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Implementation of new leasing standard IFRS 16 Leases (IFRS 16) will have a fundamental impact on lessees accounting records, while most aspects of lessor accounting will remain the same.
The new standard comes into effect for annual reporting periods beginning on or after 1st January 2019, with earlier application permitted (as long as IFRS 15 is also applied); and it will replace the current IAS 17 Leases (IAS 17).
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, i.e. a lessee should recognise assets and liabilities arising from a lease.
To meet that objective, 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. As a consequence, the difference between the accounting treatment of finance and the operating lease will be eliminated. Instead of operating lease expense, lessees recognise 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.
Some industries will be impacted significantly by IFRS 16, such as retail, telecommunications, transport and logistics, mining, oil and gas enterprises, but also insurance and banking service providers
Lease payments of an operating lease under IAS 17 are presented within operating expenses, while, under the right-of-use model, depreciation and interest expense will be recognised separately, having a positive impact on EBITDA. Effects on balance sheets will include a rise in the value of lease assets and financial liabilities, while cash flow will be influenced by a rise in cash from operating and financing activities.
Initial recognition of a right-of-use asset and lease liability is based on the present value of lease payments, adjusted for lease incentives and prepayments, as well as initial direct costs and an estimate of restoration, removal and dismantling costs. Present value is to be calculated by applying a lease interest rate or, alternatively, an incremental borrowing rate. It is important to emphasise that lease liability measurement should include an estimation of the lease term and its reassessment if a significant change in circumstances occurs. Lease components are to be separated from non-lease components unless an entity treats the whole contract as a lease, which this new standard allows.
Exemptions from the new standard include low-value assets and short-term leases, in order to reduce the costs and complexity of IFRS 16 implementation.
Some industries will be impacted significantly by IFRS 16, such as retail, telecommunications, transport and logistics, mining, oil and gas enterprises, but also insurance and banking service providers. The cost of implementation could be significant, particularly if there is no in-house lease information system.