Methods and Options to Adopting IFRS 16

Method 1 – Fully Retrospective Method (FRM)

HIGH TIME & COST

Key points to note

• Requires prior year comparatives to be restated.
• Requires NZ IFRS 16 to be applied in full, from the beginning of each and every lease.

Why might an entity want to use this method?

• If there is an absolute need for restated prior year comparatives.

What are the drawbacks that need to be considered?

• To apply NZ IFRS 16 in full from the beginning of each and very lease, and entity would need to:

• Obtain historic information (e.g. discount rates, initial direct costs etc.)
• Make management judgements without the use of hindsight (e.g. use or non-use of renewal options etc.), and
• Identify and then process adjustments relating to events that have occurred over the life of the lease such as (i) lease modifications, (ii) variable lease payments, and (iii) changes in management judgements.

• As such, the FRM may be “problematic” (if not impossible) for entities with older lease populations.

Method 2 – Modified Retrospective Method (MRM)

MODERATE TIME & COST

Key points to note

• Prohibits prior year comparatives to be restated.
• Previous Finance leases are brought over unchanged.
• For previous Operating leases:

• Lease liability is based on remaining payments and current discount rates.
• RoU asset calculated on a rolled forward basis, but using the current discount rate.
• Difference between the Lease liability and RoU asset is recognised in opening Retained earnings.

• Has other adoption options available to make the adoption accounting less onerous (see below).

Why might an entity want to use this method?

• There is less of a need for restated prior year comparatives.
• Entity wants the values upon adoption to reflect those that would be present mid-lease (i.e. a higher Lease liability compared to the RoU asset).

What are the drawbacks that need to be considered?

• Having to calculate the RoU asset on a rolled forward basis will still require time and cost.
• For exiting Finance leases, not being able to use the other adoption options (i.e. must be brought over at their previous carrying amounts).

Method 3 – “Simplified” Modified Retrospective Method (S-MRM)

LOWER TIME & COST

Key points to note

• As above for the MRM, but with the difference (“simplification”) that:

• The RoU asset is set equal to the Lease liability (plus/minus any prior period lease-related accruals)
• As such, no adjustment to opening Retained earnings is needed.

• Can be applied on lease-by-lease basis if preferred (i.e. can have certain leases on the MRM, and others on the S-MRM).

Why might an entity want to use this method?

• There is less of a need for restated prior year comparatives.
• Entity wants to adopt NZ IFRS 16 on a “clean slate” basis, (easier for users to understand, and lower time and cost to implement).

What are the drawbacks that need to be considered?

• The RoU asset will “technically” be higher than it otherwise would be, leading to slightly higher amortisation expense in subsequent years.
• Same restriction around leases previously classified as Finance leases as for MRM above.

Allows more “aggressive” grouping of leases for the purposes of applying discount rates.

Consequence of not utilising:

• Potentially more discount rates required for adoption accounting.

For leases that expire within 12 months of NZ IFRS 16 being adopted, these can continue being recognised in profit or loss rather than being brought onto balance sheet.

Consequence of not utilising:

• Potentially more leases to be brought on balance sheet.

When determining the RoU asset at adoption date, an entity can disregard having to go back and identify, capitalise, and then roll-forward, any initial direct costs incurred at the start of a lease.

Consequence of not utilising:

• Additional time and cost to adopt NZ IFRS 16.
• The unamortised portion of these costs would be recognised in profit or loss a second time (via the RoU asset’s subsequent amortisation over the remaining lease term).

The RoU asset is required to be assessed for impairment upon adoption.

However, in the prior period an entity would have made an onerous lease assessment, which largely follows the same principles and measurement requirements.

Therefore, this option allows an entity to use its previous onerous lease assessment as its adoption date impairment assessment of its RoU assets.

Consequence of not utilising:

• Additional time and cost to adopt NZ IFRS 16.

When determining the lease-term with respect to the use or non-use of renewal and termination options, an entity can use current information it has as at adoption date (i.e. it can use hindsight with respect to facts, circumstances, and events that have already transpired).

Consequence of not utilising:

• Historic management judgements and estimates as detailed in the FRM would need to be worked through and applied, resulting in additional time and cost to adopt NZ IFRS 16.