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Agenda ref30EJune 2019STAFF PAPERIASB MeetingProjectComprehensive review of the IFRS for SMEs StandardPaper topicNew IFRS Standards—IFRS 16 LeasesCONTACT(S)Yousouf 44 (0) 20 7246 6470Michelle 44 (0) 20 7246 6963This paper has been prepared for discussion at a public meeting of the International Accounting StandardsBoard (Board) and does not represent the views of the Board or any individual member of the Board.Comments on the application of IFRS Standards or the IFRS for SMEs Standard do not purport to set outacceptable or unacceptable application of IFRS Standards or the IFRS for SMEs Standard. Technicaldecisions are made in public and reported in IASB Update.Purpose1.At this meeting we are asking Board members if the Request for Information, thatwill be issued as part of the 2019 Comprehensive Review of the IFRS for SMEsStandard, should seek views on whether and, if so, how the requirements of the IFRSfor SMEs Standard should be aligned with IFRS 16 Leases.2.The objective of the Request for Information is to obtain evidence that will assist theBoard in deciding whether and how to develop an Exposure Draft of amendments tothe IFRS for SMEs Standard.Summary of staff recommendations3.The staff recommends that the Board seeks views in the Request for Information, onwhether and, if so, how Section 20 of the IFRS for SMEs Standard could be alignedwith IFRS 16 Leases, namely:(a) requiring a single lease accounting model to be applied to all leases, otherthan short-term or low-value asset leases;(b) incorporating simplifications and practical expedients already permittedby IFRS 16;(c) introducing additional simplifications.New IFRS Standards—IFRS 16 LeasesPage 1 of 26

Agenda ref4.30EThe staff also recommends the Board clarifies in the Request for Information it doesnot intend to amend the requirements in the IFRS for SMEs Standard for lessoraccounting.Structure of this paper5.This paper is structured as follows:(a) background (paragraphs 6–10):(i)overview of IFRS 16 Leases (paragraphs 6–9);(ii)overview of Section 20 Leases (paragraph 10);(b) applying the alignment principles (paragraphs 11–59);(i)principle 1—relevance (paragraphs 13–20);(ii)principle 2—simplicity (paragraphs 21–61);(iii) principle 3—faithful representation (paragraphs 62–66);(c) stakeholder views (paragraphs 67–74);(d) other considerations (paragraphs 75–76);(e) questions for the Board;(f) Appendix A—Summary of SMEIG members’ views on whether to alignthe IFRS for SMEs Standard with IFRS 16 Leases; and(g) Appendix B—Overview of Section 20 and differences between IAS 17and Section 20.BackgroundOverview of IFRS 16 Leases6.In January 2016 the Board issued IFRS 16 and completed its project to improvefinancial reporting for leases. IFRS 16 superseded IAS 17 Leases and becameeffective on 1 January 2019.New IFRS Standards—IFRS 16 LeasesPage 2 of 26

Agenda ref7.30EIFRS 16 was issued after the 2012 Comprehensive Review of the IFRS for SMEsStandard was completed. The Board has not previously considered aligning theIFRS for SMEs Standard with IFRS 16.8.IFRS 16 eliminates the requirement for lessees to classify leases as eitheroperating leases or finance leases. Instead, IFRS 16 requires a single model forthe accounting for leases and requires recognition of all lease obligations. Thereare some limited optional recognition exemptions for short-term leases and leasesof low-value assets.9.IFRS 16 retains the IAS 17 requirements for lessor accounting. However, there isnew guidance for lessors on the definition of a lease, a sublease and on theaccounting for sale and leaseback transactions.Overview of Section 20 Leases10.Section 20 of the IFRS for SMEs Standard is based on IAS 17, except for someminor differences. A list of these differences and an overview of the requirementsof Section 20 are provided in Appendix B of this paper.Applying the alignment principles11.At its May 2019 meeting (Agenda Paper 30), the Board decided that to determinewhether, and if so how, to align the IFRS for SMEs Standard with new andamended IFRS Standards, it would apply three principles:12.(a)relevance;(b)simplicity; and(c)faithful representation.The following paragraphs apply the alignment principles to assist the Board indetermining whether and how to align the IFRS for SMEs Standard with IFRS 16.New IFRS Standards—IFRS 16 LeasesPage 3 of 26

Agenda ref30EPrinciple 1—Relevance13.Leasing is widely used by SMEs. The 2015 SAFE Report 1 ranked leasing as thethird most important source of financing after lines of credit and bank loans toSMEs. Further, according to the 2015 report The Use of Leasing AmongstEuropean SMEs, about 40% of SMEs use leases and about 17% of SMEs’ totalinvestment is financed by leasing. 214.The Effects Analysis of IFRS 16 states that the Standard is the Board’s response to concerns about thelack of transparency of the information provided about leaseobligations.That lack of transparency made it difficult forinvestors and others to obtain an accurate picture of acompany’s assets and financial leverage, and to properlycompare companies that borrow to buy assets with those thatlease assets. The Board concluded that IFRS 16 will result ina more faithful representation of a company’s assets andliabilities and greater transparency about the company’sfinancial leverage and capital employed. This is expected to:(a) reduce the need:(i) for investors and analysts to adjust amounts reportedon a lessee’s balance sheet and income statement; and(ii) for companies to provide ‘non-GAAP’ information aboutleases. IFRS 16 provides a richer set of informationthan was available applying IAS 17, giving furtherinsight into a company’s operations.(b) improve comparability between companies that leaseassets and companies that borrow to buy assets.(c) create a more level playing field for market participants byproviding transparent information about leases. A company1EU Directorate-General for Internal Market, Industry, Entrepreneurship and SMEs, Survey on the access tofinance of enterprises (SAFE)—Analytical Report 2015.2Leaseurope, The Use of Leasing Amongst European SMEs, 2015.New IFRS Standards—IFRS 16 LeasesPage 4 of 26

Agenda ref30Eapplying IFRS 16 will more accurately measure assets andliabilities arising from leases than estimates made bysophisticated investors and analysts for companiesapplying IAS 17. This information is helpful to users makinglending and other credit decisions.15.A lease conveys the right to control the use of an asset in exchange for a paymentobligation. Applying IFRS 16, this right and the related liability are recognised inthe statement of financial position whether the lease is an operating or financelease.16.Considering the prevalence and importance of lease financing to entities applyingthe IFRS for SMEs Standard, and given the benefits of IFRS 16 as set out in theEffects Analysis of that Standard, the staff is of the view that the benefits arerelevant to users of financial statements prepared applying the IFRS for SMEsStandard.17.Financial statements prepared using the aligned Standards would provide consistent,relevant and more accurate information about lease liabilities and financial leverage.18.The IFRS for SMEs Standard states: users of financial statements of SMEs may have greaterinterest in short-term cash flows, liquidity, balance sheetstrength and interest coverage, and in the historical trends ofprofit or loss and interest coverage, than they do in informationthat is intended to assist in making forecasts of an entity’s longterm cash flows, profit or loss, and value. 319.The staff believes that improving information for finance leases on the statement offinancial position would improve the quality of information to users of the financialstatements of entities applying the IFRS for SMEs Standard.20.3Therefore IFRS 16 is relevant to entities applying the IFRS for SMEs Standard.IFRS for SMEs Standard, Basis for Conclusions paragraph BC45.New IFRS Standards—IFRS 16 LeasesPage 5 of 26

Agenda ref30EPrinciple 2—Simplicity21.Requiring a single lessee accounting model could be viewed as a simplification asusers of SMEs’ financial statements will no longer have to analyse two separateaccounting treatments for operating and finance leases (except where exemptionsapply).Implementation costs22.The Effects Analysis of IFRS 16 states that implementation costs will depend on:(a) the size of a company’s portfolio of leases;(b) the terms and conditions of its leases; and(c) the systems it already has in place to account for leases.23.The Effect Analysis also states: The IASB expects that companies with material off balancesheet leases will incur costs to (a) set up systems andprocesses, including educating staff; (b) determine thediscount rates used to measure lease assets and leaseliabilities on a present value basis; and (c) communicatechanges to reported information to external parties. Once acompany has updated its systems to provide the informationrequired by IFRS 16, the IASB expects costs to be onlymarginally higher compared to those incurred when applyingIAS 17. The data required to apply IFRS 16 is similar to thatneeded to apply IAS 17, with the exception of discount ratesthat are required for all leases when applying IFRS 16.24.Given what the Board has said in the Effect Analysis of IFRS 16, staff do notexpect the costs of implementation of a simplified version of IFRS 16 to besignificant for entities applying the IFRS for SMEs Standard.Simplifications in IFRS 1625.IFRS 16 already permits some simplifications, including:(a) specific recognition exemptions for:New IFRS Standards—IFRS 16 LeasesPage 6 of 26

Agenda ref(i)leases of 12 months or less (short-term leases); and(ii)leases of low-value assets. 430E(b) other simplifications and practical expedients, such as:26.(i)exempting entities from the requirement to separate a leasecomponent from any associated non-lease components 5,(ii)simplifying measurement requirements for some variable leasepayments, and for optional payments, such as those relating toextension options.The Board stated in the Effect Analysis that these exemptions, simplificationsand practical expedients would provide substantial cost relief for potentially highvolumes of leases without any significant effect on the improvements introducedby IFRS 16.27.The staff notes that the simplifications already included in IFRS 16 can be includedin the IFRS for SMEs Standard and provide cost relief to entities applying theStandard.28.Feedback received from entities implementing IFRS 16 indicated that gathering therequired data to implement the Standard is challenging. The challenges include:29.(a)locating contracts;(b)assessing the contracts; and(c)systems implementation.Staff recommends that the Request for Information seeks views on whether the samechallenges are likely to apply to entities applying the IFRS for SMEs Standard.4IFRS 16 paragraph 5.5IFRS 16 paragraphs 12 and 15.New IFRS Standards—IFRS 16 LeasesPage 7 of 26

Agenda ref30EAdditional simplifications to IFRS 16 for the IFRS for SMEs Standard30.The staff proposes that the following additional simplifications can be introducedinto the IFRS for SMEs Standard, when aligning with IFRS 16:(a)removing the quantitative threshold for low value assets and introducing alist of examples to assist companies identifying such assets (paragraphs32–39);(b)providing additional relief to assist entities with identifying the discountrate to be applied when determining the liability (paragraphs 40–45);(c)providing additional relief to assist entities with determining andreassessing the lease term (paragraphs 40–44);(d)simplifying the requirements for subsequent measurement (reassessment)of lease liability (paragraphs 52–55);(e)retaining the existing finance lease disclosures applying the IFRS for SMEsStandard (paragraphs 56–59); and(f)31.simplifying the language of the Standard (paragraph 60).The staff believes that these additional simplifications to IFRS 16 willsignificantly reduce complexity.Removing the quantitative threshold for low value assets32.The Board explained in the Basis for Conclusions to IFRS 16 that in deciding onthe exemption the IASB had in mind leases of underlying assets with avalue, when new, in the order of magnitude of US 5,000 orless. 633.The reference to a quantitative amount in the Basis for Conclusions is intended tohelp companies identify leased assets that might be captured by the exemption.6IFRS 16, Basis for Conclusions paragraph BC100.New IFRS Standards—IFRS 16 LeasesPage 8 of 26

Agenda ref34.30EFurthermore, the quantitative threshold addressed some of the operationalityconcerns raised by outreach participants when the Board developed theexemptions. It is intended to provide context for the Board’s decision at the timethat it was made.35.The staff believes there are three options the Board could consider in aligning theIFRS for SMEs Standard with IFRS 16:(a)retaining the quantitative threshold either at the IFRS 16 level, or set alower level;(b)retaining the principle of low-value assets and provide an indicative list ofassets that are typically expected to qualify as low-value assets. The list oflow-value assets could include items such as tablets and personalcomputers, small items of office furniture and telephones; or(c)36.eliminating the relief.The staff does not believe a quantitative threshold is appropriate for entitiesapplying the IFRS for SMEs Standard, given the diversity in the size of entitieseligible to apply the Standard. The existing threshold of US 5,000 is more likelyto be considered material for smaller entities applying the IFRS for SMEsStandard that entities applying full IFRS Standards, whilst an alternativethreshold will be arbitrary. Arguably, the exemption is already familiar to entitiesapplying full IFRS Standards, therefore, the threshold is no longer needed.37.The staff also believes that the same concerns that arose during the developmentof IFRS 16 with regard to the costs of capitalising low-value assets are relevantfor entities applying the IFRS for SMEs Standard, and consequently does notsupport eliminating the relief. Accordingly, providing relief for these leases hasthe potential to provide significant cost relief whilst not losing a significantamount of useful information.38.The staff therefore supports option (b)—retaining the exemption and providingan indicative list of assets. This option simplifies the application of the low-valueassets exemption. Staff believes most items that would qualify for the low-valueassets exemption can be covered by the list. Consequently, entities applying theNew IFRS Standards—IFRS 16 LeasesPage 9 of 26

Agenda ref30EIFRS for SMEs Standard would have to assess materiality only for the few itemsnot included in the list.39.As noted in paragraph 22, staff also support retaining the IFRS 16 exemption forshort-term leases unmodified in the IFRS for SMEs Standard.Determining the discount rate40.IFRS 16 requires lease payments to be discounted using the interest rate implicitin the lease, if that can be readily determined. If that rate cannot be readilydetermined, the lessee shall use the lessee’s incremental borrowing rate. 741.The Board explained in the Basis for Conclusions to IFRS 16: the IASB noted that it is likely to be difficult for lessees todetermine the interest rate implicit in the lease for many leases,particularly those for which the underlying asset has asignificant residual value at the end of the lease, for example,property leases. 842.The Effects Analysis of IFRS 16 acknowledge that companies with material offbalance sheet leases are expected to incur costs to measure lease assets and leaseliabilities at the present value of future lease payments mainly due to the need todetermine a discount rate for each lease (other than short-term leases and leasesof low-value assets).43.The IFRS Interpretations Committee (Committee) received a submission about thedefinition of a lessee’s incremental borrowing rate in IFRS 16 Leases. The submitterasks whether a lessee’s incremental borrowing rate must reflect the interest rate in aloan with both a similar maturity to the lease and a similar payment profile to thelease payments. The Committee will discuss the submission at its June 2019meeting.7IFRS 16 paragraph 26.8IFRS 16 Basis for Conclusions paragraph BC161New IFRS Standards—IFRS 16 LeasesPage 10 of 26

Agenda ref44.30ETo address concerns about the cost to entities applying the IFRS for SMEsStandard in determining discount rates, staff proposes the IFRS for SMEsStandard requires:(a)lease payments to be discounted using the interest rate implicit in the lease, ifthat can be readily determined; or(b)use the lessee’s incremental borrowing rate.If (a) and (b) cannot be readily determined, the lessee shall determine the rateused to discount lease payments by reference to market yields at the end of thereporting period on high quality corporate bonds.45.The staff recommends the option to use a discount rate by reference to marketyields on high quality corporate bonds because such a rate reflects the time valueof money and includes a risk allowance for the risk associated with the liabilityand hence such a discount rate is appropriate to discount the lease liability.Lease term46.IFRS 16 states: the lease term is the non-cancellable period of a lease,together with both:(i)periods covered by an option to extend the lease if thelessee is reasonably certain to exercise that option; and(ii)periods covered by an option to terminate the lease if thelessee is reasonably certain not to exercise that option. 9In assessing whether a lessee is reasonably certain to exercisean option to extend a lease, or not to exercise an option toterminate a lease, an entity shall consider all relevant facts andcircumstances that create an economic incentive for the lessee9IFRS 16 paragraph 18.New IFRS Standards—IFRS 16 LeasesPage 11 of 26

Agenda ref30Eto exercise the option to extend the lease, or not to exercisethe option to terminate the lease. 1047.There is no definition of lease term currently in Section 20 of the IFRS for SMEsStandard. Two possible approaches are:48.(a)retain the current approach of Section 20 of not defining the lease term; or(b)simplify the IFRS 16 definition of lease term.The staff does not recommend approach (a) as incorporating IFRS 16 into theIFRS for SMEs Standard is expected to result in an increase in lease assets andfinancial liabilities. Staff thinks this will include property leases, where theunderlying asset will have a high residual value and lease agreements mayinclude more complex terms regarding the lease term. Consequently, it wouldhelp preparers to apply the IFRS for SMEs Standard if there is a definition oflease term.49.The Committee also received a submission about applying the lease termrequirements in IFRS 16 Leases to cancellable or renewable leases. The submitterasks whether a lease contract is enforceable beyond the notice period of a cancellablelease or the initial period of a renewable lease and the useful life of any nonremovable leasehold improvements is limited to the lease term of the related lease.The Committee will discuss the submission at its 2019 June meeting.50.The staff recommends simplifying the definition of lease term by changing it to‘the non-cancellable period for which an entity is required to comply with thelease’. Any subsequent extension to the lease term shall be accounted for as anew lease.51.This simplification will make it simple and easy for entities applying the IFRS forSMEs Standard to determine the lease term. Staff thinks determining the leaseterm using the simplified definition will not likely to result in a significantlydifferent lease term applying IFRS 16 in most cases.10IFRS 16 paragraph 19.New IFRS Standards—IFRS 16 LeasesPage 12 of 26

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New IFRS Standards—IFRS 16 Leases Page 1 of 26 . Agenda ref 30E STAFF PAPER June 2019 IASB Meeting Project Comprehensive review of the IFRS for SMEs Standard Paper topic New IFRS Standards—IFRS 16 Leases CONTACT(S) Yousouf Hansye 44 (0) 20 7246 6470

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