Workbook on IFRS 16 Leases
IFRS 16 – Leases
⚡ Examiner's Top 5 Mark-Winning Points
- Split the P&L correctly — NEVER put the "lease payment" as an expense. Show Depreciation (ROU Asset) AND Interest Expense (Lease Liability) separately. This is the #1 error the examiner reports.
- Identify exemptions first. Short-term (<12 months, no purchase option) and Low-Value assets → straight expense. A car is NEVER low-value. Tablets and phones typically are.
- Choose the right discount rate. Use the interest rate implicit in the lease first. Only use the incremental borrowing rate (IBR) if the implicit rate cannot be readily determined.
- Lease modifications require a REVISED discount rate. Using the original rate from inception is the most common error. Always re-rate at the date of modification.
- Sale and Leaseback: never recognise the full gain. Restrict the gain to the proportion of rights transferred. The portion relating to the rights retained via the leaseback stays deferred.
📋 Contents
- Objective & Core Principle
- Scope & Exemptions
- Identifying a Lease
- Lease Term
- Initial Recognition — Lessee
- Subsequent Measurement
- The Amortisation Table (Exam Tool)
- Presentation & Disclosure
- Discount Rates: Implicit vs. IBR
- Lease Modifications
- Sale and Leaseback
- Lessor Accounting
- Past Exam Case Studies
- Expert Tutor Strategy
- Glossary
IFRS 16 sets out principles for the recognition, measurement, presentation and disclosure of leases. Its objective is to ensure that lessees and lessors provide relevant information so users can assess the effect that leases have on the financial position, financial performance and cash flows of an entity.
The standard is effective for annual reporting periods beginning on or after 1 January 2019 and supersedes IAS 17, IFRIC 4, SIC-15 and SIC-27 .
IFRS 16 applies to all leases, including subleases of right-of-use assets. Exceptions include leases for minerals/natural resources, biological assets (IAS 41), service concessions (IFRIC 12), and IP licences (IFRS 15/IAS 38).
🚦 Two Optional Recognition Exemptions (Para 5)
- Lease term of 12 months or less at commencement date
- Must not contain a purchase option
- Election by class of underlying asset
- Treatment: recognise as straight-line expense in P&L
- Assessed on absolute basis when the asset is new (regardless of age when leased)
- Examples: tablets, phones, small office furniture
- Election can be made on a lease-by-lease basis
- Treatment: recognise as straight-line expense in P&L
Fleet of cars for 10 months → Short-term (10 months < 12 months) = expense. But the short-term election is by class of asset, so it applies to all similar leases. Cars are not low value!
A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. This is a critical first step — not all service contracts are leases.
The Three-Part Test
| # | Test | Key Question | Examiner Tip |
|---|---|---|---|
| 1 | Identified Asset | Is a specific asset designated? Does the supplier have a substantive right to substitute it? | If the supplier can swap the asset freely AND benefits economically from doing so → NOT identified → NOT a lease |
| 2 | Right to Obtain Economic Benefits | Does the customer obtain substantially ALL economic benefits from use throughout the period? | Exclusive use = yes. Revenue-sharing that still leaves customer with most benefit = still yes |
| 3 | Right to Direct Use | Does the customer decide how and for what purpose the asset is used, OR did they design it to predetermine this? | Merely operating an asset is NOT directing its use. The customer must control the decision-making |
The lease term is the non-cancellable period plus periods covered by extension options the lessee is reasonably certain to exercise, plus periods covered by termination options the lessee is reasonably certain NOT to exercise
Factors for "Reasonably Certain" Assessment [file:40]
- Contractual terms vs. market rates in the optional period
- Significant leasehold improvements undertaken
- Costs of relocation or finding a replacement asset
- Importance of the asset to the lessee's operations
- Past practice of the lessee with similar assets
At the commencement date, a lessee shall recognise a Right-of-Use (ROU) Asset and a Lease Liability. This is the defining feature of IFRS 16 — everything comes onto the balance sheet.
- Initial measurement of Lease Liability (the PV calculation)
- + Any lease payments made at or before commencement date
- — Any lease incentives received
- + Any initial direct costs incurred by the lessee
- + Estimated costs of dismantling/restoring the asset (if obligated)
- Fixed payments (less lease incentives receivable)
- Variable payments linked to an index or rate (e.g., CPI, LIBOR)
- Amounts under residual value guarantees
- Exercise price of purchase option (if reasonably certain)
- Penalties for termination (if lease term reflects termination)
- Excluded: variable payments NOT linked to index/rate
| Account | Dr/Cr | Basis |
|---|---|---|
| Right-of-Use Asset | DEBIT | PV of lease payments + initial direct costs + prepayments ± dismantling provision |
| Lease Liability | CREDIT | Present value of future lease payments (at implicit rate or IBR) |
This section determines how marks are earned or lost in every sitting. The two assets diverge in their measurement profiles.
- Applies cost model by default (like PPE under IAS 16)
- Depreciated over the shorter of the lease term OR the useful life of the asset
- Exception: if ownership transfers or purchase option likely exercised → depreciate over the full useful life
- Subject to impairment testing under IAS 36
- May use fair value model (IAS 40) if investment property, or revaluation model (IAS 16)
- Measured at amortised cost
- Increases by: interest accrual (constant rate on carrying amount)
- Decreases by: lease payments made
- Remeasured for: modifications, changes in lease term, index changes, purchase option reassessment
- Interest rate = the original discount rate (or revised rate if applicable)
- Depreciation of the ROU Asset (under operating expenses or cost of sales)
- Interest Expense on the Lease Liability (under finance costs — required by IAS 1 para 82(b))
Every numerical IFRS 16 question can be solved with a basic amortisation table. Master this pattern and you capture all the calculation marks.
| Year | Opening Liability | Interest @ 5% | Payment | Closing Liability |
|---|---|---|---|---|
| 1 | $23,341 | $1,167 | ($8,571) | $15,937 |
| 2 | $15,937 | $797 | ($8,571) | $8,163 |
| 3 | $8,163 | $408 | ($8,571) | $0 |
| Total | — | $2,372 | ($25,713) | — |
PV of 3 × $8,571 @ 5% = $23,341. ROU Asset depreciation = $23,341 ÷ 3 = $7,780/year. Total P&L impact = $2,372 interest + $23,341 depreciation = same total as 3 × $8,571 = $25,713
| Transaction | Dr/Cr | Account | Amount |
|---|---|---|---|
| Interest accrual | DR | Interest Expense (P&L) | $1,167 |
| CR | Lease Liability | $1,167 | |
| Lease payment | DR | Lease Liability | $8,571 |
| CR | Cash / Bank | $8,571 | |
| Depreciation | DR | Depreciation (P&L) | $7,780 |
| CR | Accumulated Depreciation – ROU Asset | $7,780 |
Balance Sheet Presentation [file:40]
- ROU Assets presented separately from other assets, OR disclosed within the same line as the underlying asset class with disclosure in notes
- Lease Liabilities presented separately from other liabilities, split between current and non-current
- ROU Assets that are investment property → presented as investment property (IAS 40)
Cash Flow Classification
- Financing activities: principal repayments on lease liability
- Operating OR Financing activities: interest payments (per IAS 7 policy)
- Operating activities: short-term lease payments, low-value lease payments, variable payments not in lease liability
The examiner consistently provides two rates and expects you to select the correct one. The rule is hierarchical — always try the implicit rate first .
The rate that makes the present value of (a) lease payments + (b) unguaranteed residual value equal to the fair value of the underlying asset + initial direct costs of the lessor. In practice, the lessor knows this rate — ask the lessor!
Use when: The rate is readily determinable (usually when the lessor provides the payment schedule with the implicit rate).
The rate the lessee would pay to borrow over a similar term, with similar security, to obtain an asset of similar value in a similar economic environment.
Use when: The implicit rate cannot be readily determined — which is common in practice and in exam scenarios where only the IBR is provided .
A lease modification is a change in the scope or consideration of a lease that was not part of the original terms [file:40]. The first question to ask is whether the modification creates a separate new lease or modifies the existing one.
Decision: Separate Lease or Modification of Existing?
| Condition | Outcome | Accounting Treatment |
|---|---|---|
| Scope increases (adds new ROU) AND consideration increases by standalone price | Separate New Lease | Account for the additional asset as a completely new lease. Original lease continues unchanged. |
| All other modifications (extension of term, reduction in scope, change in payments) | Modification of Existing Lease | Remeasure lease liability using revised discount rate at modification date. Adjust ROU Asset. |
Accounting for a Modification (Not a Separate Lease)
- Allocate consideration using the updated stand-alone prices
- Determine the revised lease term
- Remeasure the Lease Liability using the revised discount rate
- Adjust: if scope reduces → decrease ROU Asset; recognise gain/loss in P&L; if all other → adjust ROU Asset for the change in liability
| Item | Amount | Basis |
|---|---|---|
| Original lease: 5 years, Year 3 remaining = 2 years | — | — |
| Extension negotiated: 4 additional years | — | Modification (not separate — no new asset added) |
| New remaining lease term | 2 + 4 = 6 years | — |
| Revised lease liability | PV of 6 years payments @ revised IBR at modification date | MUST use revised rate |
| Adjustment to ROU Asset | = Change in lease liability | Credit/Debit ROU Asset |
❌ Error: Using the original rate from Year 0. ✅ Correct: IBR (or implicit rate) at the modification date (start of Year 3).
In a sale and leaseback, a seller-lessee transfers an asset to a buyer-lessor and immediately leases it back. The first question is always: is the transfer a "sale" under IFRS 15?
Step 1 — Is the Transfer a Sale? (IFRS 15 Test) [file:40]
- Seller-lessee derecognises the asset
- Recognises ROU Asset at proportion of previous carrying amount relating to rights retained
- Recognises Lease Liability at PV of future lease payments
- Gain recognised only on rights TRANSFERRED to buyer-lessor
- Seller-lessee keeps the asset on its books
- Recognises a financial liability equal to proceeds (IFRS 9)
- Buyer-lessor does NOT recognise the asset
- Buyer-lessor recognises a financial asset equal to proceeds (IFRS 9)
Calculating the Gain — The Critical Formula
Rights Retained = PV of Lease Liability ÷ Fair Value of Asset
Rights Transferred = 1 − Rights Retained
Gain Recognised = Total Gain × Rights Transferred %
| Item | Amount | Calculation |
|---|---|---|
| Sale proceeds (= Fair Value) | $10,000,000 | — |
| Carrying amount | $6,000,000 | — |
| Total potential gain | $4,000,000 | $10m − $6m |
| PV of leaseback liability (say) | $4,000,000 | PV of 10 years @ relevant rate |
| Rights Retained % | 40% | $4m ÷ $10m |
| Rights Transferred % | 60% | 100% − 40% |
| Gain recognised in P&L | $2,400,000 | $4m × 60% |
| Gain deferred (in ROU Asset) | $1,600,000 | $4m × 40% |
❌ Common error: Recognising the full $4m gain. IFRS 16 restricts this — the deferred portion stays embedded in the ROU Asset measurement
Unlike lessees, lessor accounting under IFRS 16 is largely unchanged from IAS 17 [file:41]. The lessor must still classify each lease as either a finance lease or an operating lease.
| Classification | Test | Lessor's Treatment |
|---|---|---|
| Finance Lease | Transfers substantially all risks and rewards of ownership (5 examples in para 63) | Derecognise asset; recognise Net Investment in Lease (receivable); allocate finance income over term using constant return on net investment |
| Operating Lease | Does NOT transfer substantially all risks and rewards | Keep asset on balance sheet; depreciate per IAS 16; recognise lease income on straight-line basis (or another systematic basis) |
5 Finance Lease Indicators (Para 63)
- Ownership transfers to lessee at end of term
- Lessee has a bargain purchase option reasonably certain to be exercised
- Lease term covers the major part of the asset's economic life
- PV of lease payments = substantially all of the fair value of the asset
- Asset is so specialised that only the lessee can use it without major modifications
Is it a short-term lease (≤12 months, no purchase option)? Is it a low-value asset when new (laptop/phone)? If yes → expense in P&L. Done. Remember: cars are never low-value, regardless of the entity's size.
Apply the three-part test: identified asset + right to obtain substantially all economic benefits + right to direct use. Many service contracts are NOT leases. The warehouse with variable location = service contract.
Implicit rate first (if determinable — ask the lessor). Otherwise, use the lessee's incremental borrowing rate. For modifications and reassessments, always use the revised rate at the date of change.
Opening + Interest − Payment = Closing. Calculate lease liability for year-end. Split each payment: interest goes to P&L, principal reduces liability. In P&L: show depreciation AND interest separately — never the cash payment alone.
Ask: does it add a new asset with proportionate consideration? → New lease. Otherwise → remeasure at a revised rate. Extension → adjust ROU Asset upward. Scope reduction → reduce ROU Asset + recognise gain/loss in P&L.
First: IFRS 15 sale test. If sale: "Don't recognise the whole gain." Calculate rights retained (PV lease ÷ FV asset). Gain recognised = Total gain × rights transferred %. Balance stays in ROU Asset. Variable payment adjustments: below market = prepayment; above market = financing.
| Feature | IAS 17 (old) | IFRS 16 (current) |
|---|---|---|
| Lessee classification | Finance vs. Operating | Single model — all on-balance-sheet (except exemptions) |
| Operating lease on BS? | ❌ Off-balance-sheet | ✅ ROU Asset + Lease Liability |
| P&L impact | Single rental expense | Depreciation + Interest (front-loaded) |
| Lessor accounting | Finance vs. Operating | Largely unchanged from IAS 17 |
| Effective date | Superseded | 1 January 2019 |
