Subsequent measurement of right-of-use assets
AASB 16 extract:
Paragraphs 29 and 35 of AASB 16 require lessees to measure ROU assets at cost, unless the revaluation model is applied to ROU assets relating to a class of property, plant and equipment (PPE) measured at fair value under AASB 116 Property, Plant and Equipment (AASB 116).
Under paragraph 37 of AASB 116, a class of PPE assets is a grouping of assets of a similar nature and use in an entity’s operations.
Examples: Separate classes of PPE assets
Examples of separate classes of PPE include land, land and buildings, machinery, ships, aircraft, motor vehicles, furniture and fixtures, office equipment and bearer plants.
The rights, obligations, risks and benefits of assets under lease contracts may differ substantially from corresponding assets that are owned outright. Lease ROU assets are therefore a distinct grouping of assets (to corresponding assets owned outright) and are separately disclosed in Commonwealth entity financial statements. Fitout assets should not be incorporated into the related ROU assets.
Lease ROU assets can therefore be classified by Commonwealth lessees as separate asset classes to corresponding assets owned outright. Because ROU assets are a separate asset class, and do not relate to a class of PPE to which Commonwealth entities already apply the revaluation model, ROU assets should be measured at cost under paragraph 29 of AASB 16.
Peppercorn leases are those lease arrangements that are agreed for a nominal monetary amount to satisfy the requirements of creating a legal contract. Peppercorn leases, as defined by paragraph Aus25.1 of AASB 16, are leases that have significantly below market terms and conditions principally to enable the entity to further its objectives.
Paragraph 8 of AASB 1058 Income of Not for Profit Entities (AASB 1058) states that entities should apply the requirements of other Australian Accounting Standards, including AASB 16, for the recognition and measurement of assets within the scope of AASB 1058. Commonwealth lessees should therefore measure any peppercorn lease ROU assets at cost rather than at fair value, consistent with other ROU assets.
Where an agreement for the right to use an identified asset for a specified period has no consideration, the arrangement is not a lease as defined under AASB 16. Arrangements where consideration is nominal, such as a dollar, may also be treated as substantively having no consideration for purposes of applying AASB 16. In this case, the right to use the identified asset for a specified period may be an intangible asset under AASB 138 Intangible Assets (AASB 138). Under paragraph 24.1 of AASB 138, not for profit entities should initially recognise intangible assets at fair value, where consideration for the asset is significantly less than fair value principally to enable the entity to further its objectives. Where there is no agreement at all or an agreement with no specified term, income may be recognised under AASB 1058 with a corresponding expense.
Note 7: Subsequent measurement of right-of-use assets
Impairment of right-of-use assets
AASB 16 extract:
- less any accumulated depreciation and any accumulated impairment losses; and
- adjusted for any re-measurement of the lease liability specified in paragraph 36(c).
Paragraph 30 of AASB 16 requires ROU assets held at cost to be measured after deducting accumulated depreciation and any accumulated impairment losses.
Under paragraph 33 of AASB 16, lessees are required to apply AASB 136 Impairment of Assets (AASB 136) to determine whether ROU assets held at cost are impaired and to account for any impairment losses.
Definitions at paragraph 6 of AASB 136, include:
- impairment loss – the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount
- recoverable amount – for an asset or cash generating unit, is the higher of its fair value less costs of disposal and its value in use
- fair value – the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
- costs of disposal – incremental costs directly attributable to the disposal of an asset or cash generating unit, excluding finance costs and income tax expense.
- value in use – the present value of the future cash flows expected to be derived from an asset or cash generating unit.
Paragraph Aus5.1 of AASB 136 notes that, under AASB 13 Fair Value Measurement (AASB 13), the recoverable amount will generally equal fair value for many assets of not-for-profit entities that are held for continuing service capacity rather than to generate net cash inflows. Paragraph 53A of AASB 136 and paragraph 2 of AASB 13 note that fair value is a market based rather than an entity specific measurement.
Paragraph 9 of AASB 136 requires non-financial assets to be assessed for impairment indicators at the end of each reporting period. Where impairment indicators exist, the recoverable amount of the assets should be estimated.
Under paragraph 110 of AASB 136, where impairment losses have been previously recognised, entities are to assess whether there are indications that the impairment previously recognised has decreased. If so, the recoverable amount of that asset should be re-estimated.
For impairment indicators that are to be applied (as a minimum) by entities, see paragraph 12 of AASB 136.
Impairment indicators applicable to ROU assets include that:
- cheaper alternatives to the leased space are available, due to either restructures or other changes in operational requirements or unexpected changes in market rental rates
- the leased space has become surplus
- market interest rates have increased significantly since lease commencement, which would cause a re-rating of the relevant incremental borrowing rate (IBR).
The recoverable amount of ROU assets will need to be estimated where impairment indicators exist. However, ROU asset carrying balances should generally already approximate fair value where:
- the lease recently commenced and was negotiated on commercial terms
- a market rent review was recently undertaken
- the rent escalation factors applied under the lease contract closely reflect estimated changes in market rates since lease commencement
- the lease term is near completion, at which time both the fair value and the carrying value of the ROU asset will be nil.
Property indices may be available in some cases to estimate changes in market rental rates. Commonwealth entities can liaise with their portfolio department to see if a relevant property index is available. Where the property is specialised and has unique attributes, which may not be reflected in a general index, separate management estimates or external valuations may be required.
Entities should also apply their estimated IBR as at the time of their recoverable amount calculation.
AASB 136 requires the discount rate, when estimating the value in use, to be a pre-tax rate that reflects current market assessments of both the:
- time value of money
- risks specific to the asset for which the future cash flow estimates have not been adjusted.
Appendix A of AASB 136 allows the entity’s IBR to be used as an estimate of the discount rate in this case and includes guidance on estimating the discount rate when an asset specific market rate is not directly available.
Surplus lease space should generally be accounted for under AASB 136 – rather than AASB 137 Provisions, Contingent Liabilities and Contingent Assets (AASB 137).
AASB 137 states at:
- paragraph 5 that when another accounting standard deals with a specific type of provision entities should apply that standard instead of AASB 137
- paragraph 69 that before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets dedicated to that contract (see AASB 136).
Impairment for surplus lease space should not be recognised where the lease space is currently surplus but it is likely that the entity will be able to either use the space, or sublet it soon at a similar rent to the head lease.
AASB 137 will still be applicable to lease contracts where an ROU asset has not been recognised (e.g. lease contracts that become onerous before commencement date, or onerous short-term or low-value leases). AASB 137 defines onerous contracts as contracts in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it.
Note 8: Impairment indicators
ROU assets with indicators of impairment must have their recoverable amount estimated under AASB 136. ROU asset balances should generally approximate fair values where the:
- lease recently commenced and was negotiated on commercial terms
- lease was recently subject to a market rent review
- rent escalation factors applied to date, under the lease contract, approximate estimated changes in market rates since lease commencement
- lease term has almost expired.