In previous articles we have considered how to initially recognise the lease liability. In this month’s IFRS 16 article we look at how lessees should measure the ‘right of use asset’.
How do you initially measure the right-of-use asset?
“At the commencement date, a lessee shall measure the right-of-use asset at cost” (IFRS 16 para 23). If we look at the definition of cost within IFRS 16, this means that the initial measurement of the right-of-use asset is calculated as follows:
Initial lease liability Plus
1) Payments made less incentives received before commencement date of the lease
2) Initial direct costs incurred by the lessee
3) Estimated costs for dismantling, removing and restoring.
Taking each of these components in turn:
- Initial lease liability – see IFRS 16: Initial recognition of the lease liability by lessees
- Payments made before the commencement date of the lease – this does not relate to payments for the construction or design of an underlying asset but would include any payments made for the right to use the asset, regardless of the timing of those payments (IFRS 16 B44)
- Incentives received before commencement date of the lease – these are defined within IFRS 16 as “Payments made by a lessor to a lessee associated with a lease, or the reimbursement or assumption by a lessor of costs of a lessee”. Examples of lease incentives could be an initial cash payment to the lessee or a reimbursement of certain lessee costs associated with obtaining the lease (such as real estate commission). This would not include cash received from a lessor for items that are not included within the cost of the right-of-use asset. An example here would be if the lessor agrees to provide funds for leasehold improvements. This would not be included as a component of the lease accounting
- Initial direct costs - these are the incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained. These might include costs such as finder’s fees, commissions to agents for establishing the lease and up-front fees. It is important to note that the standard emphasises that direct costs must be ‘incremental’. This precludes an entity from making an allocation of administrative costs relating to obtaining a lease, such as a portion of finance and management salaries. Such costs would not be incremental as they would be incurred regardless of whether an entity enters into a specific lease.
- Estimated costs for dismantling, removing and restoring - some leases contain requirements for lessees to return assets in a specified condition, such that the lessee would be required to incur costs to restore it – as an example, the lessee of a manufacturing site may have to remove significant amounts of equipment and customised leasehold improvements at the end of the lease term. Certain types of assets may also have significant transportation and removal costs to return them to the lessor as specified in the lease agreement. These types of obligations may be incurred at the commencement date of a lease or as a consequence of using an underlying asset. These costs shall be recognised as part of the cost of the right-of-use asset when the lessee incurs the obligation by applying the requirements of IAS 37 Provision, Contingent Liabilities and Contingent Assets.
What happens next?
Subsequent to initial recognition, a lessee measures the right-of-use asset at cost unless the entity applies a measurement model as follows, either:
Right-of-use assets are measured at cost less accumulated depreciation and impairment losses. The carrying value is also adjusted for any re-measurement of the lease liability.
- REVALUATION MODEL
If an entity applies the revaluation model under IAS 16 to any class of property, plant or equipment then a lessee MAY elect to apply the revaluation model to right-of-use assets of the same class
- FAIR VALUE FOR INVESTMENT PROPERTY
If an entity applies the fair value model in IAS 40 to investment property then this MUST also be applied to right-of-use assets that meet the definition of investment property.
Note that under the cost model, when determining the relevant time period to calculate depreciation, an entity uses the lease term as determined in the initial recognition calculation unless the initial recognition contemplates purchase options being utilised or the lease transfers ownership of the underlying asset to the lessee by the end of the lease term. In those cases, the period of time to utilise is the useful life of the asset. Under the cost model it will also be necessary to apply IAS 36 Impairment of Assets to determine whether the right-of-use asset is impaired.
Read more on accounting for leases:
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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