What you need to know first
- For lessees, almost all leases bring a Right-of-Use (ROU) asset and a corresponding lease liability onto the statement of financial position.
- Straight-line rent expense is replaced by depreciation of the ROU asset plus finance cost (interest) on the lease liability.
- Practical exemptions exist for short-term leases (12 months or less with no purchase option) and low-value underlying assets.
1. Identifying a Lease Under IFRS 16
A contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Control means the customer has both the right to obtain substantially all economic benefits from the asset and the right to direct how and for what purpose the asset is used.
2. Initial & Subsequent Measurement
At commencement, the lease liability is measured at the present value of unpaid lease payments discounted using the interest rate implicit in the lease—or, if that cannot be readily determined, the lessee’s incremental borrowing rate (IBR).
- Lease Liability = Present value of fixed payments + reasonably certain extension options.
- Right-of-Use Asset = Initial lease liability + initial direct costs + prepaid lease payments + estimated restoration costs.
- Each period, the liability increases by interest expense and decreases by cash rent paid, while the ROU asset is depreciated over the shorter of useful life and lease term.
Practical Tip: In Pakistan, where property agreements often contain annual escalation clauses (e.g., 10% per annum) and renewal options, documenting management’s assessment of the enforceable lease term is essential before calculating the discount schedule.