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Lease accounting: are you up to speed with the new approach?

The new lease accounting standard, IFRS 16 Leases, comes into effect for periods beginning on or after 1 January 2019. Shipping companies need to make sure they have assessed and understood its implications.

IFRS 16 has the biggest impact on lessees, for whom it removes the distinction between an operating lease and a finance lease, with all lease arrangements being brought onto the balance sheet. For all arrangements that meet the definition of a lease, other than those for a year or less, the lessee must determine and account for the lease liability and the related ‘right of use asset’.

A key first step in applying IFRS 16 is to identify all arrangements that qualify as leases. A lease is a contract, or part of a contract, where one party has the right to control the use of an identified asset for a period of time in exchange for consideration. A lease may not exist if the owner has the right to substitute an alternative asset, the ability to do so, and there is an economic benefit from the substitution.

The concept of control is key. If a lessee can determine, for example, the route a vessel takes, whose cargo is carried, what cargo is carried and what speed the vessel may sail at, there will be control. This is still the case when there are some restrictions designed to protect the owner’s interests, such as prohibitions on passing through areas known for piracy.

If a contract has multiple components, such as a time charter rather than a bareboat charter, the lessee may choose to separate the different components and account for each accordingly. This is only possible where the components are not highly dependent and the underlying asset can be used on its own, or with readily available resources. A time charter, for example would be split into an amount for the hire of the asset, and an amount for operating costs.

A right of use asset is recognised at the start of the lease contract. This is calculated as the lease liability (the present value of lease payments due) together with any payments made prior to commencement, direct costs incurred and any dismantling and restoration costs that are expected to arise at the end of the lease. There are various other accounting details to consider, such as whether the right of use asset is accounted for using a cost model or a revaluation model, and the need for re-measurement of the lease liability once a contract is under way.

IFRS 16 has less impact on lessors, for whom the distinction between finance and operating leases remains, with classification continuing to be set by whether the arrangement ‘transfers substantially all the risks and rewards incidental to ownership of the underlying asset’. The associated accounting also remains largely unchanged, although there are again some specific issues to consider.
Source: Moore Stephens

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