Lessor Accounting Explained: Finance & Operating Leases IFRS 16
Table of Contents
- Introduction
- Definitions
- Treatment for Lessees
- Treatment for Lessors
- Practical Challenges
- Conclusion
Introduction
IFRS 16, which replaced IAS 17 in January 2019, introduced significant changes to the accounting treatment of leases. The distinction between finance leases and operating leases remains crucial for lessors, but for lessees, the standard requires most leases to be recognised in the statement of financial position. This article explores the key differences between finance and operating leases under IFRS 16.
Definitions
The fundamental distinction between finance and operating leases lies in the transfer of risks and rewards:
Finance Lease
A lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset.
Operating Lease
A lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.
Treatment for Lessees
Under IFRS 16, lessees no longer classify leases as finance or operating leases. Instead, they:
- Record a right-of-use asset
- Recognise a corresponding lease liability
The following leases are exempt from the treatment above, and are still recognised through profit and loss:
- Short-term leases (12 months or less)
- Leases for low-value assets
The distinction between finance and operating leases is no longer relevant for lessees, as both types are recognised similarly to finance leases under the previous standard (IAS 17).
Treatment for Lessors
Classification Criteria
A lease is classified as a finance lease if it meets one or more of the following criteria:
| Criterion | Description |
|---|---|
| Ownership Transfer | Ownership transfers to the lessee at the end of the lease term |
| Purchase Option | The lessee has a purchase option that is reasonably certain to be exercised |
| Lease Term | The lease term covers the major part of the asset's economic life |
| Present Value | The present value of lease payments equals or exceeds substantially all the fair value of the asset |
| Specialised Nature | The leased asset is of a specialised nature and has no alternative use to the lessor |
Finance Lease Treatment
- Derecognise the leased asset
- Recognise a receivable equal to the net investment in the lease
- Record interest income over the lease term
- Capitalise initial direct costs
- For manufacturer/dealer lessors: recognise revenue, cost of sales, and profit/loss
Operating Lease Treatment
- Retain the underlying asset in the statement of financial position
- Recognise rental income on a straight-line basis
- Capitalise initial direct costs as part of the underlying asset
- For right-of-use assets sublet as operating leases: apply IAS 40 Investment Property
Practical Challenges
Key Implementation Challenges
- Exercising judgment in lease classification
- Collecting comprehensive lease data
- Managing multiple lease agreements
- Determining appropriate discount rates
- Handling lease modifications
Conclusion
IFRS 16 has significantly changed lease accounting, particularly for lessees. While lessors continue to distinguish between finance and operating leases, lessees now recognise most leases on their balance sheet. Understanding these requirements is crucial for:
- Accurate financial reporting
- Compliance with accounting standards
- Effective lease management
- Stakeholder communication
For additional guidance, please contact insight@leash.co.za.