IFRS 16, lease accounting: what changes and how to manage it

IFRS 16 deals with contracts that convey the right to control the use of an identified asset for a period of time, in exchange for consideration. The first question is therefore not an accounting one but a qualifying one: is the contract a lease or simply a service?

To conclude that a lease exists, three conditions must be met:

• the existence of an identified asset;
• the right to obtain substantially all the economic benefits from its use;
• the right to direct the use of that asset.

For the lessee, the general model requires recognising on the balance sheet a right-of-use asset and a lease liability. The standard provides limited exemptions for short-term contracts and certain low-value assets, which must remain defensible and must not be applied too broadly.

The lessee mechanics rest on two linked balance sheet items:

• the lease liability is measured at the present value of the lease payments;
• the right-of-use asset (the ROU) is measured from that liability, adjusted for certain initial items: direct costs, prepayments, incentives received.

The discount rate

When the interest rate implicit in the contract is not available, the lessee uses its incremental borrowing rate (IBR). This rate is specific to the contract: it must reflect a term, a security, an amount and an economic environment similar to those of the right-of-use asset. A flat, unadjusted corporate rate is often insufficient.

The income statement impact

The local presentation of rent disappears, in whole or in part, in favour of two distinct expenses:

• the depreciation of the right-of-use asset;
• the interest on the lease liability.

In principle, there is no direct impact in OCI (other comprehensive income, the items of income and expense recognised in equity outside net profit). The lease term, decisive for the calculation, depends on the options reasonably certain to be exercised or not. This is a sensitive point: one month of misjudged option shifts the liability.

Unlike the lessee, the lessor has not seen any upheaval: the standard keeps a dual model. Each contract is classified as a finance lease or an operating lease. The substantive criterion is the transfer, or not, of substantially all the risks and rewards incidental to ownership. The classification is made at inception and is revised only in the event of a contract modification.

Finance lease

• The lessor recognises an asset for the net investment in the lease;
• finance income is recognised at a constant periodic rate of return;
• IFRS 9 (the standard on financial instruments, which governs in particular the impairment of receivables) applies to the net investment: impairment, unguaranteed residual values.

Operating lease

• Lease payments are recognised as income on a straight-line basis or another more representative systematic basis;
• the lessor continues to carry the underlying asset on its balance sheet and applies IAS 36 (the standard on the impairment of assets) to test its value.

In a sublease, an intermediate lessor classifies the sublease by reference to the right-of-use asset arising from the head lease, and not by reference to the underlying asset.

Term and options

For cancellable or renewable leases, you must first determine the enforceable period, then apply the "reasonably certain" tests to the options. Non-recoverable fit-outs (leasehold improvements) interact with the term and are analysed together.

Incremental borrowing rate (IBR)

The IBR is a rate specific to the contract: it reflects a similar term, security, amount and economic environment. An unadjusted corporate rate is often insufficient.

Impairment of the right-of-use asset (IAS 36)

IFRS 16 explicitly requires applying IAS 36. If the right-of-use asset does not generate largely independent cash flows, the test is performed at the level of the CGU (cash-generating unit, the smallest group of assets producing independent cash flows), with a symmetrical treatment of the lease liability in the numerator and the denominator of the test.

• Balance sheet: the appearance of a right-of-use asset and a lease liability, where there were only off-balance-sheet commitments;
• Income statement / EBITDA: the rental expense disappears in favour of depreciation and interest, which changes the structure of expenses around EBITDA;
• Ratios and covenants: indebtedness and expense structure are modified, to be re-read in the light of the standard;
• Statement of cash flows: the nature of the flows changes (depreciation / interest / debt repayment);
• Information system: collecting contracts, payment schedules, options and IBR data requires a reliable framework;
• Notes: maturities, exemptions used, variable charges, reconciliations.

IFRS 16 also interacts with IAS 12 (the standard on income taxes: deferred tax impacts), IFRS 9 (security deposits, renegotiations) and IFRS 15 (the standard on revenue: mixed contracts, subleases).

• Diagnostic: inventory of contracts and mapping of asset families. Identify arguable contracts (concessions, sites, royalties) rather than excluding them from the outset;
• Collection: contracts and amendments, payment schedules, start and end dates, options, lease / service split, IBR data;
• Judgement memo: qualification, term, rate and exemptions, documented;
• Workbook / calculator: lease liability, right-of-use asset, depreciation, interest and disclosures.

Common risks to avoid: concluding too quickly that there is no lease, applying the low-value exemption too broadly, under-documenting the term chosen, forgetting service components, and mixing a high-level diagnostic with a robust measurement.