In this month’s article on IFRS 16 we consider the recognition exemption available for short-term leases.
Why do I need to know what a short-term lease is?
When applying the new standard entities will need to look at all their lease arrangements and determine whether they are in scope of IFRS 16 Leases. The standard states that a lessee need not apply the requirements of the standard to any leases that are short-term or low value. A short-term lease is defined as:
“A lease that, at the commencement date, has a lease term of 12 months or less. A lease that contains a purchase option is not a short-term lease.”
What are the key considerations?
It is important to think beyond the number of months written down in the lease contract and consider the commercial reality. IFRS 16 requires an entity to consider the option to extend the lease and the likelihood of those being taken up. The standard states that “The shorter the non-cancellable period of a lease, the more likely a lessee is to exercise an option to extend the lease or not to exercise an option to terminate the lease.”
The application guidance also says that a “lessee’s past practice regarding the period over which it has typically used particular types of assets (whether leased or owned), and its economic reasons for doing so, may provide information that is helpful in assessing whether the lessee is reasonably certain to exercise, or not to exercise, an option.”
A lease has a non-cancellable term of 11 months 29 days, there is an option to extend for a further 11 month 29 day period - which the entity expects to take - can the lease be classified as short-term?
No. Put simply the application guidance forces you to consider the substance of the arrangement. Where a lease term is artificial and designed purely to avoid IFRS 16 requirements, this is unlikely to be successful because the intention of the entity and its actions in practice will point to it being classed as a lease with a term of over 12 months.
The exemption is optional
An entity can instead account for its short-term leases using the full measurement requirements of IFRS 16. This is an accounting policy choice and the election must be made by class of underlying asset.
However, any lease with a purchase option cannot be a short-term lease qualifying for the exemption – even if the lessee has no intention of taking the option and has no history of ever doing so (intention and past practice are not relevant).
Other things to consider
As noted in previous articles, recognising a right of use asset and a lease liability will improve EBITDA. Where EBITDA is a measure is of importance, the entity may wish to adopt IFRS 16 for short-term leases as an accounting policy choice. This decision will need to be balanced by an assessment of the additional work that will need to be undertaken to implement the policy.
When taking the exemption, the entity still has to disclose the amount expensed during the period in relation to short-term leases, unless the expense is for a lease with a term of one month or less. This means the entity will need to keep a record of the amounts spent on all short-term leases.
For help and advice on IFRS16 please get in touch with your usual BDO contact or Richard Matthews.
Read more on accounting for leases:
IFRS 16 - a closer look at separating lease components
IFRS 16 - Definition of a lease
IFRS 16 – a closer look at ‘low value’
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