IFRS 16 Summary and Examples of the IAS 17 Transition for Lessees

This article is made up of three sections. The first provides a summary of IFRS 16 and a glimpse of the transition considerations for lessees because of the new international lease accounting standard. The second part answers how to transition from an operating lease under current IAS 17 to the single lessee accounting model – a finance lease using the cumulative effect approach. It also provides a detailed example of the cumulative effect approach or modified retrospective method with the accounting entries that illustrate the transition impact of IFRS 16. The third and final section provides a detailed example of the full retrospective approach with the accounting entries that illustrate the transition impact of IFRS 16. Click the links below to skip directly to each section.

1. IFRS 16 summary

• Leases under IFRS 16
• IFRS 16 effective date
• IFRS 16 vs IAS 17
• Full retrospective vs modified retrospective approach (cumulative effect approach)
• Cumulative effect approach and operating leases
• Cumulative effect approach and capital/finance leases

2. Example using the modified retrospective approach (cumulative effect approach)
3. Example using the full retrospective approach

IFRS 16 summary

Companies accounting under IAS 17 have likely transitioned to IFRS 16 earlier this year. If you’re still confused about the differences between old standards and new, the information below will help.

IFRS 16 leases

Under IFRS 16, there is no classification for operating leases and capital leases. There is only one umbrella for all leases – finance leases. Per the new rules, all leases must be accounted for on your balance sheet. Because your leases are no longer classified, you no longer need to use separate calculations – straight-lined vs. an outline of your interest and depreciation expense. Under IFRS 16, all leases will be calculated using your interest expense and depreciation expense.

What is the IFRS 16 effective date?

The IFRS 16 effective date was on January 1, 2019. The standard is now effective for organizations with annual reporting periods beginning on or after that date. Earlier application was permitted if IFRS 15, revenue recognition, was also applied.

IFRS 16 vs IAS 17: What are the differences?

Under IAS 17, there are two types of leases: operating and capital. Accounting for leases under IAS 17 is similar to ASC 840 in that operating leases were not required to be recognized on the balance sheet. Because companies are now required to recognize all leases on their balance sheet, the change to a single classification of leases will also impact the expense recognized on the income statement. Additionally, IFRS 16 has updated disclosure practices.

Full retrospective vs modified retrospective approach: How to transition with ease

Now that you know more about IFRS 16, you may be wondering how to transition, and there are two ways to do so. There’s the full retrospective and the cumulative effect approach, also referred to as the modified retrospective approach. With the full retrospective approach, companies must apply the guidelines of the new standard to all contracts from contract inception as if the new rules were in effect until now, which will require significant work and restatement of prior financials. Because companies compare information across several periods with this approach, it can provide them with better data to use when they forecast their finances. Since there is a lot of data to review, however, it can be quite an undertaking. The cumulative approach allows for a cumulative effect adjustment and comes into effect for the fiscal years ending after December 1, 2018.

For the cumulative approach, companies can elect a few practical expedients to help ease the transition. Under this method, IFRS 16 standards only need to be applied to leases that exist as of the effective date and leases that begin after the effective date. With this method, companies have less data to review.

Whichever method you select, it must be applied consistently to all of your leases as a lessee.

Cumulative effect approach and operating leases

If the cumulative effect approach method is chosen, the following 3 steps MUST be applied by lessees for operating leases:

1. Recognize a lease liability at the date of initial application
2. Recognize right-of-use asset at the date of initial application for leases previously classified as an operating lease applying IAS 17. On a lease-by-lease basis, the company will measure that right-of-use asset at either:

• Its carrying amount as if the Standard had been applied since the commencement date, but discounted using the lessee’s incremental borrowing rate at the date of initial application; or
• An amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease recognized in the statement of financial position immediately before the date of initial application.

3. Apply IAS 36, Impairment of Assets to right-of-use assets at the date of initial application as applicable.

Cumulative effect approach and finance leases

If the cumulative effect approach method is chosen, the carrying amount of the right-of-use asset and the lease liability at the date of initial application shall be the carrying amount of the lease asset and lease liability immediately before that date measured applying IAS 17. For those leases, a lessee shall account for the right-of-use asset and the lease liability applying this standard from the date of initial application.

Example #1: modified retrospective approach or cumulative effect approach

Helpful Tip: Under the cumulative effect approach, a lessee does not restate comparative information.

Key Differences for lessees with leases previously classified as operating leases

IAS 17	IFRS 16
Off-Balance Sheet Accounting Treatment	Assets and Liabilities on the Balance Sheet
Single Lease Rent Expense	Depreciation and Interest on the Income Statement

Here are the steps we will follow

1. Calculate present value of remaining payments over remaining lease term discounted using the incremental borrowing rate on transition. (This is the lease liability)
2. Determine the right-of-use asset on a lease by lease basis using 1 of 2 options explained below.
3. Adjust the right-of-use assert for impairment under IAS 36 if applicable.

Example: consider the following scenario:

Commencement date:	January 1, 2015
Lease Term:	10 years
Payments (paid in arrears):	$10,000/year
Incremental Borrowing Rate (on transition):	6%

Step 1: Calculate present value of remaining payments over remaining lease term discounted using the incremental borrowing rate on transition. (This is the lease liability)

The lease liability amortization schedule of remaining payments is as follows:

The remaining payments of $60,000 less the total interest expense of $10,827 equals a lease liability on transition of $49,173.

Note: Comparative period information does not change in this scenario.

Step 2: Determine the right-of-use asset amount on a lease-by-lease basis using 1 of 2 options.

Option 1 – Calculate the ROU asset beginning from the lease commencement date using a discount rate based on the lessee’s incremental borrowing rate at the date of initial application

The following is the straight-line amortization schedule for the lease in this scenario since commencement:

Using Option 1, the lessee takes the cumulative beginning balance or carrying amount of $44,161 which has been discounted at 6% to determine the right-of-use asset amount.

The cumulative entry to make in January 2019 using Option 1 would be:

DR	Right-of-Use Asset	44,161
DR	Equity	5,012
CR	Lease Liability	49,173

Option 2 – Amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments recognized immediately before the effective date.

Using Option 2, the lessee makes the right-of-use asset as an amount equal to the lease liability of $49,173 determined in Step 1.

The cumulative entry to make in January 2019 using Option 2 would be:

DR	Right-of-Use Asset	49,173
CR	Lease Liability	49,173

Step 3: Adjust the right-of-use assert for impairment under IAS 36 if applicable.

In this scenario, there were no impairment indicators noted per IAS 36.

Example #2: IFRS 16 full retrospective approach

What is retrospective application in accounting?

Retrospective application means adjusting the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied.

Here are the steps we will follow:

1. Calculate the initial lease liability as of the commencement date and calculate the subsequent lease liability using the effective interest method.
2. Calculate the right-of-use asset as of the commencement date and calculate the subsequent right-of-use asset by depreciating the ROU asset.

Example. Consider the following scenario:

Commencement date:	January 1, 2015
Lease Term:	10 years
Payments (paid in arrears):	$10,000/year
Incremental Borrowing Rate (on transition):	6%

Step 1: Calculate the initial lease liability as of the commencement date and calculate the subsequent lease liability using the effective interest method.

The lease liability schedule since commencement date is as follows:

Step 2: Calculate the right-of-use asset as of the commencement date and calculate the subsequent right-of-use asset by depreciating the ROU asset.

The following is the straight-line amortization schedule for the lease in this scenario since commencement:

The lessee will restate the comparative figures as if IFRS 16 had always been in effect under the full retrospective approach. On transition, the opening balance sheet control accounts for 2017, 2018, and 2019 are as follows:

Balance Sheet Accounts	January 1, 2017	January 1, 2018	January 1, 2019
Lease Liability (Step 1)	62,098	55,824	49,173
Right-of-Use Asset (Step 2)	58,881	51,521	44,161
Equity ADJ	3,217	4,303	5,012

The journal entry to make on January 1, 2019 (transition date) would be:

DR	Lease Liability	6,651
DR	Equity	709
CR	Right-of-Use Asset	7,360

That concludes our example of how to complete a full retroactive approach for lease journal entries. 

Jakarta, 8th June 2020




Muhammad Hasan Mufid