Leasing operations play a key role in the financial statements of many companies, especially in industries where the long-term use of assets without purchase is part of the business model. The introduction of IFRS 16 Leases has fundamentally changed the approach to accounting for such transactions, requiring lessees to recognize substantially all lease liabilities and related assets on their balance sheets. This step was intended to increase transparency in financial statements, eliminate the need for analyst adjustments and ensure better comparability between companies.

Now, a few years after the standard came into force, the IASB is conducting a post-implementation review to assess how well the key provisions of the standard are working. In particular, it is focusing on three important aspects:

• Are the criteria for whichthe transaction is classified as a leaseand are there any opportunities to avoid recognizing lease assets?
• Does the mechanism for determining thelease termIn particular, in contracts with the possibility of extension or early termination?
• Does it correspond totenant accounting model expectations of companies and whether it creates an excessive administrative burden?

Lease definition: are all leases really recognized in the balance sheet?

One of the central issues is the correct definition of a lease in a contract. The standard states that an arrangement is classified as a lease if it conveys the right to control the use of an asset for a specified period of time in exchange for consideration. This means that the lessee must receive all the economic benefits from the asset and be able to determine how it will be used.

However, in the process of applying the standard, it was found that in some cases companiesstructure transactions to avoid lease recognition. Instead of leases, they formalize the agreements as services, which allows them to keep the corresponding assets and liabilities off the balance sheet. This is particularly relevant in the case of long-term power supply contracts, where it is difficult to determine whether the consumer is gaining control of a particular power plant or merely using its output.

Another problem isAmbiguity in the definition of an identifiable asset. For example, when only a part of the space is leased (such as an advertising space on a vehicle), the question arises whether this transaction meets the criteria for a lease.

There are also difficulties in cases wherethe contract provides for the possibility of replacing the asset by the lessor. For example, if the supplier of equipment reserves the right to replace it at any time, you need to assess whether the asset is sufficiently 'identified' to classify the arrangement as a lease.

The IASB does not yet see any reason to fundamentally revise the definition of a lease, as most of the problems are related to the application of the standard in certain complex situations rather than to its conceptual deficiencies. However, the Board recognizes that it may be necessary toadditional clarification to avoid misunderstandings in complex cases.

Lease term: assessing the likelihood of extending or terminating the contract

Determining the lease term is also difficult, especially when the contract provides for an extension option or an early termination option. According to the standard, when assessing the lease term, an entity shouldtake into account all factors that affect its intention to exercise the optionand recognize only those periods in which itreasonably confident in exercising their rights.

However, in practice, the question arises as to how to interpret this "reasonable certainty". For example, a company may not be legally restricted from terminating a lease, but if it has consistently renewed leases for similar facilities in the past, should it be assumed that it is likely to do so again?

Another problem isrisk of manipulation of the lease term. Some companies may intentionally enter into short-term agreements with automatic renewal to avoid formally recognizing long-term liabilities.

Different approaches to estimating the lease term createrisk of incomparability of financial statementsas two companies with identical assets may have significantly different results simply because of different assumptions about future contract renewals. This issue has already attracted attention from analysts, and the IASB plans to collect more data on whether changes to the lease term measurement requirements are needed.

Lessee accounting model: balance between benefits and costs

IFRS 16 has radically changed lease accounting by requiring companies to recognize all lease assets and liabilities on the balance sheet, regardless of their classification. Most analysts believe this approach is correct, as it increases transparency and eliminates the need for complex adjustments.

However, there are complaints among the companies themselves aboutexcessive administrative burdenrelated to lease accounting. Particularly problematic is the definition ofdiscount ratesThe high variability of approaches to this issue also affects comparability. The high variability of approaches to this issue again affects the comparability of the financial statements.

Another point of discussion isAccounting for variable lease paymentsthat are dependent on the revenue or use of the asset. Currently, they are not included in the measurement of the liability, which may create a difference compared to fixed payments.

Summary and next steps

The post-implementation review of IFRS 16 demonstrates that the standard is generally working as intended, but there are areas that need to be improved. In particular, the IASB will continue to analyze:

• Is there a need for clarification on the definition of lease in complex cases?
• Is there a need to clarify the requirements for assessing the lease term to reduce the risk of manipulation?
• Is it possible to simplify the approach to determining discount rates and accounting for variable payments?

Decisions on possible changes will be made after receiving additional comments from market participants.

Relevant webinars on the topic of the publication:

Leases in IFRS: a practical perspective for lessees and lessors >>>https://amsfo.com.ua/course/orenda_v_msfz/

© Olena Kharlamova