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IFRS 16 Rent lease accounting

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Hi,

I would like some advice on how to treat rent lease agreement in the stat accounts under the IFRS 16. Accounting year end is Sep 2019.

The lease contract is very simple - it is 12months contract for rent of offices and car park with monthly invoice and payment of £1,700 per month and deposit of £1,500 (paid 3 years ago as lease is renewed every year). Lease started in Dec 2018 and ends in Nov 2019. Year end is Sep 2019. As at year end Right of Use  asset is 2x £1,700= £3,400 and liability is also £3,400. Does this make sense? I just would like to know if I understand the presentation requirements of this new standard properly. 

In the standard it states that it needs to be adopted for periods starting in January 2019. So I wonder if I could use this standard for earlier period or have to wait until next accounting year end?

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By paul.benny
02nd Dec 2019 15:15

Way off, I'm afraid.

Firstly, you have to look beyond the lease term to expected renewals. That you've already renewed several times shows that it isn't a one year lease in terms of the standard.

With a September year end, you don't.have to adopt IFRS16, this year but you can early adopt.

The amount to be capitalised is the Npv of future lease rentals, not just the aggregate of future rentals.

You should capitalise the right of use assed from the lease inception - not just at the balance sheet date.

The monthly p&l charge is then amortisation of the ROU asset and interest from unwinding of the discounting. The combined amount isn't necessarily the same as the monthly rental.

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By Bobbo
02nd Dec 2019 16:10

Worth considering carefully Paul's comments about is it really a 12 month lease given the pattern of renewals.

However, IF you end up being entirely content that the recurring 12 month leases can be looked at as standalone leases - does IFRS 16 not provide an exemption from recognition for short term leases (12 months or less)?

Note: I have zero experience of IFRS 16 other than having just googled it.

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Replying to Bobbo:
Hallerud at Easter
By DJKL
02nd Dec 2019 17:26

No idea how this works down South, but if the lease was originally to Nov 19 and the tenant is currently still in occupation as at 2nd December 2019, and no relevant and timeous notice re vacating was given re the Nov 2019 lease end date, then certainly up here the lease now runs until November 2020. (Tacit relocation)

I suspect legally you have similar automatic renewal though what terms apply I could not say, my knowledge of leasing being confined to Scots Law.

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Replying to Bobbo:
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By paul.benny
03rd Dec 2019 07:58

On the facts presented, this does not qualify as a short term lease.

In determining the length of a lease, IFRS16 refers to exercise of options to renew leases. In determining the likelihood of renewal, the application guidance is very clear that account should be given to past practice and also to the costs of obtaining a replacement asset.

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Replying to paul.benny:
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By Bobbo
03rd Dec 2019 21:47

I understand your points and reiterate that I really do not know IFRS 16 (or any other IFRS!) other what I've read in a piece by EY found on google.

However, in the OP's case no mention is made of an option being exercise to renew the lease (though this doesn't mean that isn't what's happening). Therefore, *without making assumptions* as to what's in the lease (and being a 12 month term is this potentially a licence not a lease - if that makes any difference), surely all we can say is that its a 12 month lease being replaced by a 12 month lease every year?

Just a thought - grateful for any input you may have.

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Replying to Bobbo:
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By paul.benny
04th Dec 2019 08:32

IFRS16 defines lease term as " the non-cancellable period for which a lessee has the right to use an underlying asset, together with periods covered by an option to extend if the lessee is reasonably certain to exercise that option..."

We have evidence from past practice that the lessee has extended the rental. We don't know from the OP how the property is being used. The application guidance discusses factors such as the costs of relocation and of acquiring a replacement property as being indicative that the lease will be extended (para B37).

A license is specific type of lease and should still be accounted for as such. The short term nature makes determination of the likely term more subjective.

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Accountants & Tax Advisors
By Gladstone
02nd Dec 2019 17:02

Not an expert on this new standard, however, I did some work for a client along with PwC (their auditors), so based on my understanding, the following:

For year ended 30 Sep 2019, you can early adopt or decide not to adopt. If you early adopt, you need to do an analysis going back in time (several options available under IfRS16) taking input like rent agreed, deposit involved, discount rate to arrive the the correct NPV etc, and create a retrospective asset and liability which will then needs to be adjusted on 01 Jan 2019 against the retained earnings. Please note that since the lease is renewed every 12 months (legal form), you do need to take into account the likely substance ie how many years you expect to renew this as of day one and do this analysis.

On the other hand, a counter argument can be that this is less than 12 months expiry as at 30 Sep 2019 and ignore IFRS16 for 2019 year-end. Other point for argument could be that it is a low value item ie less than USD 5k so not bother adjusting this.
I hope I didn't cause any confusion.
G

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Replying to Gladstone:
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By paul.benny
03rd Dec 2019 07:46

IFRS16 does permit "low value" assets to be treated as, in effect operating leases. "Low value" is not quantified but defined in terms of the value of the underlying asset. It gives a number of examples such as phones and tablets.

It's highly unlikely that a lease of real estate could ever qualify as "low value".

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Replying to paul.benny:
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By johnt27
03rd Dec 2019 18:25

All very true, but as you've said "low value" is only given an indicative, but non-binding, value of USD 5,000.

The low value concept could be utilised in the wider context of materiality. The annual rentals here are reasonably low (hard to say for certain without wider context) and so this should be considered further.

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Replying to johnt27:
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By paul.benny
04th Dec 2019 08:44

The application guidance to the standard (para B3-8) is explicit that "low value" refers to the asset, not to the lease rentals.

It also states that assessment of as asset being low value is not affected by the size, nature or circumstances of the lessee.

It's very unlikely, on the facts presented, that this would qualify as a low value asset.

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