A lease under IFRS 16 is a contract that grants the right to use an asset for a specified period in exchange for consideration. It must provide:

  • Control over the asset's economic benefits.
  • The right to dictate the asset's use.

Under IFRS 16, lessees no longer differentiate between operating and finance leases. Instead, all leases are treated as finance leases. This means:

  • Capitalization: Leases are recorded on the balance sheet as a Right of Use (ROU) asset and a corresponding lease liability.
  • Expense Recognition: The income statement recognizes both the depreciation of the ROU asset and the interest on the lease liability.

Step 1: Recognize the Lease Liability and Right-of-Use Asset

At the start of a lease, record the lease liability and right-of-use (ROU) asset as follows.

Create General Ledger (GL) accounts named as Right of Use (ROU) assets under Non-current assets 

 Create an Inventory Item-Set up an inventory item and select the "Right to Use" GL account from the Edit GL Accounts option.

Create an invoice received document. In the main tab, enter the required details and select the Current Finance Lease Liabilities GL under the Accounts Payable column.

 

In the inventory tab, add the item and complete the necessary details.

Once filled. post the document.

The below entry will be created. Dr Right to use

                                                    Cr Current finance lease liabilities.

Step 2: Recognize the Unwinding of the Lease Liability and Amortization of the Right-of-Use Asset

For each reporting period, you need to record the following:

1. Payments Made

Recognize any lease payments made during the period, which will reduce the lease liability. Create a cash/Bank payment document with transaction type Others.

In the Bank payment tab, choose Current finance lease liability GL, and choose the company and contract. Review the document and post the transaction.

The below entry will be created 

Dr Current finance lease liabilities

Cr Bank accounts

2. Amortization of the Right-of-Use Asset

Depreciation for a lease is typically recorded under the Amortization Expense, reflecting the expense related to the right-of-use (ROU) asset. it is categorized under Operating Expenses on the income statement.

Create a new GL under operating expense GL

Create an expense entry to record the Depreciation-Go to Accounting > Other expense document

Create a new document, select the accrual option in the main tab, and choose the relevant entity.

Add the Amortization Expense GL on the debit side of the document, and on the credit side, include the Right-of-Use GL.

The entry will be Dr Amortization expense (Lease)

                           Cr Right to use          

2. Interest Accrued

Recognize the interest expense on the lease liability, which represents the borrowing cost. Create a new Other Expense document.

In the main tab, select the accrual option and choose the appropriate entity.

In the expense tab, add the Financial Expense GL on the debit side and the Current Finance Lease Liabilities on the credit side of the document.

The below entry will be created.

After all the above entries, the financial statements will reflect the following effects:

  1. Income Statement:

    • Increased Expenses: Amortization and interest expenses will reduce net income.

  2. Balance Sheet:

    • Assets: The Right-of-Use asset will decrease over time due to amortization.
    • Liabilities: The Lease Liability will decrease as payments are made and interest is recognized.

Step 3: Continue to Record Journal Entries Until Lease Expiry

Record entries for lease payments, interest, and amortization. These entries will gradually reduce both the lease liability and the right-of-use asset to zero by the lease expiry.

Thanks for being a Firstbit customer!                                      #Leases #Finance lease #right to use asset

  • No labels