At the commencement of a lease, a lessee incurs initial direct costs to negotiate the lease, makes a lease payment before commencement, receives a cash incentive from the lessor, and estimates a legal obligation to dismantle leasehold improvements and restore the leased space at the end of the lease. Under IFRS 16 paragraph 24, which of these amounts form part of the initial cost of the right-of-use asset?
- Only the initial measurement of the lease liability; initial direct costs, pre-commencement payments, incentives, and restoration cost estimates are recognized separately as period expenses or provisions rather than added to the right-of-use asset
- Only the initial direct costs and the estimated dismantling and restoration costs; lease payments made before commencement and lease incentives received are excluded from the right-of-use asset because they relate to the lease liability rather than the asset
- Only the pre-commencement lease payment and the lease incentive received, netted against each other; initial direct costs and restoration cost estimates are always expensed as incurred under IFRS 16
- All of them: the initial measurement of the lease liability, the pre-commencement lease payment, the initial direct costs, and the estimated dismantling and restoration costs are all included, with the lease incentive received deducted from the total
Why D? And why not the others?
Correct answer: D. All of them: the initial measurement of the lease liability, the pre-commencement lease payment, the initial direct costs, and the estimated dismantling and restoration costs are all included, with the lease incentive received deducted from the total
IFRS 16 paragraph 24 defines the cost of the right-of-use asset as the sum of the initial measurement of the lease liability, any lease payments made at or before commencement (less lease incentives received), any initial direct costs incurred by the lessee, and an estimate of costs to dismantle, remove, or restore the underlying asset or site under the lease's terms; every item described here therefore forms part of the asset's initial cost, with the incentive reducing rather than adding to that total. The option limiting the asset to only the lease liability's initial measurement is wrong because paragraph 24 explicitly adds the other listed components rather than treating them as separate expenses or provisions unrelated to the asset. The option excluding pre-commencement payments and incentives is wrong because paragraph 24 specifically includes payments made before commencement, net of incentives received, within the right-of-use asset's cost. The option limiting the asset to only the netted payment and incentive is wrong because it omits the lease liability's initial measurement and the initial direct costs, both of which paragraph 24 requires to be included, and because initial direct costs are added to, not expensed against, the asset.
Source: IFRS 16 Leases, paragraph 24 (initial measurement of the right-of-use asset)