Accounting for Right-of-Use Assets Under IFRS 16
16 Dec 2023
14 min read
An entity must identify whether a contract contains a lease, which is the case if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
The right to control an asset arises where, throughout the period of use, the customer has:
(a) The right to obtain substantially all of the economic benefits from use of the identified asset; and
(b) The right to direct the use of the identified asset.
The identified asset is typically explicitly specified in a contract. However, an asset can also be identified by being implicitly specified at the time that the asset is made available for use by the customer.
Even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use.
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Accounting for Right-of-use asset
Initial Measurement of Right-of-use asset
According to IFRS 16, the right-of-use asset is initially' measured at its cost, which includes:
The amount of the initial measurement of the lease liability (the present value of lease payments not paid at the commencement date)
Payments made at/before the lease commencement date (less any lease incentives received)
Initial direct costs (e.g. legal costs) incurred by the lessee
An 'estimate of dismantling and restoration costs (where an obligation exists).
Subsequent Measurement of Right-of-use asset
The right-of-use asset is normally measured subsequently at cost less accumulated depreciation and impairment losses in accordance with the cost model of IAS 16 Property, Plant and Equipment
The right-of-use asset is depreciated from the commencement date to the earlier of the end of its useful life or end of the lease term (end of its useful life if ownership is expected to be transferred).
Alternatively the right-of-use asset is accounted for in accordance with:
(a) The revaluation model of IAS 16 (optional where the right-of-use asset relates to a class of ,property, plant and equipment measured under the revaluation model, and where elected, must apply to all right-of-use assets relating to that class).
(b) The fair value model of IAS 40 Investment Property (compulsory if the right-of-use asset meets the definition of investment property and the lessee uses the fair value model for its investment property)
Presentation of Right-of-use asset in the financial statements
Right-of-use assets are presented either as a separate line item in the statement of financial position or by disclosing which line items include right-of-use assets.
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Activity Question
A company enters into a 4-year lease commencing on 1 January 2023 (and intends to use the asset for 4 years). The terms are 4 payments of UGX50 million, commencing on 1 January 2023, and annually thereafter. The interest rate implicit in the lease is 7.5% and the present value of lease payments not paid at 1 January 2023 (i.e. 3 payments of UGX50 million) discounted 'at that rate is UGX130,026,000.
Legal costs to set up the lease incurred by the company were UGX402,000.
Required
Explain the treatment of the right-of-use asset.
Solution
IFRS 16 Leases requires the right-of-use asset to be measured at cost.
For purposes of our activity question, the right-of-use asset shall be initially recognised at a cost of UGX180,428,000 determined as follows;
UGX | |
Initial measurement of the lease liability | 130,026,000 |
Payment made before or at commencement of lease | 50,000,000 |
Legal costs | 402,000 |
TOTAL | 180,428,000 |
Subsequently, the right-of-use asset shall be depreciated over the shorter of the useful life ot the lease-term.
About the Writer
CPA Innocent MUGISHA
CPA Innocent Mugisha is a Professor of Finance and Accounting with over 10 years experience in teaching Accounting and Finance related courses including Financial Accounting both at University and Professional level. His qualifications are: PhD (candidate), MBA(Finance), CPA(U), FCCA, CIPS, CTA and BCOM (Accounting). Innocent has also published various books on most topics in Accounting and Finance for Business and Professional Studies.
