FRS 116: LEASES

Ng Eng Juan Professor and Head of Accountancy Program

Singapore University of Social Sciences

Agenda: Introduction Impact of FRS 116 Definition of a lease Some salient points Conclusion

“ISCA Implementation Roadmap Guidance for FRS 116 Leases”

ED (2010) issued in 2010 ED (2013) issued in 2013 IFRS 16 issued in January 2016 FRS 116 issued on 30 June 2016 To supersede FRS 17, INT FRS 15, INT FRS 27, INT

FRS 104 Effective date: 1 January 2019

Basic changes: To require lessee to capitalize all leases (except

(i) short term leases and (ii) leases with low value underlying asset) • FRS 17: “purchase” model • FRS 116: “right of use” model

No major changes for lessor

Agenda: Introduction

Impact of FRS 116 Definition of a lease Some salient points Conclusion

IASB’s study: Listed companies using either IFRS or US GAAP US$ 3.3 trillion of lease commitments Only 15% is recognized in balance sheets If all lease commitments are on-balance-sheet,

total assets may increase >20% for some industries (eg airlines and retail)

B/S: Right-of-use asset, and Lease liability

Increase in debt-asset ratio Debt covenant may be affected

P/L: Depreciation expense, and Interest expense

Front loading of expenses initially Profit may be reduced in earlier years

CF: Principal payment: financing Interest payment: operating/financing

Increase in operating cash flows

Agenda: Introduction Impact of FRS 116

Definition of a lease Some salient points Conclusion

Definition of lease: A contract that conveys the right to use an

asset for a period of time in exchange for consideration

Two important elements • There is an identified asset; and • Customer controls the use of the asset

There is an identified asset when: the asset is specified in the contract, and the supplier does not have a substantive

right (practical ability and economic benefits) to substitute the asset throughout the period of use

Customer controls the use of the asset when the customer has the right to: obtain substantially all the economic

benefits from the use of the asset throughout the period of use, and

direct the use of the asset throughout the period

Is there is an identified asset for a capacity portion of an asset?

Yes, if it is physically distinct • a floor of a building? • a capacity portion of fibre optic cable?

Who has the onus to show whether the supplier has a substantive substitution right? The onus is for the customer to produce

evidence of the existence of supplier’s SSR If the customer cannot readily determine

whether supplier has SSR, it is presumed that the supplier does not have SSR

Does customer have the right to obtain substantially all the economic benefits from the use of the asset, if customer has to pay, say, 30% of revenue from use of asset to supplier?

Yes (benefits is the “gross” amount)

Does customer has the right to direct the use of the asset in cases where the how and for what purpose the asset is used is “predetermined”?

Yes, if the customer has right to operate the asset in a manner it determines (and supplier has no right to change), or if the customer designed the asset

Agenda: Introduction Impact of FRS 116 Definition of a lease

Some salient points Conclusion

Upon inception of lease, lessee should recognise (i) right-of-use asset and (ii) lease liability

= pv of lease payments discounted using the implicit rate (if known), or lessee’s incremental borrowing rate

1. Variable lease payments:

Depend on index: • Use the index at commencement date • Subsequent changes accounted for

prospectively • (flat yield curve concept)

1. Variable lease payments (cont): Linked to future performance or use of asset

• Not accounted for at commencement date (do not meet definition of liability)

• Any additional payment charged to P/L when incurred

2. Options to renew, purchase, terminate: Subject to “reasonably certain” criterion at

commencement date (consider all facts and circumstances that creates an economic incentive)

3. Residual value guarantee: Only the amount expected to be payable by

lessee is accounted for

4. For (i) short term leases and (ii) leases with low value underlying asset: Lessee may elect to recognise lease

payments as expense (ie accounted for as operating lease)

4.1 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)

4.2 Leases with low value underlying asset

Small items of office furniture or equipment (IFRS BC: assets with a value, when new, of

approximately US$5,000 or less; not a bright line; an absolute figure, and not in terms of materiality)

Not highly dependent on or highly interrelated to other underlying assets

Lessor : As per FRS 17 (ie operating leases and

finance leases) • same tests • same accounting treatment • enhanced disclosures

Additionally: Lease modifications Sub-lease Sales-type lease Sale and leaseback

Additionally: Presentation issues Disclosure issues Transitional issues

Agenda: Introduction Impact of FRS 116 Definition of a lease Some salient points

Conclusion

Conclusion: Early preparation is crucial • Communication with stakeholders, eg bank covenants, etc • Lease-buy decision • Terms of lease agreements • Practical expediencies, judgement • Accounting and IT system…

For any enquiries, please contact ISCA’s Corporate Reporting & Ethics (CoRE) Division @ core@isca.org.sg.

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