If you are accounting for your leases under IFRS 16, it is important to understand the journals that you will need to post in order to account for the leases appropriately.
Under IFRS 16, the main items that will appear on the balance sheet are a “right of use asset” and a lease liability. However, it is also important to understand how to calculate the related interest payments for the lease at each payment interval as well as the depreciation amounts.
An explanation for each of the double entries you’ll need to know can be found below.
Calculating the Lease Liability
If we take a very simple lease agreement with a term of 3 years, Monthly payments of £1,000 and an interest rate implicit in the lease of 5.5% per annum it will be easier to demonstrate the journal entries required.
To calculate the IFRS 16 lease liability we must first calculate the present value of minimum lease payments to be made until the end of the lease term. We can do this by using the present value formula. This formula is readily available in Excel by entering the formula “=PV”. A guide for this formula can be found here.
- Once you understand how to use this formula we can enter the numbers above. This should look like this: =PV(5.5%/12,36,£1,000)
- Using this formula gives us the amount of minimum lease payments discounted to present value which is: £33,365.70 which we will round up for the purpose of this demonstration.
We have now calculated our IFRS 16 lease liability as £33,366
The journal entry required for this will be discussed below as we need to understand one more thing before we put this item on our balance sheet.
Calculating the IFRS 16 Right of Use Asset
In order to calculate the opening IFRS 16 Right of Use asset (ROU) the only step required is to calculate the lease liability which we have already done, above.
The opening ROU asset should match the opening lease liability on the balance sheet and the double entry for this is much like accounting for any other item of PPE. (If you need more help on this, I have written a guide here).
The double entry journal should be as follows:
- Debit Right of Use asset £33,366
- Credit Lease Liability £33,366
Calculating the Interest Payments
The steps up until now have been relatively simple, however calculating the interest payments is where IFRS 16 accounting becomes slightly more complex but please do not be deterred.
We know that the interest rate is 5.5% and that we make monthly payments towards the total liability. As the payments are monthly we are going to divide the interest rate by 12 before continuing with our calculation – this allows us to work out the interest on a monthly basis. Please note that all of the calculations performed in this example can be easily adapted if they are quarterly or annual for example. Just perform these calculations on those terms rather than 12 times in the year as we have done here.
For each period the interest is calculated on the lease liability at the end of the last period. For the first month the liability is £33,366 – we will multiply this by the monthly interest rate to get the interest charge for this month.
- £33,366 * 5.5%/12 = £152.93
The interest amount for the first month is therefore, £152.93. For the interest double entry to work, we also have to factor in the actual amount of the cash payment made:
- Firstly, take the amount of the monthly payment which as we know, is £1,000
- Then reduce this amount by the interest we just calculated for the month. £1,000 – £152.93 = £847.07 – This monthly payment less interest is what will reduce the lease liability by on the balance sheet.
The journal entry for the above IFRS 16 calculations contains three elements:
- Debit Lease Liability £847.07
- Debit Interest Expense £152.93
- Credit Cash £1,000
These journals take into consideration the cash actually paid to the lessor to reduce the lease liability and consider the amount of interest expense that needs to be put through the profit and loss account.
The final step for our IFRS 16 journals is to calculate the depreciation on the Right of Use asset
Calculating Depreciation on the IFRS 16 Right of Use Asset
Now that we have started to reduce the liability on the balance sheet, it is appropriate to start depreciating the asset on the balance sheet also.
The deprecation on the RoU asset is normally calculated on a straight line basis over the length of the lease term (that is to say, the useful economic life of the asset to the lessee)
In our example, the agreement is for 3 years and as such, we will depreciate the IFRS 16 asset over the same period.
This is perhaps the most simple calculation required for our IFRS 16 workings and is done by simply dividing the opening RoU asset by 3 to get the annual depreciation. If we wanted to get the monthly depreciation amount we simply divide by 36 (12 months * 3 years) :
Monthly depreciation = £33,366/36 = £926.83
The journal entry for this depreciation is the same as if the asset was any other item of PPE:
- Debit Right of Use Asset Depreciation £926.83
- Credit Right of Use Asset Accumulated Depreciation £926.83
This journal entry should be entered on a monthly basis until the end of the lease agreement and the IFRS 16 asset on the balance sheet has fully unwound leaving the net book value at zero.
The journal entries/double entries above are all the entries required to recognize the IFRS 16 calculations within the accounts of a business that holds a lease. Please note that now, under IFRS 16 there is no distinction between an operating lease and a finance lease and these should be treated in the same way. If you need further guidance on distinguishing between these two types of lease please see this handy guide: https://onlineaccountingguide.com/what-is-the-difference-between-an-operating-lease-and-a-finance-lease/
IFRS 16 is effective for all companies reporting under IFRS for periods beginning on and after 01/01/2019.
Related Posts
If you found this post useful, the following posts about IFRS 16 may be of interest to you: