## Learning Outcomes

- Explain how right-of-use assets and lease liabilities are presented in the statement of financial position.
- Identify the main profit or loss and cash flow statement effects of lessee accounting under IFRS 16.
- Describe the purpose and content of a maturity analysis for lease liabilities.
- Distinguish between discounted lease liabilities and undiscounted maturity analysis cash flows.
- Explain significant judgements commonly disclosed for leases, including lease term and extension options.
- Apply exam-focused reasoning to presentation and disclosure requirements in ACCA FR questions.

## ACCA Financial Reporting (FR) Syllabus

IFRS 16 Leases is examined in ACCA FR as part of applying IFRS Accounting Standards to prepare and interpret financial statements. Questions often focus on recognising and measuring the right-of-use asset and lease liability, but candidates also need to understand where the resulting amounts appear and what note disclosures help users assess lease obligations.

- Present right-of-use assets and lease liabilities in the statement of financial position.
- Classify lease liabilities between current and non-current liabilities.
- Show depreciation and finance cost effects in profit or loss.
- Explain how lease payments affect the statement of cash flows.
- Describe the maturity analysis required for lease liabilities.
- Explain the difference between lease liability carrying amounts and undiscounted future payments.
- Identify significant judgements, especially about lease term, renewal options and whether a contract contains a lease.
- Recognise common disclosure points for lessees and lessors at FR level.

## 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. Where may a lessee present right-of-use assets in the statement of financial position?
2. Why will the total undiscounted lease payments in a maturity analysis usually differ from the lease liability in the statement of financial position?
3. Which judgement is often required when a lease contract contains an option to extend the lease?
4. How are the principal element and interest element of lease payments normally classified in the statement of cash flows?
5. Give two lease-related disclosures, other than the maturity analysis, that help users understand the effect of leases on the financial statements.

## Introduction

IFRS 16 requires most lessees to recognise a right-of-use asset and a lease liability. This means leases are not just a profit or loss issue. They affect non-current assets, current and non-current liabilities, finance costs, depreciation, cash flows and ratios such as gearing and return on capital employed.

Presentation and disclosure are therefore tested because users need to understand the amount, timing and uncertainty of lease cash flows. In ACCA FR, a question may give you a statement of financial position extract showing a right-of-use asset and lease liabilities split between current and non-current amounts. You may be asked to identify correct presentation, explain movements, or state what further disclosures are needed.

> **Key Term: Right-of-use asset**
> An asset representing a lessee’s right to use an identified underlying asset for the lease term.

### Presenting lease assets, liabilities, expenses and cash flows

For a lessee, IFRS 16 generally brings leases onto the statement of financial position. At commencement of the lease, the lessee recognises:

- a right-of-use asset; and
- a lease liability.

The right-of-use asset is a non-current asset unless it meets criteria for current classification, which will be rare in FR questions. It may be presented as a separate line item, such as “right-of-use asset”, or included within the same line item that would have been used if the underlying asset had been owned. For example, a right-of-use asset relating to factory equipment may be included within property, plant and equipment if not shown separately. If not shown separately on the face of the statement of financial position, the notes must identify where it is included.

> **Key Term: Lease liability**
> The obligation recognised by a lessee to make lease payments, measured initially at the present value of lease payments not paid at commencement.

Lease liabilities may also be presented separately in the statement of financial position. If they are not shown separately, the notes disclose which line items include them. In many FR questions, lease liabilities are split between non-current liabilities and current liabilities. This reflects the amount due to be settled after more than 12 months and within 12 months respectively.

A typical presentation could include:

- non-current assets: right-of-use asset;
- non-current liabilities: lease liabilities due after more than one year;
- current liabilities: lease liabilities due within one year.

This presentation is consistent with the way FR statements often show lease liabilities in separate current and non-current categories.

In profit or loss, the single operating lease rental expense seen under older lease accounting is replaced for most lessees by:

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

Depreciation is usually included with other depreciation expenses. Finance cost is presented as part of finance costs. This changes performance analysis. Operating profit may increase because lease interest is below operating profit, while depreciation remains within operating expenses. EBITDA increases because depreciation and interest are both excluded from EBITDA, even though cash payments have still been made.

Cash flow presentation also matters. Lease payments are split into:

- principal repayments of the lease liability; and
- interest payments.

The principal portion is normally classified as a financing cash flow. Interest is classified in accordance with the entity’s accounting policy under IAS 7 Statement of Cash Flows, often as either operating or financing. Payments for short-term leases, low-value asset leases and variable lease payments not included in the lease liability are usually operating cash flows.

> **Test Tip:**
> In an FR question, do not describe lease payments only as “rent expense”. For most lessee leases under IFRS 16, the accounting effect is depreciation plus finance cost, with a lease liability presented in the statement of financial position.

Some leases are exempt from the full IFRS 16 lessee model. A lessee may choose not to recognise right-of-use assets and lease liabilities for short-term leases and leases of low-value assets. Instead, payments are expensed, usually on a straight-line basis over the lease term.

> **Key Term: Short-term lease**
> A lease that, at commencement, has a lease term of 12 months or less and does not contain a purchase option.

### Maturity analysis of lease liabilities

The maturity analysis is a note disclosure showing when lease cash payments are due. It helps users assess liquidity risk: whether the entity has enough cash or finance available to meet future lease obligations.

> **Key Term: Maturity analysis**
> A disclosure that analyses future contractual cash flows by time period, showing when payments are due.

For lessees, IFRS 16 requires a maturity analysis of lease liabilities. This is prepared by applying the financial instruments disclosure principles in IFRS 7 and is disclosed separately from maturity analyses for other financial liabilities. The analysis normally groups future undiscounted lease payments into time bands, such as:

- not later than one year;
- later than one year and not later than two years;
- later than two years and not later than five years;
- later than five years.

The exact time bands may vary, but the aim is to show the timing of future cash outflows.

A key exam point is that the maturity analysis uses undiscounted cash flows. The lease liability in the statement of financial position is measured using discounted amounts: the present value of future lease payments. Therefore, the total of future payments in the maturity analysis will usually be higher than the carrying amount of the lease liability.

Example: a company has three remaining annual lease payments of $40,000 each. The maturity analysis may show total undiscounted payments of $120,000. However, the lease liability in the statement of financial position might be $109,000 because those future payments have been discounted to present value.

> **Exam Warning:**
> Do not agree the total maturity analysis payments directly to the lease liability. The lease liability is a present value; the maturity analysis shows future cash payments before discounting.

The maturity analysis also differs from the current/non-current split. The current lease liability is a statement of financial position classification. The maturity analysis is a note showing contractual timing across several future periods. Both are useful, but they answer different questions.

The current/non-current split answers: “How much of the liability is due within the next reporting period?”
The maturity analysis answers: “What cash payments will be required in each future period?”

A simple exam-style explanation may be:

> The lease liability is split between current and non-current liabilities in the statement of financial position. A separate maturity analysis should disclose the undiscounted future lease payments in time bands. This allows users to assess the timing of cash outflows and the entity’s liquidity risk.

The maturity analysis should include lease payments that form part of the lease liability. These usually include fixed payments, in-substance fixed payments, amounts expected to be payable under residual value guarantees, exercise prices of purchase options if reasonably certain to be exercised, and termination penalties if the lease term assumes termination.

Variable lease payments that are not included in the lease liability, such as payments based on future sales or usage, are not included in the lease liability maturity analysis. They are disclosed separately where relevant because they can still create future cash outflows.

> **Key Term: Variable lease payments**
> Lease payments that vary because of changes in facts or circumstances, such as sales, usage, an index or a rate.

Variable lease payments linked to an index or rate are included in the lease liability using the index or rate at the measurement date. For example, if lease payments increase with inflation, the initial lease liability is measured using the inflation index at commencement. Future changes may lead to remeasurement when the lease payments change.

### Significant judgements and estimates in lease disclosures

IFRS 16 disclosures are not limited to numbers. Entities must also explain significant judgements made in applying lease accounting. This is especially relevant where management decisions affect whether an asset and liability are recognised, and how large those amounts are.

> **Key Term: Significant judgement**
> A judgement made by management in applying accounting policies that has a significant effect on amounts recognised in the financial statements.

A common judgement is whether a contract contains a lease. A contract is, or 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. This means the customer must have both:

- the right to obtain substantially all the economic benefits from use of the identified asset; and
- the right to direct the use of that asset.

For example, if a company rents a specific machine for three years and decides how and when it is used, the contract is likely to contain a lease. If instead the supplier can substitute the machine freely and controls how the service is performed, the arrangement may be a service contract rather than a lease.

Another major judgement is the lease term.

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

Extension and termination options can have a large effect on lease liabilities. Suppose a retailer leases a store for five years with an option to extend for a further five years. If management is reasonably certain to extend, the lease term is ten years. If not, the lease term is five years. The difference could materially change the right-of-use asset, lease liability, depreciation and finance cost.

When assessing whether an option is reasonably certain to be exercised, management considers economic incentives such as:

- the importance of the location to the business;
- leasehold improvements made to the property;
- costs of relocation;
- availability of alternative premises;
- penalties for termination;
- market rental rates compared with the contract rate.

The discount rate can also require judgement or estimation. Lease payments are discounted using the interest rate implicit in the lease if that rate can be readily determined. If not, the lessee uses its incremental borrowing rate.

> **Key Term: Incremental borrowing rate**
> The rate of interest a lessee would have to pay to borrow over a similar term, with similar security, the funds needed to obtain an asset of similar value in a similar economic environment.

In many practical cases, the interest rate implicit in the lease is not readily available to the lessee. The incremental borrowing rate then becomes important. A higher discount rate reduces the initial lease liability and right-of-use asset; a lower discount rate increases them.

> **Test Tip:**
> If an FR question asks for “judgements” rather than “calculations”, focus on decisions such as lease term, extension options, identifying a lease, separating lease and service components, and determining the discount rate. Do not only repeat the recognition entries.

Other useful disclosure areas include:

- restrictions or covenants imposed by leases;
- sale and leaseback transactions;
- residual value guarantees;
- leases not yet commenced to which the lessee is committed;
- exposure to variable lease payments;
- short-term lease commitments if the current expense is not representative of future commitments.

Disclosures should help users understand the amount, timing and uncertainty of cash flows arising from leases. This phrase is useful in written answers because it links specific disclosure points to the overall purpose of IFRS 16 disclosure.

### Lessors, exemptions and exam pitfalls

Although ACCA FR often focuses on lessees, lessor presentation and disclosure can also be tested at a basic level. Lessor accounting under IFRS 16 retains the distinction between finance leases and operating leases.

For a finance lease, the lessor recognises a receivable equal to the net investment in the lease. Finance income is recognised over the lease term. Disclosure includes information about selling profit or loss, finance income, variable lease income not included in the net investment, and a maturity analysis of lease payments receivable.

For an operating lease, the lessor keeps the underlying asset in its statement of financial position and recognises lease income, usually on a straight-line basis. The lessor discloses lease income and a maturity analysis of undiscounted lease payments to be received, often showing amounts due annually for at least each of the first five years and a total for later years.

> **Key Term: Finance lease**
> A lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset.
>
> **Key Term: Operating lease**
> A lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

Short-term lease and low-value asset exemptions are also frequent sources of errors. If the exemption is applied by a lessee, no right-of-use asset or lease liability is recognised. The lease payments are recognised as an expense. However, the entity still discloses the expense for short-term leases and low-value asset leases where required.

A common exam pitfall is to mix up lessee and lessor accounting. For lessees, most leases create right-of-use assets and lease liabilities. For lessors, classification as finance lease or operating lease remains relevant.

Another pitfall is to ignore the effect of lease presentation on interpretation. Recognising leases increases assets and liabilities. This may increase gearing and reduce asset turnover. Profit patterns may also change because finance cost is higher in earlier years when the lease liability is larger. In a statement of cash flows, operating cash outflows may reduce if principal lease repayments are shown as financing cash flows.

> **Exam Warning:**
> Be careful when interpreting ratios. A company adopting IFRS 16-style lessee accounting may appear more highly geared because lease liabilities are recognised. This does not automatically mean the business has taken out new bank debt.

For written FR answers, use clear links between the accounting treatment and the disclosure reason. For example:

- “The maturity analysis should be disclosed because users need to assess the timing of future lease cash outflows.”
- “The judgement about the extension option should be disclosed because it affects the lease term and therefore the size of the lease liability.”
- “Variable lease payments not included in the liability should be disclosed separately because they expose the entity to future cash outflows not shown in the recognised liability.”

This style earns marks because it does more than list disclosures: it explains why the disclosure matters.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- A lessee usually recognises a right-of-use asset and a lease liability for a lease under IFRS 16.
- Right-of-use assets may be shown separately or included in the same line item as similar owned assets.
- Lease liabilities are presented separately or disclosed in the notes and are split between current and non-current liabilities.
- Profit or loss normally includes depreciation of the right-of-use asset and finance cost on the lease liability.
- Principal repayments of lease liabilities are normally financing cash flows.
- A maturity analysis shows future contractual lease payments by time period.
- The maturity analysis uses undiscounted cash flows, while the lease liability is measured at present value.
- Significant lease judgements include identifying whether a contract contains a lease and determining the lease term.
- Extension and termination options affect the lease term if management is reasonably certain about exercising or not exercising them.
- The incremental borrowing rate is used when the interest rate implicit in the lease cannot be readily determined.
- Variable lease payments may require separate disclosure, especially when not included in the lease liability.
- Lessor accounting still distinguishes between finance leases and operating leases.

## Key Terms and Concepts

- Right-of-use asset
- Lease liability
- Short-term lease
- Maturity analysis
- Variable lease payments
- Significant judgement
- Lease term
- Incremental borrowing rate
- Finance lease
- Operating lease


Presentation and disclosures - Maturity analysis and significant judgements