Internal Memo

To: Finance Director
From: Finance Controller
Date: May, 2024

Subject: Explanation of Lease Accounting Under IFRS 16 for the Leased Warehouse

The adoption of IFRS 16 – Leases requires significant changes in how companies recognize and report leases compared to the previous IAS 17 – Leases. This memo addresses the implications for Ododoeye PLC, specifically regarding the five-year lease of a warehouse.

Key Changes:

1. Right-of-Use Assets: Under IFRS 16, leases with terms exceeding 12 months must be recognized as right-of-use assets and lease liabilities on the statement of financial position. This differs from IAS 17, where leases were classified as either operating or finance leases.
2. Lease Details: For Ododoeye PLC, the annual lease rental of ₦5,000,000 is payable in arrears. Interest of 10% will be charged on the total balance of ₦20,000,000 (₦18,950,000 principal + ₦1,050,000 interest) before the installment payment of ₦5,000,000.

Accounting Treatment:

• Initial Recognition: A debit of ₦20,000,000 will be made to non-current assets as right-of-use assets, which will be depreciated over five years.
• Depreciation: For March, depreciation is calculated as ₦20,000,000 x 20% x 6/12 = ₦2,000,000, resulting in a carrying amount of ₦18,000,000 (₦20,000,000 – ₦2,000,000).
• Right-of-Use Asset Cost: Includes the present value of lease payments plus any direct cost, which totals ₦20 million at October 1, 2022 (₦18,950,000 + ₦1,050,000).
• Separate Component: The right-of-use asset is shown as a separate component of property, plant, and equipment and depreciated over the lease term.
• Lease Liability: Initially measured at the present value of the lease payment (₦18,950,000). The liability is increased by finance costs based on the liability’s carrying amount and the lease’s interest rate.

Financial Statement Impact:

• Statement of Financial Position: Right-of-use assets and lease liabilities are presented separately, leading to higher reported debt and interest.
• Statement of Profit or Loss: Depreciation of the right-of-use asset and interest on the lease liability are presented separately, with interest as a financial expense.
• Cash Flow Statements: Reflect changes in lease liabilities and interest expenses.

Conclusion: Chief Okechukwu’s concerns regarding the treatment of leased assets under IFRS 16 are valid. The adoption of IFRS 16 requires Ododoeye PLC to recognize right-of-use assets and lease liabilities for long-term leases like the warehouse, impacting both the statement of financial position and the income statement compared to IAS 17.