Today’s article is made up of three sections. The first section provides an overview 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.

Overview of the IFRS 16 transition

  • Overview: Under IFRS 16, a lessee accounts for a lease under a single lessee accounting model – a finance lease.
  • Effective Date: IFRS 16 is effective for annual reporting periods beginning on or after January 1, 2019, with earlier application permitted (if IFRS 15, Revenue Recognition, is also applied).
  • Transition Methods: Full retrospective approach (refer to Option A below) or cumulative effect approach (refer to Option B below)

*Helpful Tip: The election chosen MUST be consistently applied to ALL leases in which the company is a lessee.

  • Option A: If the full retrospective approach is chosen, apply the guidance under current international standard IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors.
  • Option B: If the cumulative effect approach is chosen, a lessee does not restate comparative information. Instead, the lessee shall recognize the cumulative effect of initially applying this Standard as an adjustment to the opening balance of retained earnings (or other component of equity, as appropriate) at the date of initial application.

The Cumulative Approach and Operating Leases under IAS 17 (current standard): 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:
    1.  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
    2. 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.

The Cumulative Approach and Finance Leases under IAS 17: 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.

Get the Comprehensive IFRS 16 Compliance Ebook

Example #1: cumulative effect approach or modified retrospective method

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 is an ebook, written by accountants, of the IFRS 16 transition for an operating lease from current IAS 17 to IFRS 16 for lessee accounting.

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)

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

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

Let’s explain the steps with an 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)

Get the Present Value Test Now To Follow Along

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

To see my blog on how to calculate the present value of the remaining lease payments, click here.

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:


To see my blog on how to calculate the present value of the right-of-use asset since the commencement date, click here.

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 was no impairment indicators noted per IAS 36.

Example #2: full retrospective approach

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 step to the IFRS 16 transition for an operating lease from current IAS 17 to IFRS 16 for lessee accounting.

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

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.

 

Let’s explain the steps with an 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:

To see my blog on how to calculate the present value of the remaining lease payments, click here. 

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:

 

To see my blog on how to calculate the present value of the remaining lease payments, click here.

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 Adjustment 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

And there you have it, how to complete a full retroactive approach for lease journal entries. If you need to comply with the upcoming changes to lease accounting, we can guide you through the process. Click the button below to get started.

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