In last month’s Business Edge, we introduced the two different approaches to transition available in IFRS 16 for lessees, these are the:
- Fully retrospective approach, and
- Modified retrospective approach.
One of the attractions of the modified retrospective approach is the practical expedients that are on offer for entities using this approach. The practical expedients are summarised below:
- Application of a single discount rate to a portfolio of leases with reasonably similar characteristics
This expedient can be applied to leases with, for example, a similar remaining lease term, and similar underlying assets and in a similar economic environment.
- Reliance on an assessment of whether a lease is onerous by applying IAS 37 Provisions, Contingent Liabilities and Contingent Assets immediately before the date of initial application as an alternative to performing an impairment review using the principles in IAS 36 Impairment of Assets.
Where this expedient is used, the right of use asset at the date of initial application is adjusted by the amount of any provision for onerous leases recognised in the balance sheet immediately before the date of initial application. The scope of this expedient appears to be wide, for example, even if no onerous lease provisions had been recognised under IAS 37, providing an assessment was carried out, the expedient can be relied upon such that no impairment test would be required at the date of initial application.
- No recognition of leases whose term ends within 12 months of the date of initial application
If this expedient is applied, such leases would be accounted for in the same way as short-term leases (ie usually expensed through profit or loss on a straight line basis). This transitional expedient is independent of the short term lease recognition exemption. The recognition exemption must be applied consistently to leases of underlying assets in the same class whereas the transitional expedient can be applied on a lease-by-lease basis.
- Exclusion of initial direct costs from the measurement of the right of use asset at the date of initial application
This expedient will be particularly useful for entities with less detailed records of costs incurred when operating leases were taken out in the past. It is also worth noting that, by not adding initial direct costs to the right of use asset, the carrying value of the asset will be lower and, therefore, depreciation in future periods will also be lower and impairment of the asset may be less likely.
- Hindsight may be used, such as in determining the lease term if the contract contains options to extend or terminate the lease
This may be useful to entities applying the modified retrospective approach to transition and who choose to measure the right of use asset as if IFRS 16 had always applied but using the incremental borrowing rate at the date of initial application. The expedient will prevent such entities having to re-construct their initial assessment of the lease term and any subsequent changes to it.
Each of the five practical expedients above can be applied on a lease-by-lease basis and are only applicable to entities applying the modified retrospective approach to transition.
In addition, IFRS 16 contains one further practical expedient relevant to transition in relation to the assessment of whether a contract meets the definition of a lease. This expedient, in contrast to the above, is applicable to both transition approaches and is to be applied as an accounting policy choice rather than on a contract-by-contract basis.
Why does it matter?
The number of options available in IFRS 16 is significant. Most of them are only relevant at the point of transition so this is where there is most scope to make decisions that will affect the profit and loss account, balance sheet and key metrics.
If you haven’t already done so, we recommend:
- Developing a transition group with buy-in from senior management and, if relevant, the Audit Committee.
- Understanding the needs of stakeholders/investors – how important is comparable data?
- Modelling the different transition options using high level assumptions and/or focusing on the largest lease contracts that are likely to have the biggest impact.
- Considering the implementation costs of each transition approach.
- Developing a timeline through to the implementation date.
- Liaising with your auditor.
For help and advice on accounting for leases please get in touch with your usual BDO contact or Richard Matthews.
Read more on accounting for leases:
IFRS 16: Transition for lessees
IFRS 16: Lessee accounting - recognition of the right-of-use asset
IFRS 16: Initial recognition of the lease liability by lessees
IFRS 16: a closer look at short-term 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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