Leases: formula sheet

Key formulas

Definition of a lease

Lease = contract conveying the right to control the use of an identified asset for a period of time in exchange for consideration

Both an identified asset and control of its use are required. A period of time can be expressed as an amount of use, such as units produced.

Right to control use: two tests

(1) Right to obtain substantially all economic benefits AND (2) right to direct the use of the asset

Both tests must be met throughout the period of use. If either fails, there is no lease.

Substitution right is substantive only if

Supplier has the practical ability to substitute AND would benefit economically from substituting

Assess at inception. If the customer cannot readily tell, assume the right is not substantive.

Allocation to components

Allocated price = Contract price × (Standalone price of component ÷ Total of standalone prices)

Lessee uses this for each lease and non-lease component, unless it elects not to separate.

Optional exemptions (lessee)

Short-term lease: term of 12 months or less with no purchase option. Low-value asset: low value when new, assessed per asset

Lessee recognises payments as an expense, normally straight-line. These are elections, not requirements.

Scope exclusions

Not in IFRS 16: leases to explore for minerals, oil and gas; biological assets (IAS 41); service concession arrangements (IFRIC 12); licences of IP granted by a lessor (IFRS 15); rights held under licensing agreements for films, patents and copyrights (IAS 38)

A lessee may, but need not, apply IFRS 16 to intangible assets other than the licences of IP scoped out.

Lease liability at commencement

Lease liability = Σ [lease payment ÷ (1 + r)^t] for payments not yet paid

r is the rate implicit in the lease if readily determinable, otherwise the IBR. Payments in advance are discounted for zero periods.

Initial ROU asset

ROU asset = lease liability + payments made at or before commencement + initial direct costs + estimated dismantling/restoration costs − lease incentives received

Dismantling costs are also recognised as a provision under IAS 37.

Subsequent measurement of the liability

Closing liability = opening liability + interest (opening liability × r) − payment made

For payments in arrears, interest accrues before the payment. For payments in advance, the payment on the first day reduces the balance before interest accrues.

Depreciation of the ROU asset

Annual depreciation = (ROU cost − residual value) ÷ shorter of lease term and useful life

Use the useful life if ownership transfers or a purchase option is reasonably certain to be exercised.

Current and non-current split

Current liability = liability at year end − liability expected at next year end (before next year's payment is deducted, i.e. the principal repaid in the next 12 months)

Equivalent for payments in arrears: next payment − next year's interest.

Exemptions

Short-term: lease term ≤ 12 months and no purchase option. Low-value: asset of low value when new.

Short-term is chosen by class of underlying asset. Low-value is chosen lease by lease. Expense payments straight-line (or another systematic basis).

Variable payments

Index- or rate-linked: include in liability. Usage- or sales-linked: expense as incurred.

Index-linked payments use the index at commencement. Remeasurement later is covered under lease modifications and remeasurement.

Separate lease test (lessee)

Separate lease = extra right of use of underlying asset(s) AND price increase ≈ standalone price of the extra scope

Both conditions must be met. The standalone price may be adjusted for the circumstances of the contract. An extension of term alone does not add an asset, so it is not a separate lease.

Modification that is not a separate lease: liability

New liability = PV of revised remaining payments, discounted at the revised rate at the modification date

Use the rate implicit in the lease for the remaining term if it can be readily determined. Otherwise use the lessee's incremental borrowing rate at the modification date. Also reallocate the consideration and determine the new lease term.

Decrease in scope (partial or full termination)

Reduce ROU asset in proportion to the scope decrease. Gain or loss = reduction in liability − reduction in ROU asset

Recognise the gain or loss in profit or loss. Any remaining difference from remeasuring the liability is adjusted against the ROU asset.

Other modifications (not a separate lease, no scope decrease)

ROU asset adjusted by the full remeasurement of the lease liability

Dr ROU asset and Cr lease liability if the liability rises. Do the reverse if it falls.

Reassessment of lease term or purchase option

Remeasure liability using a revised discount rate at the date of reassessment. Adjust ROU asset by the same amount

If the ROU asset is reduced to zero, take any further reduction to profit or loss.

Change in residual value guarantee or in an index or rate

Remeasure liability using the original discount rate. Adjust ROU asset

Exception: if the change comes from a floating interest rate, use a revised discount rate that reflects the rate change.

COVID-19 rent concession expedient (lessee)

Concession is not assessed as a modification if: direct result of COVID-19, consideration is substantially the same or less, reduction affects only payments due on or before 30 June 2022, no other substantive change

Account for the concession as a negative variable lease payment. Derecognise the part of the liability that is forgiven and credit profit or loss. It is optional and applied consistently to similar leases.

Finance lease indicators

Assessed at inception. Any of these normally points to a finance lease: (1) ownership transfers to the lessee by the end of the term; (2) a purchase option is reasonably certain to be exercised; (3) the term covers the major part of the economic life; (4) the PV of payments amounts to at least substantially all of the fair value; (5) the asset is so specialised that only the lessee can use it without major modification.

These are examples that individually or in combination normally lead to a finance lease. Further indicators: lessee bears lessor's cancellation losses, gains or losses from fair value changes fall on the lessee, and the lessee can renew at a substantially below-market rent. Judge the overall substance.

Net investment in the lease

Net investment = PV of lease payments receivable + PV of unguaranteed residual value (both at the rate implicit in the lease)

Lease payments include fixed payments, variable payments based on an index or rate, residual value guarantees from the lessee, a purchase option price if reasonably certain, and termination penalties if the term reflects termination. The implicit rate is defined so that the lessor's initial direct costs are included in the net investment automatically, except for manufacturer or dealer lessors.

Finance income

Finance income = opening net investment × implicit rate

Closing net investment = opening + finance income − cash received.

Operating lease income

Annual income = total lease payments over the term ÷ lease term (straight-line)

Include rent-free periods and fixed escalations in the total. Add depreciation of the asset as an expense.

Sub-lease classification

Intermediate lessor classifies sub-lease by reference to the head-lease right-of-use asset

Exception: if the head lease is a short-term lease accounted for under the exemption, the sub-lease is operating.

Right-of-use asset retained

ROU = Carrying amount × (PV of lease payments ÷ Fair value of asset)

Use the PV of the lease payments, which equals the lease liability at commencement. Any prepayment adjustment or initial direct costs are added to the ROU asset separately. They are not part of this proportion.

Total gain before restriction

Total gain = Fair value − Carrying amount

This applies when the sale is at fair value. Adjust for off-market terms first.

Gain recognised

Gain recognised = Total gain × (Fair value − PV of lease payments) ÷ Fair value

Only the gain on rights transferred is recognised. The rest is absorbed in the ROU asset.

Below fair value adjustment

Prepayment of lease payments = Fair value − Sale price

Adjust the proceeds up to fair value: cash received + prepayment = fair value. Include the prepayment in the ROU asset, on top of the proportion above. The lease liability is the PV of the actual lease payments. See the third worked example.

Above fair value adjustment

Additional financing = Sale price − Fair value

Account for it as a financial liability by the seller-lessee. Cash received = fair value proceeds + loan.

Failed sale

Financial liability = Proceeds received

Seller-lessee keeps the asset and continues to depreciate it. The buyer-lessor books a financial asset.

Lease expense replaced

Old rent expense → depreciation of ROU asset + interest on lease liability

Total expense over the lease is similar, but it is front-loaded under IFRS 16.

Interest on lease liability

Opening liability × discount rate

Presented as a finance cost.

Cash flow classification

Principal repaid → financing; interest → operating or financing per policy

Short-term, low-value and variable payments not in the liability are normally operating.

EBITDA effect

EBITDA = operating profit + depreciation + amortisation

Lease depreciation is added back, so EBITDA rises by the former rent on capitalised leases.

Gearing

Debt ÷ equity, or debt ÷ (debt + equity)

State whether lease liabilities are included. Including them raises gearing.

Interest cover

Profit before interest and tax ÷ finance costs

Falls as lease interest is added to finance costs.

Quick revision

• A lease conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
• A supplier's substantive right to substitute the asset means there is no identified asset.
• Lessees recognise a right-of-use asset and a lease liability at the commencement date.
• Lease liability is the present value of unpaid lease payments, discounted at the rate implicit in the lease, or the lessee's incremental borrowing rate if that cannot be readily determined.
• Right-of-use asset is the initial liability plus payments made at or before commencement, initial direct costs and restoration costs, less incentives received.
• Interest accrues on the liability using the discount rate, and payments reduce it; the asset is depreciated, normally over the shorter of lease term and useful life unless ownership transfers.
• Short-term leases and low-value asset leases can be expensed on a straight-line basis as an optional exemption.
• A modification that adds a right of use at a stand-alone price is a separate lease; otherwise remeasure the liability.
• Lessors classify a lease as finance if it transfers substantially all the risks and rewards of ownership; otherwise it is operating.
• In a sale and leaseback, first test whether the transfer is a sale under IFRS 15; if not, the seller-lessee keeps the asset and recognises a financial liability.
• If it is a sale, the seller-lessee measures the right-of-use asset at the proportion of the previous carrying amount that relates to the right retained, and recognises only the gain relating to rights transferred.
• Disclosures help users understand the amount, timing and uncertainty of lease cash flows.

Common mistakes

• Relying on the contract's title, such as 'service agreement' or 'hire agreement'. Fix: Apply the definition. Substance decides, not the label.
• Treating any substitution right as ending the lease. Fix: Only a substantive right defeats an identified asset. Substitution only for repair, or where the supplier gains nothing, is not substantive.
• Including initial direct costs in the lease liability. Fix: The liability contains only the present value of lease payments. Initial direct costs, prepaid payments and restoration costs go into the ROU asset only.
• Discounting payments in advance as if they were in arrears. Fix: Discount the first payment for zero periods if it is paid on day one. The liability at commencement is then the present value of the remaining payments, and the day-one payment is added into the ROU asset.
• Treating every extension of term as a separate lease. Fix: A separate lease needs extra scope, meaning an additional underlying asset, plus a commensurate price. A pure term extension of the same asset is a modification that remeasures the liability.
• Using the original discount rate for a modification or a term reassessment. Fix: Use a revised rate at the modification date or reassessment date. The original rate is only kept for changes in an index or residual value guarantee payments, with the floating-rate exception.
• Applying the lessee's single-model approach to the lessor Fix: Remember that lessor accounting still has two models. Only the lessee has one model, with exemptions for short-term and low-value leases.
• Treating numeric thresholds such as 75% of life or 90% of fair value as strict rules Fix: IFRS 16 uses indicators and overall substance. Use the figures only as a guide and justify your conclusion.
• Recognising the whole gain (fair value − carrying amount) in profit or loss. Fix: Under IFRS 16, recognise only the gain relating to rights transferred. The rest is built into a lower ROU asset.
• Measuring the ROU asset at the lease liability or at fair value. Fix: In a sale and leaseback, ROU = carrying amount × PV of payments ÷ fair value.

Exam tips

• Start every 'is it a lease?' answer by quoting the definition, then apply it to facts. Markers award marks for application, not recall.
• Look for scenario clues: named asset, supplier substitution clauses, who sets the use, minimum purchase or take-or-pay terms.
• State the conclusion early and justify it. Use professional scepticism where a contract title does not match the economics.
• Mention the exemptions and the practical expedient only when the facts fit. Do not list every scope exclusion.
• If the contract is a lease, link briefly to the accounting consequence, then point to the measurement topic.
• Read the payment timing first: in advance or in arrears. It changes both the present value and the opening liability. Underline it in the question.
• Show the liability table even if you get the first number wrong. Marks are given for method, and follow-through errors are usually not penalised twice.
• If the question mentions a short lease or a cheap asset, test the exemption conditions before you calculate anything. State the condition in a short sentence, such as no purchase option and 12 months or less.