Lease identification can involve significant judgement
Under the new leasing standard, IFRS 16, lease definition becomes the key on-/off-balance sheet test. Therefore, assessing whether an arrangement is, or contains, a lease will be one of the biggest practical issues.
Our publication, Lease Definition (PDF 657 KB), will help you to determine whether a transaction is, or contains, a lease and to understand the differences to current practice.
Applying the new lease definition
In many cases, assessing whether a transaction is a lease will be straightforward, and a transaction that is a lease today will be a lease under the new standard. A key focus will be completing and documenting the assessment.
In other cases, the assessment will be more complex and there may be changes in which transactions are identified as leases – e.g. power purchase, IT outsourcing and transport agreements.
Deciding whether to grandfather the lease definition
As companies prepare to adopt the new standard, a key decision will be whether to apply the practical expedient to grandfather the lease definition for existing contracts on transition. This is a balancing act.
Although this practical expedient offers considerable relief, it may result in continued lease accounting for contracts that are not leases under IFRS 16. In addition, it may impact comparability in the years after transition.
You need to weigh potential cost savings against reduced comparability.
Identifying all lease agreements and extracting all key data
The effort required to identify all lease agreements and extract all relevant data may be substantial. Even if the simplified model is applied for short-term and low-value item leases, each lease will still need to be identified and its key terms extracted.
The task ahead should not be underestimated.