Introduction to IFRS16 Lessor Accounting

IFRS 16, issued in January 2016, applies to annual reporting periods beginning on or after January 1, 2019.

The IFRS 16 standard sets out principles for recognizing, measuring, presenting, and disclosing leases. IFRS 16 provides information that represents lease transactions and offers a basis for users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.

IFRS 16 specifies treatments for both lessor and lessee accounting.

Asset finance or leasing involves one party agreeing to rent assets or equipment owned by another for a specified period or for the entire lifespan of the asset. Businesses may choose to lease equipment rather than purchase it for several reasons, such as:

• The business needs the equipment only for a short period.
• Leasing allows the business to stay current with updated technology. When the equipment becomes outdated, the business can enter into a new lease contract for more advanced equipment.

The table below lists the lease terminologies along with its definition.

A lessor classifies a lease as either a finance lease or operating lease as follows:

• Leases that transfer substantially all the risks and rewards incidental to ownership of the underlying asset are finance leases.
• All other leases are operating leases.

Asset finance is a commercial arrangement where the contract outlines the terms under which the lessor (bank user) grants the lessee (customer or borrower) the right to use the equipment in exchange for payments over a specified period.

• Lessee selects an asset (equipment, vehicle, software).
• Lessor purchases the asset.
• Lessee uses the asset during the lease term.
• Lessee pays a series of rentals or installments for the use of the asset.
• Lessor recovers a significant portion or all of the asset's cost and earns interest from the rentals paid by the lessee.

• Capture lease arrangement contracts with essential details such as:
  • Lease Type (classify as ‘Operating Lease’ or ‘Finance Lease’)
  • Lease Amount
  • Lease Term
  • Interest Rate
  • Residual Value
  • Payment Schedule
  • Reporting Conditions
• Handoff cash flow projections for lease contracts to the cash flow engine
• Manage lease contracts throughout their lifecycle, including:
  • For Finance Leases:
    • Recognize Receivables: Record finance lease receivables at the net investment in the lease.
    • Recording gains or losses on asset disposal in the P&L.
    • Accounting for fees and charges using the straight-line method.
    • Accruing and recognizing lease income using the linear method
    • Managing payment schedules.
    • Handling modifications to lease contracts.
    • Accounting for residual value at the end of the lease term.
    • Managing purchase options at the end of the lease contract.
  • For Operating Leases:
    • Recognize Rentals: Record rental income on a straight-line basis over the lease term.
    • Accounting for fees and charges using the straight-line method.
    • Accruing and recognizing rental income using the straight-line method.
    • Managing payment schedules.
    • Handling modifications to lease contracts.

Read Asset Finance for more information on the Asset Finance End to End Solution.

• Manage assets on the lessor’s books, including leased assets.
• For finance leases: Derecognize the leased asset from the lessor’s balance sheet, as it is recorded as a receivable.
• For operating leases: Continue depreciating the leased asset according to the lessor’s depreciation policy, as the asset remains on the lessor’s balance sheet.

Read Fixed Asset Management for more information on leased assets.

• Record cash flow projections for each lease contract and integrate them into the IFRS solution for lease measurement.

• Measurement of Leases
  • For Finance Leases
    • Derive the Interest Rate Implicit in the Lease or Effective Interest Rate (EIR) by discounting future cash flows (including periodic payments, guaranteed residual value, and unguaranteed residual value) to the net investment in the lease.
    • Measure Finance Lease Receivables: Calculate the present value of lease payments (periodic payments plus guaranteed residual value) and any unguaranteed residual value, discounted at the interest rate implicit in the lease (that is, the EIR).
    • Generate Accounting Entries: Implement multi-GAAP accounting for amortization using the EIR, to provide the view of General Ledger under IFRS 16.
  • For Operating Leases:
    • Measure Operating Lease Rentals: Determine the straight-line amount of rental income by dividing the total lease rentals (including variable lease payments) by the lease term.
    • Generate Accounting Entries: Implement multi-GAAP accounting for recognizing rental income using the straight-line method, to provide the view of General Ledger under IFRS 16.
• Staging, ECL, Impairment, Modification and Takeover for Lease Contracts
  • Apply IFRS 9 impairment requirements to lease receivables and rentals.
  • Assess and assign risk stages for lease receivables and rentals.
  • Calculate and post Expected Credit Losses (ECL) for lease receivables and rentals.
  • Apply IFRS9 modification or derecognition requirements to lease receivables and rentals.
  • Support takeover or migration of lease contracts from external systems to the Transact system, capturing EIR or carry cost during migration.
  • Assess the estimated unguaranteed residual value for finance leases and recognize any reductions in the Profit & Loss (P&L) statement immediately.
• Disclosures
  • Disclose the present value of unguaranteed residual value for reconciliation of net investment in the finance lease and provide a comprehensive maturity analysis.

• Select, classify, calculate, and record provisions on outstanding lease receivables and rentals on the balance sheet for lease contracts