Accounting For Short-Term and Low-Value Leases (Straight-Line Method) - IFRS 16

Straight-Line Recognition Exemption

The IFRS 16 recognition exemption for short-term or low-value leases allows lessees to recognise lease payments as an expense on a straight-line basis, rather than recognising a lease liability and right-of-use asset on the balance sheet.

The election is made by class of underlying asset, rather than on an individual lease-by-lease basis. For example, a lessee may elect to apply the exemption to all short-term vehicle rentals.

This article forms part of our full IFRS 16 guide.

Short-Term Leases

A short-term lease is a lease that, at the commencement date:

• has a lease term of 12 months or less; and
• does not contain a purchase option.

The lease term includes renewal options that the lessee is reasonably certain to exercise, and termination options that the lessee is reasonably certain not to exercise. This assessment requires judgment and must reflect the economic substance of the arrangement.

Low-Value Leases (IFRS 16.B3–B8)

The low-value exemption is intended to provide relief for leases of assets that are insignificant in value on an absolute basis.

Key principles include:

• Assessment when new
  Whether an asset is of low value is assessed based on the value of the underlying asset when it is new, regardless of the age or condition of the asset at the time it is leased.

• Absolute basis
  The assessment is made on an absolute basis and is not dependent on materiality, the size of the entity, or the scale of its operations.

• Standalone usability
  An underlying asset can be of low value only if:

  • the lessee can benefit from use of the asset on its own or together with other resources that are readily available to the lessee; and
  • the underlying asset is not highly dependent on, or highly interrelated with, other assets.

• Subleasing restriction
  If a lessee subleases an asset, or expects to sublease an asset, the head lease does not qualify as a lease of a low-value asset.

Examples of low-value underlying assets per IFRS 16 include tablet and personal computers, small items of office furniture and telephones.

Expense Recognition for Exempt Leases

For leases that qualify for the recognition exemption, the lessee recognises the lease payments associated with those leases as an expense:

• on a straight-line basis over the lease term; or
• on another systematic basis, if that basis is more representative of the pattern of the lessee’s benefit.

How to Calculate Straight-Line Lease Expense

Step 1: Determine Lease Payments

Lease payments include:

• fixed payments, less any lease incentives receivable;
• variable lease payments that depend on an index or a rate;
• amounts expected to be payable by the lessee under residual value guarantees;
• the exercise price of a purchase option if the lessee is reasonably certain to exercise that option; and
• payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.

Step 2: Determine the Lease Term

The lease term comprises the non-cancellable period of the lease, together with any extension periods that the lessee is reasonably certain to exercise and any termination periods that the lessee is reasonably certain not to exercise.

Step 3: Calculate the Monthly Expense

The total lease payments are divided by the lease term to determine the straight-line lease expense per month.

See below for an illustrative example.

Modifications of Straight-Line Leases

When a lease to which the exemption is applied is modified, the modification is accounted for as a new lease, provided the exemption continues to apply.

Straight-line leases often result in accrued or prepaid lease payments, when the monthly payment and straight-line expense in any given month are not the same. These differences eventually net to zero by the time the lease ends.

In our view, any prepaid or accrued lease payments relating to the original lease should be considered as part of the lease payments for the new lease. This corresponds to the treatment applied to operating lease modifications, which are also accounted for on a straight-line basis.

Illustrative Example – Short-Term Lease Modification (Including Prepaid Lease Expense)

Background

Entity A enters into a 12-month office lease for temporary project staff.

• Lease term: 1 January 20X1 to 31 December 20X1
• Monthly cash payment: CU12,000, payable monthly in advance

The lease qualifies as a short-term lease and Entity A elects the IFRS 16 recognition exemption. Lease payments are recognised on a straight-line basis.

Original accounting:

• Total lease payments: CU144,000
• Monthly straight-line lease expense: CU12,000
• No right-of-use asset or lease liability is recognised

Because payments are made in advance, at any point during the month Entity A recognises a prepaid lease expense.

Position at Modification Date

On 1 July 20X1, Entity A has paid the July rent of CU12,000 in advance.

At that date:

• Lease expense recognised for July: CU0
• Cash paid for July: CU12,000
• Prepaid lease expense (asset): CU12,000

Lease Modification

On 1 July 20X1, the parties agree to:

• extend the lease by six months, to 30 June 20X2; and
• set the monthly rent for the extension period at CU11,000.

At the modification date, the remaining lease term is 12 months or less. The lease therefore continues to qualify for the short-term lease exemption.

Accounting Treatment

Because the recognition exemption continues to apply:

• no lease liability is recognised or remeasured;
• no right-of-use asset is recognised; and
• the modification is treated as a new straight-line lease arrangement.

The prepaid lease expense of CU12,000 existing at the modification date represents consideration already paid by the lessee, but not yet recorded as an expense. Accordingly, this amount is included in determining the revised straight-line lease expense over the remaining lease term.

As a result:

• the prepaid balance is not written off immediately; and
• it is recognised as lease expense systematically over the revised lease term together with future lease payments.

This ensures that total lease expense continues to reflect the economic substance of the modified lease arrangement.

Conclusion

The IFRS 16 recognition exemption for short-term and low-value leases provides practical relief from balance-sheet recognition, but it does not eliminate the need for careful judgment. Lessees must assess eligibility by class of underlying asset, determine lease terms accurately, and account for lease modifications in a manner that faithfully represents the economic substance of the arrangement.

For clarification, guidance, or feedback on our article, please reach out to us at insight@leash.co.za.