In our article, identifying leases under IFRS 16, we discussed what constituents a contract to be classified as a lease. However, the question is; after you have identified your leases, what happens next?
While growing up, our family stayed in a house that belonged to the Masaka District administration. My father; a public servant was entitled to free housing; despite footing a monthly rent bill out of ignorance! For the 10 years in the house, weused the backyard for farming, planted as many flowers in the compound. We renovated the house after a period of three years. We made any modifications to the house whenever it was deemed necessary. We enjoyed all the economic benefits attached to the house. We had the right to use and chose how to use the premises.
Likewise, premises occupied by financial institutions and organizations are like my father’s childhood house. For the time you enter into a contract, you have the right to control and direct the use of these premises resulting in a Right of Use Asset (ROU). ROU is what is measured under IFRS 16, it is depreciated over the lease term on a straight-line basis when it is being occupied by the lessee. The Right of Use Asset is included in the Statement of Financial Position and the depreciation expense on it is recognized as an expense in the Statement of Profit or Loss.
To estimate the value of the Right of Use Asset at the commencement of the lease, we would have to get;
- Add the Expenditure that was incurred directly on acquiring the premises.
- Add the prepayments that were made in advance in acquiring the premises.
- Add any costs to be incurred in restoring the premises to how we found it.
- Less any incentives received from the lessor at the time of occupying the premises.
Lease liability = Ugx 8,000,000
Expenditure incurred directly on the premises during acquisition = Ugx 0
Prepayments at acquisition = Ugx 500,000
Restoration costs = Ugx 700,000
Incentives from the lessor at acquisition = Ugx 0
To calculate the Right of Use Asset at acquisition we would have to add;
Ugx (8,000,000 + 0 + 500,000 + 700,000 +0) = Ugx 9,200,000.