FRS 16 from the lessee's point of view

IFRS 16 from the lessee’s point of view

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IFRS (International Financial Reporting Standard)16 establishes the guidelines to be followed for the recognition, measurement, presentation, and disclosure of leases, both as lessor and lessee. This document focuses on the new accounting treatment of a lease from the lessee’s point of view due to an unchanged lessor’s point of view about the accounting treatment of a lease.

When signing a lease contract, the lessee must take into account whether it intends to use the lease for more than one year and whether the leased amount is representative of the entity. Therefore, he will consider from the beginning the right to the use of the asset and the future mandatory payment of the committed installments.

1. For Example

Let us assume a 2-year lease of the entity’s administrative offices. The contract starts on January 1, 2020, extending until December 31, 2021. The monthly payments established in the contract are 25,000 soles per month. In this case, it is impossible to determine the interest rate implicit in the contract for obvious reasons, so we will apply the lessee’s incremental borrowing rate, which we assume is set at 4.5% per annum.

2. Determination of present value

IFRS 16 establishes in paragraph 26 that at the lessee’s start date, the liability shall be measured at the present value of the committed future payments, and for this purpose, it shall be discounted using the interest rate implicit in the lease if that rate can be readily determined. Otherwise, the incremental borrowing rate for the enterprise is used, which is the interest rate at which the lessee could finance itself in the market for a transaction of similar expiration and risk.

Start dateExpiration dateFuture disbursementsInstallments (months)Monthly incremental rate
01/01/20×131/12/20×3600,000240,375%

VP = VF/(1+i)n

VP = 600,000 /(1+0,375%)24

VP = 573,295

AV = Present value

FV = Future Value

i = Interest rate

n = investment term

Under the standard provisions, the Company will recognize the present value of the minimum payments for the properties as a right of use for S/ 573,295 and liability for the same amount.

Subsequently, the right-of-use asset should be depreciated by IAS (International Accounting Standard) 16, the liability should be treated as financial and measured at amortized cost as established in IFRS 9.

Concerning the monthly amortization of the asset, let’s assume it is straight-line:

S/573,295/24 = 23,887 soles per month.

The determination of amortized cost is shown below:

 CapitalInterestQuotaAmortizationBalance
1573,2952,106.7525,00022,893.25550,402
2550,4022,022.6225,00022,977.38527,425
3527,4251,938.1925,00023,061.81504,363
4504,3631,853.4425,00023,146.56481,216
5481,2161,768.3825,00023,231.62457,985
6457,9851,683.0125,00023,316.99434,668
7434,6681,597.3225,00023,402.68411,265
8411,2651,511.3225,00023,488.68387,776
9387,7761,425.0025,00023,575.00364,201
10364,2011,338.3725,00023,661.63340,540
11340,5401,251.4225,00023,748.58316,791
12316,7911,164.1525,00023,835.85292,955
13292,9551,076.5625,00023,923.44269,032
14269,032988.6425,00024,011.36245,021
15245,021900.4025,00024,099.60220,921
16220,921811.8425,00024,188.16196,733
17196,733722.9625,00024,277.04172,456
18172,456633.7425,00024,366.26148,089
19148,089544.2025,00024,455.80123,634
20123,634454.3325,00024,545.6799,088
2199,088364.1325,00024,635.8774,452
2274,452273.6025,00024,726.4049,726
2349,726182.7325,00024,817.2724,908
2424,90891.5325,00024,908.470

3. Accounting entry recognized by the company

Initial recognitionDbCr
Right-of-use asset573,295 
Lease liabilities 573,295
For initial recognition of lease contracts under IFRS 16
 
Monthly depreciation record  
Depreciation expense for rights-of-use asset23,887 
Accumulated depreciation right-of-use asset23,887
For the recognition of depreciation of the right-of-use asset under IFRS 16
 
Recording of financial expense  
Financial Expense2,106 
Lease liabilities 2,106
For the recognition of interest financial expense as of 31/01/2020
Payment record  
Lease liabilities25,000 
Banks 25,000
For recording the property rent payment

Rental expenses, which will no longer be recorded, will be replaced by asset depreciation and liabilities interest.

Entities with operating leases will have more assets, but at the same time, will have more indebtedness since they have more financial liabilities.

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