As we’ve seen over the last few months, IFRS 16 has brought about a lot of changes to the existing treatment of leases, especially for lessees. Probably everyone, even if not significantly affected by this accounting standard, remembers at least the most important change: in many cases the lessees will now have to recognize their operating lease on balance sheet which means to record a right-of-use (ROU) asset and a lease liability. ”What’s so difficult about that?” you may ask. But this new accounting treatment has several not-so-obvious impacts that reveal themselves along the way… impairment of the ROU assets following IAS 36 is one of them.
Does it mean I have to test for an impairment?
The ultimate question that comes to mind when we say IFRS 16 and impairment is probably this one: is the newly recognized asset, represented by the ROU asset, tested for impairment? The response is, “YES!” (however, with some exemptions). The impairment of ROU assets recognized by a lessee is fairly similar to the accounting for impairment of a leased asset by a lessor in case of operating leases under IAS 17. In general, since the ROU asset is a non-financial asset, the IAS 36 requirements apply.
There are only two exemptions from the IAS 36 impairment model. Firstly, when a lessee applies a fair value model under IAS 40 for its investment properties, it shall also apply fair value model to the ROU asset. And secondly, if ROU assets relate to a class of PPE to which the lessee applies the revaluation model under IAS 16, then the lessee can elect to apply the revaluation model to all of the ROU assets that relate to that class of PPE.
How does it work in practice?
General IAS 36 provisions apply to the lease asset and lease liabilities in the same way as for all other assets under the IAS 36 scope. The ROU asset is tested for impairment on a single standalone basis unless it generates cash inflows only in combination with other assets, together forming a cash-generating unit (CGU). Such an ROU asset will be tested for an impairment as a part of this larger CGU and included in its carrying amount.
But what about the lease liabilities: should these be included in the CGU carrying amount and recoverable amount as well? The response is—it depends. The IAS 36.78 provision requires us to consider whether, upon a sale of the CGU, the buyer will also be required to assume the liability, which in our view also encompasses the lessee’s lease liability. In such a case the liability, and potentially the lease liability, needs to be included in the recoverable amount of the CGU and by analogy in the carrying amount of CGU as well. The conclusion of whether the buyer is required to assume the lease liability will depend on facts such as a whether the CGU is a legal entity, the lease contract terms, etc.
That’s enough to digest for now. Watch this space for more not-so-obvious points regarding impairment of leases and the accounting treatment of an impairment for a lessor.
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