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 date | Expiration date | Future disbursements | Installments (months) | Monthly incremental rate |
| 01/01/20×1 | 31/12/20×3 | 600,000 | 24 | 0,375% |
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:
| Capital | Interest | Quota | Amortization | Balance | |
| 1 | 573,295 | 2,106.75 | 25,000 | 22,893.25 | 550,402 |
| 2 | 550,402 | 2,022.62 | 25,000 | 22,977.38 | 527,425 |
| 3 | 527,425 | 1,938.19 | 25,000 | 23,061.81 | 504,363 |
| 4 | 504,363 | 1,853.44 | 25,000 | 23,146.56 | 481,216 |
| 5 | 481,216 | 1,768.38 | 25,000 | 23,231.62 | 457,985 |
| 6 | 457,985 | 1,683.01 | 25,000 | 23,316.99 | 434,668 |
| 7 | 434,668 | 1,597.32 | 25,000 | 23,402.68 | 411,265 |
| 8 | 411,265 | 1,511.32 | 25,000 | 23,488.68 | 387,776 |
| 9 | 387,776 | 1,425.00 | 25,000 | 23,575.00 | 364,201 |
| 10 | 364,201 | 1,338.37 | 25,000 | 23,661.63 | 340,540 |
| 11 | 340,540 | 1,251.42 | 25,000 | 23,748.58 | 316,791 |
| 12 | 316,791 | 1,164.15 | 25,000 | 23,835.85 | 292,955 |
| 13 | 292,955 | 1,076.56 | 25,000 | 23,923.44 | 269,032 |
| 14 | 269,032 | 988.64 | 25,000 | 24,011.36 | 245,021 |
| 15 | 245,021 | 900.40 | 25,000 | 24,099.60 | 220,921 |
| 16 | 220,921 | 811.84 | 25,000 | 24,188.16 | 196,733 |
| 17 | 196,733 | 722.96 | 25,000 | 24,277.04 | 172,456 |
| 18 | 172,456 | 633.74 | 25,000 | 24,366.26 | 148,089 |
| 19 | 148,089 | 544.20 | 25,000 | 24,455.80 | 123,634 |
| 20 | 123,634 | 454.33 | 25,000 | 24,545.67 | 99,088 |
| 21 | 99,088 | 364.13 | 25,000 | 24,635.87 | 74,452 |
| 22 | 74,452 | 273.60 | 25,000 | 24,726.40 | 49,726 |
| 23 | 49,726 | 182.73 | 25,000 | 24,817.27 | 24,908 |
| 24 | 24,908 | 91.53 | 25,000 | 24,908.47 | 0 |
3. Accounting entry recognized by the company
| Initial recognition | Db | Cr |
| Right-of-use asset | 573,295 | |
| Lease liabilities | 573,295 | |
| For initial recognition of lease contracts under IFRS 16 | ||
| Monthly depreciation record | ||
| Depreciation expense for rights-of-use asset | 23,887 | |
| Accumulated depreciation right-of-use asset | 23,887 | |
| For the recognition of depreciation of the right-of-use asset under IFRS 16 | ||
| Recording of financial expense | ||
| Financial Expense | 2,106 | |
| Lease liabilities | 2,106 | |
| For the recognition of interest financial expense as of 31/01/2020 | ||
| Payment record | ||
| Lease liabilities | 25,000 | |
| 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.
