IFRS 16

Definition

IFRS 16 is an International Financial Reporting Standard that sets out the principles for the recognition, measurement, presentation, and disclosure of leases. It changes how companies account for leases, primarily by requiring lessees to recognize nearly all leases on their balance sheets, reflecting both the asset and liability associated with leasing arrangements.

5 Must Know Facts For Your Next Test

1. Under IFRS 16, all leases longer than 12 months must be recorded on the balance sheet, which changes financial ratios and metrics significantly.
2. The standard requires lessees to account for a right-of-use asset that reflects their right to use the leased asset during the lease term.
3. IFRS 16 eliminates the distinction between operating and finance leases for lessees, meaning most leases are treated similarly on financial statements.
4. There are exemptions available for short-term leases and low-value assets, allowing some flexibility in accounting for less significant leasing arrangements.
5. Implementation of IFRS 16 can affect key performance indicators like EBITDA, as lease expenses are replaced by depreciation and interest expenses.

Review Questions

• How does IFRS 16 impact the balance sheet of lessees compared to previous leasing standards?
  • IFRS 16 requires lessees to recognize almost all leases on their balance sheets as both an asset (right-of-use asset) and a liability (lease liability). This contrasts with previous standards that allowed operating leases to be kept off-balance sheet. By including these leases on the balance sheet, companies must adjust their financial metrics and ratios, providing a clearer picture of their liabilities and asset utilization.
• Discuss the significance of the right-of-use asset in relation to lease liability under IFRS 16.
  • The right-of-use asset represents the lessee's right to control an underlying leased asset for the duration of the lease. This asset is initially measured at cost, which includes the lease liability plus any initial direct costs. The lease liability, on the other hand, reflects the obligation to make future lease payments. Together, these components provide a comprehensive view of a lessee's leasing arrangements on their balance sheet.
• Evaluate how IFRS 16 can influence a company's financing decisions and overall financial strategy.
  • The implementation of IFRS 16 may lead companies to reconsider their leasing strategies due to its impact on financial statements. With increased liabilities on the balance sheet, companies might face tighter covenants or reduced borrowing capacity. As a result, firms could explore alternative financing methods or choose to purchase assets outright instead of leasing them. Additionally, stakeholders may reassess credit risk based on new financial metrics resulting from this standard.

Related terms

Lessees: Entities that lease assets from another party, called the lessor, and are responsible for payments over the lease term.

Lessor: The party that owns an asset and leases it out to another entity, receiving lease payments in return.

Lease Liability: The present value of future lease payments that a lessee is obligated to pay over the lease term, recognized as a liability on the balance sheet.