3.2. Classification of leases
Under IFRS 16, from a lessee’s perspective, once an arrangement meets the definition of a
lease, they are all recognised in the same manner, except for practical exceptions for short–
term leases and low-value leases. The distinction between operating and finance leases
remains in IFRS 16 only from the perspective of lessors. According to IAS 17, leases are
classified at the inception of a lease as a finance lease or an operating lease, based on whether
or not substantially all the risks and rewards incidental to ownership are transferred. A
finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an asset (Peng and van der Laan Smith, 2010).
According to IFRS 16, no distinction is made between finance and operating leases from the
perspective of lessees. IFRS 16 provides an option to lessees with short-term leases to
account for them as operating leases, as they were accounted for under IAS 17 that is off
balance sheet. Same option is provided also for leases where the underlying asset is of low–
value. Short-term leases are those that as of the commencement date, have a term of 12
months or less, after considering reasonably certain lease options for extensions and
terminations. This election must be applied consistently by class of underlying asset.
Examples of low-value assets include tablets and personal
3.3. Initial and subsequent measurement (lessees)
IAS 17 requires recognition of an asset and an assumption of an obligation (to pay future
lease payments) based on the lesser of either the present value of the minimum lease
payments or the fair value of the leased asset. Subsequent to initial recognition, the asset is
amortized over the period of expected use/useful life on a basis that is consistent with the
lessee’s depreciation policy for other similar assets. Lease payments are allocated between a
finance charge and a reduction of the outstanding liability. If practicable, an entity is required
to use the interest rate implicit in the lease as the discount rate in calculating the present value
of the minimum lease payments. If not practicable, the lessee’s incremental borrowing rate
may be used. Minimum lease payments, from the perspective of the lessee, are the payments
over the lease term that the lessee is or can be required to make, excluding contingent rent,
costs for services and taxes to be paid by and reimbursed to the lessor, along with any
amounts guaranteed by the lessee. Under IFRS 16 finance leases do not exist from the
perspective of lessees. All leases (with limited exception) are recorded on balance sheet,
similar to finance lease treatment under IAS 17. Lessees are required to initially recognise a
lease liability for the obligation to make lease payments and a right-of-use asset for the right
to use the underlying asset for the lease term. The lease liability is measured at the present
value of the lease payments to be made over the lease term (see below). The lease payments
are discounted using the interest rate implicit in the lease, unless it is not readily
determinable, in which case the lessee may use the incremental rate of borrowing (Cairns
2012).
• Fixed payments for lease elements, less any lease incentives receivable over the lease
term
❖ Certain variable payments linked to an index/rate based on level of index/rate at
commencement
❖ Residual value guarantee: amounts expected to be payable under residual value
guarantees
❖ Purchase options / Termination costs: exercise price of a purchase option if the lessee
is reasonably certain to exercise that option or termination penalties if lease term
reflects exercise of a termination option
❖ Payments made previously, as lease payments made to lessor at or before
commencement date
• Lease liability
❖ The right-of-use asset is initially measured at the amount of the lease liability,
adjusted for lease prepayments, lease incentives received, the lessee’s initial direct
costs (e.g., commissions) and an estimate of restoration, removal and dismantling
costs (see below).
❖ Lease liability – the initial amount
❖ Initial direct costs
❖ Costs of removal / Costs to restore, as the estimated cost of removing and/or restoring
leased asset
❖ Payments made previously
❖ Lease incentives received
❖ Right-of-use asset
In subsequent periods, the right-of-use asset is depreciated and accounted for similarly to a
purchased asset, following either the cost or revaluation model under IAS 16 Property, Plant
and Equipment. The method chosen must be consistent within major classes of assets. Right-
of-use asset is subject to impairment testing under IAS 36 Impairment of Assets. The lease
liability is accounted for similarly to a financial liability. Accordingly, the lease liability is
accounted for under the effective interest method. Lease payments are allocated between
interest expense and a reduction of the lease obligation. For lessees that depreciate the right–
of-use asset on a straight-line basis, the aggregate of interest expense on the lease liability and
depreciation of the right-of-use asset generally results in higher total periodic expense in the
earlier periods of a lease. Lessees measure the lease liability upon the occurrence of certain
events (e.g., change in the lease term, change in variable rents based on an index or rate),
which is generally recognised as an adjustment to the right-of-use asset (Seay and Woods,
2011).
3.4 Future changes in regulation
In January 2016, International Accounting Standards Board published a new IFRS 16, which
no doubt started a new era at the accounting principles of leasing contracts, at the least from
the lessees’ point of view. According to the earlier International Accounting Standards (IAS
17), lessee had to make a clear difference between finance and operating leases. Defining the
difference between these two leasing types created many of the problems associated with the
IAS 17 (Knubley 2010, 3). Finance lease contracts had to be included on the balance sheet,
but operating lease contracts were recorded simply as expenses in the income statement
