ACCA Applied Skills · Financial Reporting

Leasing under IFRS 16 for ACCA Financial Reporting

Leasing in ACCA FR means applying IFRS 16. You identify whether a contract contains a lease, then the lessee records a right-of-use asset and a lease liability at the present value of unpaid payments. You depreciate the asset and unwind interest on the liability. Short-term and low-value leases can be expensed.

What this chapter covers

This chapter covers IFRS 16 Leases. It starts with the question of whether a contract is, or contains, a lease. It then moves to how a lessee measures and records a lease at the start, how it accounts for it in later years, how a sale and leaseback is treated, and when a lessee may use the exemptions.

The core idea is simple. A lessee that controls an asset for a period should show that asset and the matching obligation on its statement of financial position. Almost every question turns on one calculation: the present value of lease payments, and then a liability table that rolls the balance forward with interest and payments.

Leasing links to many other parts of FR. It affects property, plant and equipment through depreciation and the right-of-use asset. It affects the statement of profit or loss through depreciation and finance cost. It affects the statement of cash flows, where payments are split between interest and capital. It also changes ratios such as gearing and return on capital, which matter in interpretation questions. Leasing can appear in Section A, in a Section B case, or as part of a Section C question.

Leasing is a favourite examining area because it is calculation-based, rule-based and easy to combine with other topics. In objective questions, marking is all or nothing, so one slip in a discount factor or a payment date costs the full mark. In constructed response, a clear liability table earns method marks even if one figure is wrong. If you master this chapter, you gain reliable marks and also build skills in present values and in splitting current from non-current liabilities that help elsewhere in the paper.

Leasing: topics in the order to study them

1IFRS 16 Scope and Lease IdentificationYou must decide whether a contract contains a lease before any accounting applies, so the control test comes first.
2Lessee Accounting: Right-of-Use Asset and Lease LiabilityInitial measurement sets the opening figures that every later calculation depends on.
3Lessee Subsequent Measurement and Lease Liability ScheduleThis is the main calculation skill and builds directly on the opening liability and asset.
4Lessee Short-Term, Low-Value Leases and DisclosureThe exemptions are a short rule set that is easier once you know the full model they depart from.
5Sale and Leaseback TransactionsIt is the hardest topic because it combines IFRS 15 sale tests with lessee accounting, so learn it last.

How to prepare Leasing

Leasing rewards a step-by-step method more than memory. Practise the same routine until it is automatic.

Learn the lease definition and the control test: an identified asset, the right to obtain substantially all the benefits, and the right to direct its use.
Practise present value on its own. Discount each payment correctly, and note whether payments fall at the start or end of each year.
Build the opening entries: lease liability at present value, right-of-use asset at liability plus payments made at or before the start plus initial direct costs, less incentives received.
Draw the liability table every time: opening balance, interest, payment, closing balance. For payments in arrears, interest is on the opening balance. For payments in advance, deduct the payment first and charge interest on the reduced balance. Then split the liability into current and non-current. For payments in arrears, the non-current part is the closing liability at the end of next year, and the current part is the rest. For payments in advance, the non-current part is the liability after the next payment is deducted, before next year's interest, and the current part is the liability now less that figure.
Calculate depreciation over the shorter of lease term and useful life, unless ownership transfers or a purchase option is reasonably certain.
Work sale and leaseback questions in two stages: first test whether a sale occurred under IFRS 15, then measure the right-of-use asset as carrying amount × (PV of lease payments ÷ fair value). Recognise gain = total gain × (fair value − PV of lease payments) ÷ fair value, where total gain = fair value − carrying amount. These formulas assume the sale is at fair value. If the sale price is below fair value, treat the shortfall as a prepayment of lease payments. If it is above fair value, treat the excess as additional financing from the buyer-lessor. Make that adjustment first.
Finish with timed mixed questions and write short Section C answers that show the table, the statement extracts and any disclosure points.

Common mistakes in Leasing

Treating every contract with an asset in it as a lease.
Fix: Run the control test first and check for substitution rights and whether the customer directs the use.
Discounting payments from the wrong date.
Fix: Mark each payment on a timeline before choosing discount factors.
Reporting the whole next payment as the current liability when payments are in arrears.
Fix: For arrears, current liability equals the closing liability now minus the closing liability at the end of next year, using the table. For advance payments, the non-current part is the liability after the next payment is deducted, before interest, and the current part is the rest.
Forgetting adjustments to the right-of-use asset.
Fix: Use a short build-up line by line and tick each item against the question.
Recognising the full gain in a sale and leaseback.
Fix: Work out the total gain as fair value less carrying amount. Then recognise only total gain × (fair value − PV of lease payments) ÷ fair value, the part relating to rights transferred.
Using the lease term for depreciation when the useful life is shorter, or ignoring a purchase option.
Fix: Check for transfer of ownership or a reasonably certain purchase option, then pick the correct period.

Last-day revision: Leasing

A contract contains a lease if it gives the right to control the use of an identified asset for a period in exchange for consideration.
A supplier's substantive right to substitute the asset means there is no identified asset.
Lessee initial liability is the present value of unpaid lease payments, discounted at the rate implicit in the lease if known, otherwise the incremental borrowing rate.
Right-of-use asset starts at the liability, plus payments made before or at commencement and initial direct costs, less incentives received.
Payments in arrears: interest = opening liability × rate; closing = opening + interest − payment.
Payments in advance: interest = (opening liability − payment made at the start) × rate; closing = opening − payment + interest. The payment reduces the liability before interest accrues for that year.
Current and non-current split, arrears: non-current = closing liability at the end of next year; current = closing liability now less that figure.
Current and non-current split, advance: non-current = liability after the next payment is deducted, before next year's interest; current = liability now less that figure. Do not use the end-of-next-year closing balance.
Depreciate the right-of-use asset over the shorter of lease term and useful life, unless ownership passes.
Short-term leases (lease term of twelve months or less at commencement, no purchase option) may be expensed if the lessee elects, and the election is made by class of underlying asset. Low-value asset leases may be expensed, elected lease by lease, but the exemption cannot apply if the lessee subleases the asset. Expense the payments straight-line, or on another systematic basis if it is more representative of the benefit pattern.
In a sale and leaseback, if the transfer is not a sale under IFRS 15, keep the asset and record a financial liability for proceeds.
If it is a sale at fair value, right-of-use asset = carrying amount × (PV of lease payments ÷ fair value). Gain recognised = total gain × (fair value − PV of lease payments) ÷ fair value, where total gain = fair value − carrying amount. If the sale price differs from fair value, adjust first: a shortfall is a prepayment of lease payments, and an excess is additional financing.
Statement of cash flows: interest is classified as operating or financing in line with the entity's IAS 7 policy; the capital element of the payment is a financing outflow.

Leasing practice questions

Leasing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Leasing: frequently asked questions

Is leasing tested in objective questions or written questions?

It can appear in both. Objective questions usually test the lease definition, the liability or asset figure, or a current and non-current split. Written questions often ask for a full table and statement extracts.

Which discount rate do I use for the lease liability?

Use the rate implicit in the lease if it can be readily determined. If not, use the lessee's incremental borrowing rate. Questions normally give you the rate to use.

Do I need to know lessor accounting for FR?

The FR syllabus examines lessee accounting and sale and leaseback. Lessor accounting is not examined in detail, so put your study time into the lessee model. Check the current syllabus and study guide before you rely on this.

How do I split the lease liability between current and non-current?

It depends on when payments fall. For payments in arrears, the non-current part is the closing liability at the end of next year, and the current part is the difference between that and the current closing liability. For payments in advance, the non-current part is the liability after the next payment is deducted, before next year's interest, and the current part is the liability now less that figure.

When can a lessee expense lease payments instead?

For short-term leases (a lease term of twelve months or less at commencement, with no purchase option) and for leases of low-value assets, if the lessee chooses the exemption. The short-term election is made by class of underlying asset. The low-value election is made lease by lease, and it cannot apply if the lessee subleases the asset. The payments are expensed straight-line, or on another systematic basis if that better reflects the pattern of benefit.