By Anntice Lai
Hong Kong Financial Reporting Standard (“HKFRS”) 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases. HKFRS 16 supersedes Hong Kong Accounting Standard (“HKAS”) 17 and related interpretations.
Key changes:
- A new definition on lease is introduced. A lease contract previously does not fall within the definition of lease under HKAS 17, the similar subsequent contract may be identified as a lease under HKFRS 16.
- A new single accounting model is introduced for lessee accounting to recognise assets (i.e. Right-of-use asset) and liabilities (i.e. Lease liability) arising from the commitments in the lease arrangements, unless the relevant lease term is short and the value of the underlying asset is low.
- No substantial changes on lessor accounting as compared to the superseded standard and interpretations.
- HKFRS 16 becomes effective for annual periods beginning on or after 1 January 2019. Early application option is available with conditions. An accounting choice on retrospective adjustments is available: full retrospective and limited retrospective.
Lessee’s accounting:
- It is no longer a distinction between finance lease and operating lease so far as lessee are concerned.
- Asset side: a lessee recognises all leases as an asset by recognising a right-of-use (“ROU”) asset. This asset represents the lessee’s right to use the underlying asset in the lease term.
- Liability side: a lessee recognises a lease liability for its obligation to make lease payments.
- Expense side: The rental expense previously reported is to be replaced by depreciation of ROU and interest expense on lease liability.
- Lessee can elect not to apply the requirements, if and only if, the lease term is short and the underlying value is low. As such, the lease payment on the lease will be recognised as an expense on either a straight-line basis over the lease term or another systematic basis.
Frequently asked questions:
Q1: HKFRS 16 not only covers lease contract, but all contracts. Is that true?
Yes, HKFRS 16 covers a contract, which is or contains a lease. A contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The following 5 questions are used to determine whether the reporting entity can obtain the right to control the use of an asset in a contract:
For any contract entered by the reporting entity:
- Is there an identified asset?
- Does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use?
- Does the customer have the right to direct how and for what purpose the asset is used throughout the period of use?
- Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions?
- Did the customer design the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use?
If the above questions are yes, then the contract is, or contains, a lease.
Q2: What is a ROU asset? What is a lease liability?
Q3: What is the interest rate implicit in the lease?
The interest rate implicit in the lease is the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal to the sum of (i) the fair value of the underlying asset and (ii) initial direct costs of the lessor. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.
Q4: How to apply the recognition exemptions?
A lessee may elect not to apply the requirements related to ROU asset and lease liability to:
- Short-term leases; and
- Leases for which the underlying asset is of low value.
Short term leases are normally referred to a lease with the lease term less than 12 months.
Q5: How to prepare for the first-time application of HKFRS 16?
Q6: Does the reporting entity need to reassess all the contracts entered before the effective date of HKFRS 16?
Leases previously classified as operating leases: the lessee shall measure the lease liability at the present value of the remaining lease payments, discounted using the lessee’s incremental borrowing rate at the date of initial application.
Lease previously classified as finance leases: the lessee shall classify the carrying amount of the ROU asset and the lease liability at the date of initial application, which shall be the carrying amount of the lease asset and lease liability immediately before that date measured under HKAS 17.