guarantee.

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

❖ Initial direct costs: is the incremental costs of obtaining a lease that

would not have been incurred if the lease had not been obtained,
except for such costs incurred by manufacturer or dealer lessor in
connection with a finance lease. (e.g., initial direct costs might be
Legal fees, commissions, e.t.c).

• Both the lessor and the lessee might incur initial direct costs.

❖ The interest rate implicit in the lease: is the discount rate that
causes:

a) The aggregate present value of lease payments and the

unguaranteed residual value; to be equal to

b) the sum of the fair value of the underlying asset and any initial
direct costs of the lessor.

• The interest rate implicit in the lease is the IRR of the cash flows
from the lessor’s viewpoint. It is the rate that equates the future
cash inflows for the lessor to the amount that the lessor invested
in the asset.

• The calculation of the interest rate implicit in the lease is from the
lessor’s viewpoint. Therefore the initial direct costs that feature in
this calculation are those of the lessor

➢ Sometimes the lessee might not be able to ascertain the interest rate
implicit in the lease. In that case it would use the lessee’s
incremental borrowing cost instead.

❖ Lessee's incremental borrowing rate: is the rate of interest that a

lessee would have to pay to borrow over a similar term, and with a
similar security, the funds necessary to obtain an asset of a similar
value to the right-of-use asset in a similar economic environment.

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

Leases in the Financial Statements of Lessee – Lessee Accounting

❑ Initial Recognition

• A lease is capitalized at the commencement of the lease term. This

involves the recognition of the asset that is subject to the lease (the
underlying asset or right-of-use asset) and a liability for the future
lease payments.

• The initial double entry is based on the lease liability but the asset
might also contain other components in its initial measurement.

❑ Initial Measurement Of The Lease Liability

• The lease liability is measured at the commencement date as the

present value of the lease payments not yet paid at that date

• The lease payments are discounted using the interest rate implicit
in the lease or, if that rate cannot be readily determined, the
lessee’s incremental borrowing rate is used.
Example 1
X Plc enters into a lease. The following information is relevant:
X plc must pay five annual rentals of N100,000 in arrears.
X Plc must also guarantee the residual value of the asset at the end of
the lease term to be N40,000.
X Plc incurs initial direct costs of N5,000.
The interest rate implicit in the lease is 8%
Required: what is the amount of lease liability to be recognized initially

• NB: the amount paid before the commencement date and the initial
direct costs are not included in the measurement of the liability.
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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

❑ Initial measurement of the right-of-use asset

The right-of-use asset is measured at the commencement date as
follows:
N
Initial measurements of the lease liability X
Lease payments made at or before the commencement date
(less lease incentives received) X
Initial direct costs incurred (by the lessee) X
Estimate of the costs of dismantling and removing
the asset and restoring the site where it is lacated
(when the entity has an obligation to dismantle and
remove the asset at the end of its life) X
XX

Example 2
X Plc enters into a lease. The following information is relevant:
X plc must pay five annual rentals of N100,000 in arrears.
X Plc must also guarantee the residual value of the asset at the end of
the lease term to be N40,000.
X Plc incurs initial direct costs of N5,000.
The interest rate implicit in the lease is 8%

Required: what is the amount of right-of-use asset and lease liability to

be recognized initially?

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

❑ Subsequent Measurement of Right-Of-Use Asset:

• After the commencement date, a lessee shall measure the right-of-

use asset using a cost model unless it is a type of asset for which an
alternative measurement model is being used.

• If a lessee uses the IAS 40: investment property FV model for its
investment properties, that model must be used for right-of-use
assets that meet the definition of investment property; and

• If a lessee applies the revaluation model in IAS 16: PPE to a class

of PPE it may elect to apply the same accounting treatment to all
right-of-use assets that relate to that class.

• An asset is depreciated from the commencement date to the end of

its useful life when:

- The lease transfer ownership of the underlying asset to the

lessee by the end of the lease term; or
- If the cost of the right-of-use asset reflects that the lessee will
exercise a purchase option.

• In other cases the asset is depreciated from the commencement

date to the earlier of:
- The end of its useful life; or
- The end of the lease term

• The rules in IAS 36: impairment of assets applies to right-of-use

asset in the usual way.

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

❑ Subsequent Measurement Of The Lease Liability

A lease liability is measured as follows at each reporting date:

N N
The amt of lease liability recognized initially X
Add: interest accrued X
Less: lease payments (X)
Repayment of loan principal (of lease liability) (X)
Adjustment on remeasurement of the liability X
Amount owed now X

• Each lease payment consists of two elements:

1. A finance charge (interest charge) on liability; and
2. Partial repayment of the liability

- The finance charge is treated as a finance cost in the POL for

the period.

- The partial repayment of the lease obligation reduces the

amount of lease liability that remains unpaid

➢ Finance Charge
The total rental Payments over the life of the lease will be more than the
amount initially recognized as liability. The difference is the total
finance charge.

Total Finance charge can be calculated as follows:

N
Lessee’s lease payments (total) X
Less: Amount on initial recognition (X)
Total Finance charge X

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

Example 3
X Plc enters into a 5 year lease of a machine on 1 January year 1.
X Plc is to pay five annual rentals of N100,000 in arrears. Based on this,
the lease liability at the commencement of the lease was N426,494.
X Plc incurred initial direct costs of N5,000 when arranging the
lease.and
X Plc has guaranteed the residual value of the asset at the end of the
lease term at N40,000.
Required: what is the total finance charge of the lease?

• The Finance charge is recognized over the life of the lease.

➢ Allocating the finance charge (interest)

• The total finance charge for a lease asset is allocated “so as to provide
a constant rate of charge on the outstanding obligation”

• The periodic rate of interest is the discount rate used in the initial
measurements of the lease liability.

• Using an interest rate to allocate the interest expense is called “an

Actuarial method”

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

Example 4 (where lease payment is made annually in arrears)

X Plc enters into a lease. The following information is relevant:
X plc must pay five annual rentals of N100,000 in arrears.
X Plc must also guarantee the residual value of the asset at the end of
the lease term to be N40,000.
X Plc incurs initial direct costs of N5,000.
The interest rate implicit in the lease is 8%
Required:
(a) What is the amount of lease liability and right-of-use asset to be
recognized initially?
(b) What is the amount of interest charge (finance charge) to be
recognize each year over the lease term?
(c) What is the annual depreciation charge on the right-of-use asset?
(d) What is the current and non-current elements of the lease liability
each year over the lease term?

Example 5 (where lease payment is made annually in advance)

X Plc enters into a lease. The following information is relevant:
X Plc must pay five annual rentals of N100,000 in advance.
X Plc must also guarantee the residual value of the asset at the end of
the lease term to be N40,000.
X Plc incurs initial direct costs of N5,000.
The interest rate implicit in the lease is 12.37%

Required:
(a) What is the amount of lease liability and right-of-use asset to be
recognized initially?

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Written by: Musa M. Ibrahim, DCS, DBF, BSc, MSc, NIM, ACA 08065672917

(b) What is the amount of interest charge (finance charge) to be

recognize each year over the lease term?
(c) What is the annual depreciation charge on the right-of-use asset?
(d) What is the current and non-current elements of the lease liability
each year over the lease term?

Recognition exemption
• A company can elect not to apply the lessee accounting rules to
short-term leases (lease with a lease term of 12 months or less) and
leases for assets of low value (e.g. lap-tops and mobile phones).

• If such an election is made, the rental costs of the assets are

recognized in POL on a straight line basis or some other systematic
basis if that gives a better reflection of the benefit arising from the
asset.

Example 6 (Recognition exemption- operating leases)

Under a four-year operating lease agreement, Entity F pays a non-

returnable deposit of ₦50,000 and then four years’ rental of ₦50,000
per annum on the first day of each year.

Required
(a) Calculate the annual expense for the operating lease for each of
the four years.

(b) Calculate the asset or liability in the statement of financial position

at the end of Year 1 and at the end of Year 2.

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