IFRS 16: Identifying a lease

On the 20th of February 2019, the Central Bank of Uganda issued an instruction circular to Supervised Financial Institutions (SFIs). SFIs were required to submit a report on the implementation of the standard by 30th June 2019. Having championed IFRS 9 implementation for many financial institutions, I saw an opportunity.

For the next week, I scrolled the internet to compile a list of the SFIs with a key interest in the Head of Finance contacts. In a space of three days, my list was complete. I met my supervisor and he gave me the go-ahead to make phone calls in a request for appointments. I called about 10 CFOs, but unsuccessful. I almost gave up on the phone calls not until I made a call to Hillary (not real name).

“Good morning Sir. I am speaking to Mr. Hillary Byaruhanga,” I asked. Yes, he replied. “Do you have leases at your bank?” No, we don’t. “Do you pay rent for the office building spaces where the bank branches are operating?” Yes, we do. “Do you have rental agreements?” Yes, we do.

Inside my heart, I knew that for once I have been able to build a conversation. And this is what I all wanted. I went on: “what is the duration of the rental agreements?” About 2-3 years. “Dear Hillary, there is a new standard for such leases. And this is IFRS 16 Leases standard. The standard is effective periods beginning on or after 1 January 2019. IFRS 16 Leases brings significant changes in accounting requirements for lease accounting, primarily for lessees. And this is where your bank is affected.” “When can we meet?” Hillary asked.

So, how do you tell these rental agreements are leases?

IFRS 16, paragraph 9 gives guidance on the definition of a lease. A contract is, or contains, a lease if the contract gives the right to control the use of an identified asset (‘underlying asset’) for a period of time in exchange for consideration.

The right to control the use of an identified asset can be split into:

  1. the right to obtain substantially all of the economic benefits from the use of an identified asset and
  2. the right to direct the use of an identified asset.

The summitIFRS 16 approach to identifying a lease in a contract takes a decision tree approach. For each contract, we ask the following questions.

  1. Is there an identified asset (IFRS 16 paragraphs B13-B20)?
  2. Does the customer (bank) have all the right to obtain substantially all the economic benefits from the use of the asset throughout the period of use? (IFRS 16 paragraphs B21-23)
  3. Does the customer (bank), supplier or neither party have the right to direct how and for what purpose the asset is used throughout the period of use (IFRS 16 paragraphs B23-25)
  4. Does the customer (bank) have the right to operate the asset, throughout the period of use, without the supplier having to change those operating instructions? (Paragraph 24(b)(i) of the IFRS 16 standard)
  5. Did the customer (bank) design the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use? (Paragraph 24(b)(ii) of the IFRS 16 standard)

 Based on these questions, we can tell whether the contract or not a lease!

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