Audit Partner at RSM Poland
In the last article we mentioned that individuals may apply the new standard in the same way as other new standards – with a full retrospective approach. The modified retrospective approach may be of much greater interest. We cannot forget the opening balance adjustment completely, nevertheless the International Accounting Standards Board agreed to significant savings in time and costs when changing standards and implementing IFRS 16 by limiting the restatement of comparative years. Therefore, assuming that we apply IFRS 16 for the first time in 2019 and we are presenting comparative data for one period (2018), under such a modified retrospective approach we may use a simplified procedure to recognise, as at 1 January 2019, agreements according to IFRS 16 which were not recognised previously as at the end of 2018 (e.g. they were treated as operating leases in accordance with IAS 17 or were recognised as finance leases in accordance with IAS 17).
A contract previously treated as an operating lease
In January 2016, a Company signed an agreement for the use of a car for a period of 60 months. Its value is 100 units. As at the end of 2017, the company did not recognise the car as a finance lease. As at 1 January 2019, the value of the right to use the asset and the value of liabilities should be determined in accordance with IFRS 16:
- the value of outstanding payments (2 years) is, e.g., 38 units, and, after discounting at the rate of 4% (as at 1 January 2019), e.g. 36 units;
- the value of the right of use will therefore be assumed to be 36 units.
The column of the balance sheet as at 31 December 2018 remains unchanged.
In this scenario, however, it is possible to assume the right to use the assets at the value that would be determined if we wanted to “have always applied” IFRS 16 on the basis of accumulated payments calculated as at the lease inception date, but taking the discount rate as at 1 January 2019 into account. In such a case, it may turn out that the asset’s right of use will be e.g. 40 units. The difference of 4 units shall be transferred to the retained earnings as at 1 January 2019.
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A contract previously treated as a finance lease
In January 2016, the company signed an agreement for the use of a car worth 100 units for a period of 60 months. As at the end of 2018, the net value of the car in the books was 40 units and the value of the liability was 38. (Excludes deferred tax).
As at 1 January 2019, the value of the right to use the assets should be recorded at the amount at which the leased assets were disclosed in the balance sheet as at 31 December 2018 – similarly for lease liabilities.
As it can be seen, for entities reporting finance leases as at the end of 2018, the transition to IFRS 16 will be very easy and will not require significant time and financial outlays. However, for companies with operating leases in accordance with IAS 17, the transition will involve (under the modified approach) determining whether, for the right to use the assets, the entity wishes to choose the value of the lease liabilities as at 1 January 2019 (1) or it will record such a right of use at the value that would have been determined had IFRS 16 been applied earlier (2).
Therefore, we may now wrap up our discussion of the transition to IFRS 16 – did the company apply IAS 17 and show finance or operating leases?
1 – YES – then it may apply IFRS 16 to these contracts as at the date of first application of IFRS 16 (1.01.2019) using a simplified (modified) or fully retrospective approach.
2 – NO – the company does not have to apply IFRS 16 (as at 1 January 2019) to contracts that were not previously identified as contracts containing (whether finance or operating) a lease according to IAS 17.
Accordingly, in the case of example 1, we can reclassify the lease in the manner that is consistent with the nature of the lease: using a complete, retrospective or modified approach.
Under the modified manner it is possible to:
- adopt the value of assets and liabilities as at 1 January 2019 as they were recorded in the books as at 31 December 2018, provided that the lease was previously treated as a finance lease;
- measure the right to the assets at the value equal to the liabilities as at 1 January 2019 (1), but also at the value that would have been determined if IFRS 16 had always been applied (taking the discount rate, as at 1 January 2019 (2) into account, in situations where, previously, the lease was treated as an operating lease. Below, you will find a summary diagram showing these options.
Apparently, it is important in the first step to compare the provisions of the new IFRS 16 with the terms used under IAS 17. And how does the new IFRS 16 define a lease? You can read about it in our next article.
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