Ask the Expert: Foreign currency leases

David Holland, Moore Stephens National Head of Technical Accounting, offers his advice on technical and compliance issues that impact businesses.
 
Issue
What is the treatment of a foreign currency lease under AASB 16?
 
Conclusion
Lessees should apply AASB 121 to FX leases.  AASB 121 defines a lease liability as a monetary item and this liability should be remeasured at each reporting date using the exchange rate at that date (movement recognised in the P&L).  The ROU asset is defined as a non-monetary item and is measured at the historical rate (no subsequent re-measurement).
 
Background - AASB 16
Foreign currency exchange
BC196 IFRS 16 does not provide specific requirements on how a lessee should account for the effects of foreign currency exchange differences relating to lease liabilities that are denominated in a foreign currency. Consistently with other financial liabilities, a lessee’s lease liability is a monetary item and consequently, if denominated in a foreign currency, is required to be remeasured using closing exchange rates at the end of each reporting period applying IAS 21 The Effects of Changes in Foreign Exchange Rates.

BC197 Some stakeholders suggested that a lessee should recognise any foreign currency exchange differences as an adjustment to the carrying amount of the right-of-use asset. This approach would treat translation adjustments as an update to the cost of the right-of-use asset, which is initially measured on the basis of the initial measurement of the lease liability. These stakeholders are of the view that lease payments denominated in a foreign currency are in effect another form of variable lease payment, and should be accounted for similarly to variable lease payments that depend on an index or a rate. These stakeholders also questioned whether useful information will be obscured as a result of the profit or loss volatility that might arise as a result of recognising foreign currency exchange differences on a lessee’s lease liability in profit or loss.

BC198 The IASB decided that any foreign currency exchange differences relating to lease liabilities denominated in a foreign currency should be recognised in profit or loss, for the following reasons:

(a) this approach is consistent with the requirements for foreign exchange differences arising from other financial liabilities (for example, loans and previous finance lease liabilities accounted for applying IAS 17).

(b) a lessee with a liability denominated in a foreign currency is exposed to foreign currency risk. Consequently, foreign currency exchange gains or losses recognised in profit or loss faithfully represent the economic effect of the lessee’s currency exposure to the foreign exchange risk.

(c) if a lessee enters into derivatives to hedge its economic exposure to foreign currency risk, the recognition of foreign currency exchange differences relating to lease liabilities as an adjustment to the cost of right-of-use assets would prevent a natural offset of the economic exposure in profit or loss. This is because an entity would recognise any change in the foreign currency risk for the derivatives in profit or loss, whereas it would recognise the corresponding change in lease liabilities in the balance sheet—thus introducing volatility as a result of reducing exposure to foreign currency risk. This mismatch could distort the reported economic position of the lessee.

(d) in the IASB’s view, subsequent changes to a foreign exchange rate should not have any effect on the cost of a non-monetary item. Consequently, it would be inappropriate to include such changes in the remeasurement of the right-of-use asset.

BC199 Although this approach could result in volatility in profit or loss from the recognition of foreign currency exchange differences, an entity would disclose those changes separately as foreign currency exchange gains or losses. Accordingly, it would be clear to users of financial statements that the gain or loss results solely from movements in foreign exchange rates. Because this approach is consistent with the requirements for foreign currency exchange differences in IAS 21, the IASB concluded that it was not necessary to include any specific requirements in IFRS 16.

 
AASB 121
Monetary items

16 The essential feature of a monetary item is a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency. Examples include: pensions and other employee benefits to be paid in cash; provisions that are to be settled in cash; lease liabilities; and cash dividends that are recognised as a liability. Similarly, a contract to receive (or deliver) a variable number of the entity’s own equity instruments or a variable amount of assets in which the fair value to be received (or delivered) equals a fixed or determinable number of units of currency is a monetary item. Conversely, the essential feature of a non-monetary item is the absence of a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency. Examples include: amounts prepaid for goods and services (eg prepaid rent); goodwill; intangible assets; inventories; property, plant and equipment; right-of-use assets; and provisions that are to be settled by the delivery of a non-monetary asset.