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ACCA Strategic Professional · Strategic Business Reporting (International) · Leases

Delta Ltd leases out an investment building under a 10-year operating lease. Rent is $20,000 in year 1, rising by $2,000 each year (so $20,000, $22,000, ... $38,000), with no link to an index. Delta also paid $15,000 of initial direct costs to arrange the lease. How should Delta recognise the lease income and the initial direct costs under IFRS 16?

Delta recognises rental income straight-line at $29,000 a year, because the fixed escalations are not index-linked. Initial direct costs of $15,000 are added to the carrying amount of the building and expensed over the lease term on the same basis as the lease income.

  1. AIncome on a straight-line basis ($29,000 a year); initial direct costs added to the carrying amount of the asset and expensed over the lease term on the same basis as the incomeCorrect
  2. BIncome as invoiced each year; initial direct costs expensed immediately
  3. CIncome on a straight-line basis; initial direct costs expensed immediately
  4. DIncome as invoiced each year; initial direct costs added to the asset and depreciated over the asset's useful life only

Explanation

Total rent is the average of $20,000 and $38,000 times 10 = $290,000, so $29,000 a year on a straight-line basis, unless another systematic basis better represents the pattern of benefit. IFRS 16 requires initial direct costs of an operating lease to be added to the carrying amount of the underlying asset and recognised as expense over the lease term on the same basis as lease income. Immediate expensing is the wrong treatment.

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