## Learning Outcomes

- Present right-of-use assets and lease liabilities correctly in the statement of financial position.
- Explain how lease depreciation, interest and exempt lease expenses appear in profit or loss.
- Identify the correct cash flow classification for lease payments.
- List the main IFRS 16 disclosure requirements for lessees.
- Distinguish the statement presentation of lessee leases from lessor finance and operating leases.
- Avoid common ACCA FR errors in lease liability classification and note disclosures.

## ACCA Financial Reporting (FR) Syllabus

In ACCA Financial Reporting, leases are examined as part of accounting for transactions in financial statements. You may be required to account for lease balances, adjust draft financial statements, interpret the effect of leases on ratios, or identify correct presentation and disclosure treatment in objective test questions.

- Recognise that IFRS 16 requires most lessee leases to appear on the statement of financial position.
- Present right-of-use assets within non-current assets unless the lease is short term or low value and the exemption is applied.
- Split lease liabilities between current and non-current liabilities.
- Present depreciation and interest separately in profit or loss.
- Understand that lease payments affect operating profit, finance costs and cash flows differently.
- Identify note disclosures such as carrying amounts, additions, depreciation, interest and total cash outflow.
- Apply basic lessor presentation rules for finance leases and operating leases.

## 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 should a lessee present a right-of-use asset in the statement of financial position?
2. How should the lease liability be split between current and non-current liabilities?
3. What are the two main profit or loss charges recorded by a lessee for a lease accounted for under the IFRS 16 single lessee model?
4. What lease-related cash flow information must be disclosed by a lessee?
5. How does a lessor present an operating lease compared with a finance lease?

## Introduction

IFRS 16 Leases changed lessee accounting by requiring most leases to be recognised in the statement of financial position. Instead of showing only a rental expense for many leases, the lessee normally recognises an asset representing the right to use the leased item and a liability for the obligation to make lease payments.

Presentation and disclosure matter in ACCA FR because the numbers must be placed in the correct part of the financial statements. A lease calculation may be technically correct but still lose marks if the asset is put in the wrong category, the liability is not split between current and non-current portions, or the interest charge is treated as an operating expense.

> **Key Term: Lease**
> A contract, or part of a contract, that gives the customer the right to control the use of an identified asset for a period of time in exchange for consideration.

Under IFRS 16, the reporting objective is to provide users with information about how leases affect the entity’s financial position, financial performance and cash flows. This article focuses on where lease items appear in the primary statements and what supporting notes are commonly required.

### Statement of financial position presentation for lessees

For a lessee, IFRS 16 uses a single accounting model for most leases. At the commencement date, the lessee recognises:

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

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

The right-of-use asset is presented as a non-current asset unless the lease is very short in nature and has not been recognised because an exemption has been used. In published financial statements, IFRS 16 allows a lessee to present right-of-use assets either:

- separately from other assets; or
- within the same line item as the underlying asset would have been presented if owned.

For ACCA FR purposes, you will often see a separate line such as “Right-of-use asset” within non-current assets. For example, a statement of financial position extract might include:

- Property, plant and equipment: $799,000
- Right-of-use asset: $126,000
- Development expenditure: $290,000

This presentation makes the lease asset visible and helps users understand that not all non-current assets are legally owned by the entity.

> **Key Term: Lease liability**
> The obligation recognised by a lessee for the present value of lease payments that remain payable under the lease.

The lease liability is presented as a financial liability. In the statement of financial position, it is normally split between:

- current liabilities: the amount expected to be settled within 12 months; and
- non-current liabilities: the amount due after more than 12 months.

For example, a company may present lease liabilities of $100,000 under non-current liabilities and $17,000 under current liabilities. This split is a common exam point because it affects working capital, gearing and liquidity ratios.

> **Key Term: Current liability**
> A liability expected to be settled in the entity’s normal operating cycle, held for trading, due within 12 months, or where the entity has no unconditional right to defer settlement for at least 12 months.

The current portion of the lease liability is not usually the same as the next year’s total cash payment. Lease payments contain both principal and interest. The current liability is the part of the carrying amount of the lease liability that will be settled within the next 12 months, measured using the amortised cost schedule.

> **Test Tip:**
> In an ACCA FR statement of financial position question, show the lease liability in two places if the question gives enough information: non-current liabilities and current liabilities. Do not present the whole lease liability as a single non-current balance unless all payments are due after more than 12 months.

The right-of-use asset is subsequently depreciated, usually over the shorter of the lease term and the useful life of the underlying asset. The lease liability is increased by finance cost and reduced by lease payments. Therefore, the asset and liability balances will usually not be equal after initial recognition.

Some leases are not recognised on the statement of financial position because IFRS 16 permits exemptions. These are short-term leases and leases of low-value assets.

> **Key Term: Short-term lease**
> 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: Low-value asset lease**
> A lease of an asset that is low value when new, such as small office equipment or tablets, where the IFRS 16 recognition exemption is applied.

If the lessee applies an exemption, no right-of-use asset or lease liability is recognised. Instead, lease payments are normally charged to profit or loss on a straight-line basis over the lease term, unless another systematic basis better reflects the pattern of benefit.

### Profit or loss and cash flow presentation for lessees

For a recognised lease, the lessee does not usually record a single rental expense. Instead, the statement of profit or loss includes two main charges:

- depreciation of the right-of-use asset; and
- interest expense on the lease liability.

Depreciation is an operating expense. It may be included in cost of sales, distribution costs or administrative expenses, depending on how the leased asset is used. For example, depreciation on a leased factory machine may be included in cost of sales, while depreciation on a leased head office building may be included in administrative expenses.

> **Key Term: Finance cost**
> Interest expense recognised over time on a financial liability, including the interest charged on a lease liability.

Interest on the lease liability is presented as a finance cost. This matters because IFRS 16 changes the pattern and classification of expenses compared with simple rental accounting. Operating profit may increase because the old rental expense is replaced by depreciation and interest, with the interest shown below operating profit.

A simple example shows the presentation effect.

A company leases equipment and recognises a right-of-use asset. During the year, it records depreciation of $18,000 and interest on the lease liability of $5,000. It pays cash lease instalments of $20,000.

In profit or loss, the company records:

- depreciation expense of $18,000 within operating expenses; and
- finance cost of $5,000.

It does not record the $20,000 cash payment as a rental expense for that recognised lease. The cash payment reduces the lease liability after interest has been added.

> **Exam Warning:**
> Do not deduct the full cash lease payment as an expense in profit or loss when the lease is accounted for using the IFRS 16 lessee model. The profit or loss charges are depreciation and finance cost.

For cash flow statements, lease accounting also affects classification. The cash payment for a recognised lease is split in substance between:

- repayment of principal; and
- payment of interest.

The principal element of lease payments is classified as a financing cash flow because it repays a financing liability. The interest element is classified according to the entity’s accounting policy under IAS 7. In ACCA FR, interest paid is commonly treated as an operating or financing cash flow depending on the question’s required format and stated policy.

Payments for short-term leases, low-value asset leases and variable lease payments not included in the lease liability are usually operating cash flows because they are expensed in profit or loss as incurred.

> **Key Term: Variable lease payment**
> A lease payment that varies because of changes in facts or circumstances after the commencement date, other than the passage of time.

Variable lease payments can be examined as a presentation issue. If variable payments are based on usage or sales and are not included in the lease liability, they are expensed when the event or condition that triggers payment occurs. For example, a retailer may lease a shop and pay extra rent equal to a percentage of store sales. The sales-based variable element is charged to profit or loss when the related sales occur.

The cash flow statement and the notes must help users see the total cash effect of leasing. A lessee must disclose the total cash outflow for leases. This figure may include payments for recognised lease liabilities as well as payments for leases accounted for using exemptions.

### Disclosure notes for lessees

The primary statements show the main lease balances and expenses, but IFRS 16 also requires notes. The purpose of the notes is to help users assess the amount, timing and uncertainty of cash flows arising from leases.

At FR level, you should be able to identify the main lessee disclosures and understand what each one tells users. A lessee commonly discloses:

- depreciation charge for right-of-use assets by class of underlying asset;
- interest expense on lease liabilities;
- expense relating to short-term leases;
- expense relating to leases of low-value assets;
- expense relating to variable lease payments not included in lease liabilities;
- income from subleasing right-of-use assets;
- total cash outflow for leases;
- additions to right-of-use assets;
- carrying amount of right-of-use assets at the reporting date by class of underlying asset; and
- maturity analysis of lease liabilities.

> **Key Term: Maturity analysis**
> A note showing the timing of future contractual cash flows for liabilities, helping users assess liquidity risk.

The maturity analysis of lease liabilities is linked to financial instruments disclosure requirements. It shows when future lease payments are due, which helps users assess whether the entity may face pressure in meeting its obligations.

A typical lease note for a lessee may include wording such as:

“The group leases buildings, vehicles and equipment. Lease terms are negotiated on an individual basis and contain a range of terms and conditions. Right-of-use assets are presented separately in the statement of financial position. Lease liabilities are presented within current and non-current liabilities.”

For numerical disclosures, a note may state:

- carrying amount of right-of-use assets at year end: $126,000;
- additions to right-of-use assets during the year: $64,000;
- depreciation charge for the year: $18,000;
- interest expense on lease liabilities: $5,000;
- total cash outflow for leases: $20,000.

In ACCA FR, you are unlikely to be asked to write a full published financial statements note from scratch. However, you may need to identify missing disclosures, choose correct statements in an objective test question, or explain why a lease affects ratios.

The notes may also include qualitative information. Examples include:

- extension options and termination options;
- restrictions or covenants imposed by leases;
- sale and leaseback transactions;
- residual value guarantees; and
- variable payment features.

> **Key Term: Residual value guarantee**
> A guarantee given to a lessor that the value of the underlying asset at the end of the lease will be at least a specified amount.

Qualitative disclosures are useful where the numbers alone do not explain the entity’s exposure. For example, an entity may have relatively low recognised lease liabilities but significant future exposure because it regularly renews leases using extension options. If those extensions are not reasonably certain at the reporting date, they may not be included in the lease liability, but users still need relevant information about the entity’s leasing activities.

> **Test Tip:**
> When answering a disclosure question, group your points by statement of financial position, profit or loss, cash flows and notes. This keeps the answer focused and reduces the risk of repeating the same point in different words.

A common disclosure mistake is to say that IFRS 16 removes all lease expenses. It does not. It changes how most lessee leases are recognised. Expenses still arise through depreciation, finance costs, short-term lease expense, low-value lease expense and some variable lease payments.

### Lessor presentation and disclosure points

Although IFRS 16 changed lessee accounting significantly, lessor accounting retained the distinction between finance leases and operating leases.

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

For a finance lease, the lessor derecognises the underlying asset and recognises a receivable known as the net investment in the lease. Finance income is recognised over the lease term in a way that gives a constant periodic rate of return on the net investment.

> **Key Term: Net investment in the lease**
> The lessor’s gross investment in a finance lease discounted at the interest rate implicit in the lease.

In the statement of financial position, the finance lease receivable is presented as a financial asset. It is split between current and non-current portions if material and if the statement format requires such a split. In profit or loss, the lessor presents finance income.

For an operating lease, the lessor continues to recognise the underlying asset. For example, if a company leases out a building under an operating lease, it continues to present the building as property, plant and equipment or investment property, depending on the facts. The lessor recognises lease income, usually on a straight-line basis over the lease term.

Lessor disclosures are aimed at helping users understand the lessor’s exposure to risks linked to rights retained in leased assets. At FR level, the main points are:

- finance lease receivables are presented instead of the underlying asset;
- operating lease assets remain in the lessor’s statement of financial position;
- finance income is recognised for finance leases;
- lease income is recognised for operating leases;
- maturity information is disclosed for lease payments receivable.

> **Exam Warning:**
> Do not apply lessee presentation rules to the lessor. A lessee recognises a right-of-use asset and lease liability. A lessor classifies the lease as finance or operating and presents either a receivable or the underlying asset.

The distinction also affects ratio interpretation. For a lessee, IFRS 16 usually increases reported assets and liabilities. This may increase gearing and reduce asset turnover. Operating profit may improve because part of the lease cost is shown as finance cost. For a lessor, the statement effects depend on whether the lease is finance or operating.

In ACCA FR interpretation questions, leases can explain changes in performance and position. For example, if a company has acquired new right-of-use assets during the year, non-current assets and liabilities may rise without an equivalent cash purchase of property, plant and equipment. The cash flow statement and lease note should be reviewed before concluding that the company has bought assets outright.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- IFRS 16 requires most lessee leases to be recognised as a right-of-use asset and lease liability.
- Right-of-use assets are presented as non-current assets, either separately or within the relevant underlying asset class.
- Lease liabilities are financial liabilities and should be split between current and non-current portions.
- The current lease liability is not necessarily the same as the next cash instalment.
- Lessees recognise depreciation on the right-of-use asset and finance cost on the lease liability.
- Short-term leases and low-value asset leases may be expensed rather than recognised on the statement of financial position.
- Principal repayments of lease liabilities are financing cash flows.
- Lessees disclose items such as depreciation, interest, additions, carrying amounts and total lease cash outflow.
- Lease liability maturity analysis helps users assess liquidity risk.
- Lessors classify leases as finance leases or operating leases.
- Finance lease lessors recognise a lease receivable; operating lease lessors keep the underlying asset.
- Lease presentation affects ratio interpretation, especially gearing, liquidity, operating profit and asset turnover.

## Key Terms and Concepts

- Lease
- Right-of-use asset
- Lease liability
- Current liability
- Short-term lease
- Low-value asset lease
- Finance cost
- Variable lease payment
- Maturity analysis
- Residual value guarantee
- Finance lease
- Operating lease
- Net investment in the lease


Presentation and disclosures - Statement presentation and notes