## Learning Outcomes

- Explain the normal IFRS 16 lessee accounting model and why exemptions are available.
- Define a short-term lease and identify when the exemption cannot be used.
- Define a low-value asset lease and apply the low-value test to exam scenarios.
- Record the accounting treatment where a lessee applies an exemption.
- Distinguish between exemption elections made by class of asset and those made lease by lease.
- Avoid common ACCA FR errors involving extension options, purchase options, and low-value assets.
- Explain the impact of using an exemption on profit or loss and the statement of financial position.

## ACCA Financial Reporting (FR) Syllabus

Leases are a regular examinable area in ACCA FR. Candidates are expected to understand the main principles of IFRS Accounting Standards and apply them to financial statements. For lessees, IFRS 16 normally requires recognition of a right-of-use asset and a lease liability, but this subtopic focuses on the two practical recognition exemptions: short-term leases and leases of low-value assets.

- Identify when a lessee may avoid recognising a right-of-use asset and lease liability.
- Apply the short-term lease exemption to leases with a term of 12 months or less.
- Recognise that a lease containing a purchase option cannot be treated as short term.
- Apply the low-value asset exemption based on the value of the underlying asset when new.
- Record lease payments as an expense when an exemption is used.
- Understand how lease term assessment affects whether the short-term exemption is available.
- Explain the statement of financial position and profit or loss effects of applying an exemption.
- Spot common traps in multiple-choice and constructed-response lease questions.

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. What two items does a lessee normally recognise under IFRS 16 when a lease is not exempt?
2. A lease has a non-cancellable period of 10 months and includes an option to buy the asset at the end of the lease. Can it qualify as a short-term lease?
3. Is the low-value asset test based on the asset’s value when new or its current second-hand value?
4. If a lessee applies the short-term lease exemption, how are the lease payments normally recognised?
5. Is the low-value asset exemption applied by class of underlying asset or on a lease-by-lease basis?

## Introduction

IFRS 16 Leases brought most lessee leases onto the statement of financial position. In the usual accounting model, the lessee recognises a right-of-use asset and a lease liability. This means that a lease is treated as giving the lessee control over the use of an asset for a period, together with an obligation to make lease payments.

However, IFRS 16 includes two recognition exemptions for lessees. These are designed for leases where full recognition would often add work without giving users of the financial statements much extra useful information. The two exemptions are for short-term leases and leases for which the underlying asset is of low value.

> **Key Term: Right-of-use asset**
> An asset representing the lessee’s right to use an underlying asset during the lease term.
>
> **Key Term: Lease liability**
> The lessee’s obligation to make lease payments over the lease term, measured initially at the present value of future lease payments.

These exemptions matter in ACCA FR because lease questions often start with the normal IFRS 16 model and then include one lease that may be exempt. The exam skill is to recognise the exemption quickly, apply the correct accounting treatment, and avoid adding unnecessary right-of-use assets or lease liabilities.

### Why IFRS 16 allows lessee recognition exemptions

The starting point is that IFRS 16 uses a single lessee accounting model. For most leases, the lessee recognises:

- a right-of-use asset in non-current assets; and
- a lease liability split between current and non-current liabilities.

The right-of-use asset is usually depreciated over the shorter of the useful life of the asset and the lease term, unless ownership transfers or a purchase option is expected to be exercised. The lease liability is measured using present value techniques and is unwound using a finance cost.

The exemptions are optional. A lessee may choose not to apply the normal recognition model to:

- short-term leases; and
- leases of low-value assets.

If an exemption is used, the lessee does not recognise a right-of-use asset or lease liability for that lease. Instead, the lease payments are recognised as an expense, usually on a straight-line basis over the lease term.

> **Key Term: IFRS 16 recognition exemption**
> A permitted exception allowing a lessee not to recognise a right-of-use asset and lease liability for qualifying short-term leases or low-value asset leases.

The basic expense treatment is:

$$
\text{Annual lease expense} = \frac{\text{Total lease payments over the lease term}}{\text{Lease term}}
$$

This straight-line approach is used unless another systematic basis better represents how the lessee receives benefits from the leased asset. In most ACCA FR questions, straight-line recognition will be expected unless the question clearly gives another pattern of benefit.

> **Test Tip:**
> In an exam question, first decide whether the lease is exempt. If it is exempt and the lessee has elected to use the exemption, do not calculate a right-of-use asset, lease liability, depreciation, or finance cost for that lease.

A simple example shows the effect.

> **Question:**
> A company leases a small item of office equipment for two years at $1,200 per year, payable annually. The item qualifies as a low-value asset and the lessee applies the exemption. What is the annual accounting treatment?

The lessee records an expense of $1,200 each year. No right-of-use asset and no lease liability are recognised. The journal for each annual payment is:

- Dr lease expense $1,200
- Cr cash/payables $1,200

If payments are made in advance or arrears and do not match the reporting period, normal accruals and prepayments principles are still applied.

### Short-term leases: the 12-month rule and purchase option trap

A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less and does not contain a purchase option.

> **Key Term: Short-term lease**
> A lease that has a lease term of 12 months or less at the commencement date and contains no purchase option.

There are two parts to this definition, and both must be satisfied.

First, the lease term must be 12 months or less. This does not simply mean the written non-cancellable period if the contract includes extension or termination options. IFRS 16 requires the lessee to assess the lease term by considering the non-cancellable period, together with extension periods if the lessee is reasonably certain to extend, and termination periods if the lessee is reasonably certain not to terminate.

> **Key Term: Lease term**
> The non-cancellable period of a lease, adjusted for extension or termination options where the lessee is reasonably certain to use or not use those options.

For example, suppose a lessee signs a 10-month lease of equipment with an option to extend for another eight months. If the lessee is reasonably certain to extend, the lease term is 18 months. The lease is not a short-term lease, even though the initial written period is only 10 months.

Second, the lease must not contain a purchase option. A lease with a purchase option cannot be treated as a short-term lease even if the lease term is 12 months or less. This is a common ACCA FR trap because candidates may focus only on the number of months.

> **Exam Warning:**
> A 12-month lease with a purchase option is not a short-term lease. The presence of a purchase option blocks the short-term exemption.

The short-term lease exemption is elected by class of underlying asset. This means a lessee applies the policy consistently to a class, such as all short-term leases of office printers or all short-term leases of small storage units.

> **Key Term: Class of underlying asset**
> A grouping of underlying assets of a similar nature and use in the lessee’s operations.

For example, a company may choose to apply the short-term lease exemption to all short-term leases of delivery vans, but not to all short-term leases of warehouse equipment, if those are different classes of underlying asset. In FR exam questions, however, the question will usually state whether the exemption is applied.

If a lease that was treated as short term is later modified, or if the lease term changes, the lessee treats the lease as a new lease for the purpose of assessing the exemption. For example, if a 12-month lease is extended by a further 12 months, the lessee must reassess the position at the date of the change.

> **Test Tip:**
> Watch for words such as “reasonably certain to extend” or “management intends to renew”. If the facts show the lessee is reasonably certain to extend beyond 12 months, the short-term exemption is not available.

Consider this example.

A company enters into a lease of a machine for 11 months. The lease payments are $5,000 per month. There is no purchase option and no extension option. The company elects to apply the short-term lease exemption to this class of asset.

The lease qualifies as short term. The accounting is:

$$
11 \times \$5,000 = \$55,000
$$

The lessee recognises total lease expense of $55,000 over the 11-month period. No right-of-use asset or lease liability is recognised.

Now change the facts. The same 11-month lease includes an option to purchase the machine at the end of the lease. It cannot qualify as a short-term lease. The lessee would need to apply the normal IFRS 16 lessee model unless another exemption applies, which is unlikely for a machine of significant value.

### Low-value asset leases: applying the asset test

The second exemption is for leases where the underlying asset is of low value. This exemption is assessed based on the value of the underlying asset when new, not based on its age or current carrying amount.

> **Key Term: Low-value asset lease**
> A lease for which the underlying asset is of low value when new, allowing the lessee to expense payments if the exemption is applied.
>
> **Key Term: Underlying asset**
> The asset that is the subject of a lease and whose use is controlled by the lessee during the lease term.

IFRS 16 does not set a fixed monetary threshold in the Standard itself. In practice and in exam teaching, examples often use items such as tablets, personal computers, small items of office furniture, telephones, and similar office equipment. Assets such as cars, commercial property, production machinery, and major IT servers would not normally be treated as low value.

The assessment is made on an absolute basis, not relative to the size of the reporting entity. This means a large listed company and a small company apply the same idea of low value. An item does not become low value merely because it is immaterial to a very large group.

The test is based on the asset when new. A second-hand car leased for a low rental does not qualify merely because its current value is low. A car is not usually a low-value asset when new, so the low-value exemption would not apply.

> **Exam Warning:**
> Do not use the current age or second-hand value of the asset for the low-value test. Ask whether the underlying asset was low value when new.

The low-value exemption is available only where the leased asset can be used on its own or with other readily available resources, and where it is not highly dependent on or highly interrelated with other assets. This prevents a lessee treating a major asset as many low-value components.

For example, leasing individual laptops for staff may qualify because each laptop can be used on its own. Leasing a specialised component of a large production line is less likely to qualify if the component has value only as part of that production system.

A further practical point is that the low-value exemption is applied on a lease-by-lease basis. This differs from the short-term lease exemption, which is elected by class of underlying asset.

So, a company can choose to apply the low-value exemption to one qualifying low-value lease but not to another. In exam questions, the question will often state that the company has chosen to apply the exemption to all qualifying low-value asset leases. If it does not, read carefully for the required assumption.

The accounting is the same as for short-term leases: expense the lease payments, normally straight-line over the lease term, and do not recognise a right-of-use asset or lease liability.

Example:

A company leases 40 tablets for use by sales staff. Each tablet would cost $600 when new. The lease is for three years and payments are $9,600 per year in total. The tablets qualify as low-value assets and the lessee applies the exemption.

The annual expense is $9,600. Over three years, total expense is $28,800. No right-of-use asset and no lease liability are recorded.

This remains the case even though there are 40 tablets. The low-value assessment is usually made by reference to each underlying asset. A large number of individually low-value assets does not automatically stop the exemption from applying, although the total expense may still be material and must be recorded properly.

> **Test Tip:**
> Low value does not mean “low total contract value”. A lease of many low-value items can have a large total payment, but the exemption may still apply if each underlying asset qualifies.

### Statement of financial position and profit or loss effects

When the exemption is used, the lessee’s financial statements look different from the normal IFRS 16 treatment.

For a non-exempt lease, the statement of financial position includes:

- a right-of-use asset within non-current assets; and
- a lease liability, split between current and non-current liabilities.

Profit or loss includes:

- depreciation of the right-of-use asset; and
- finance cost on the lease liability.

For an exempt lease, the statement of financial position includes neither the right-of-use asset nor the lease liability. Profit or loss includes a lease expense, normally straight-line.

This distinction can affect ratios and interpretation. Using an exemption reduces recognised assets and liabilities compared with the normal model. It may also affect profit patterns. Under the normal model, total lease-related expense often tends to be higher in earlier years because finance cost is higher when the lease liability is larger. Under the exemption approach, the expense is usually even over the lease term.

In ACCA FR, this can appear in two main ways.

First, a numerical question may ask for the carrying amount of assets, lease liabilities, or profit. If an exemption is used, exclude that lease from the IFRS 16 asset and liability calculations and include the lease expense.

Second, an interpretation question may include right-of-use assets and lease liabilities in the statement of financial position. You should be able to explain that recognised leases increase assets and liabilities, while exempt leases remain off the statement of financial position and are expensed.

A short calculation illustrates the difference.

A company leases a low-value printer for two years. Payments are $3,000 per year, paid at each year end. The exemption is applied.

Year 1 accounting:

- Profit or loss: lease expense of $3,000.
- Statement of financial position: no right-of-use asset and no lease liability.

If the exemption had not been applied, the company would have recognised a right-of-use asset and lease liability initially, then depreciation and finance cost. But because the exemption is applied, those calculations are not needed.

Now consider a short-term lease with uneven payments.

A company enters into a 12-month lease of temporary office space from 1 January 20X5. Payments are $nil for the first three months and $4,000 per month for the next nine months. The lease contains no purchase option, no extension option, and the lessee applies the short-term lease exemption.

Total payments are:

$$
9 \times \$4,000 = \$36,000
$$

The straight-line expense for the 12-month lease is:

$$
\frac{\$36,000}{12} = \$3,000 \text{ per month}
$$

For the year ended 31 December 20X5, the lessee recognises lease expense of $36,000. If interim statements were prepared after three months, an accrued liability would be needed because the expense would have been recognised before cash payments began.

This example shows that exemption accounting is not always the same as cash accounting. The default treatment is still systematic expense recognition over the period of benefit.

> **Exam Warning:**
> Do not assume “exempt” means “ignore the lease”. The lessee still recognises lease expense in profit or loss, and may need accruals or prepayments.

A final exam point is disclosure. FR questions are more likely to test recognition and measurement than detailed disclosure, but the principle is that users should be able to see the expense recognised for leases where exemptions are applied. If a narrative question asks for presentation or explanation, mention that exempt lease payments are charged to profit or loss rather than capitalised as right-of-use assets.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- IFRS 16 normally requires lessees to recognise a right-of-use asset and a lease liability.
- Lessees may use recognition exemptions for short-term leases and low-value asset leases.
- A short-term lease has a lease term of 12 months or less at commencement.
- A lease with a purchase option cannot qualify as a short-term lease.
- Lease term includes extension periods if the lessee is reasonably certain to extend.
- The short-term lease exemption is elected by class of underlying asset.
- A low-value asset lease is assessed based on the underlying asset’s value when new.
- The low-value exemption is applied on a lease-by-lease basis.
- Low-value assets may include tablets, personal computers, small office furniture, and telephones.
- Cars, property, major machinery, and high-value servers are not normally low-value assets.
- When an exemption is applied, lease payments are expensed, usually straight-line over the lease term.
- Exempt leases do not create a right-of-use asset or lease liability in the lessee’s statement of financial position.

## Key Terms and Concepts

- Right-of-use asset
- Lease liability
- IFRS 16 recognition exemption
- Short-term lease
- Lease term
- Class of underlying asset
- Low-value asset lease
- Underlying asset


Lessee accounting - Exemptions: short-term and low-value leases