The adoption of the International Financial Reporting Standard (IFRS) 16 in 2019 has brought significant changes to the accounting treatment of lease agreements. One of the notable changes is the requirement for companies to recognize lease liabilities on their balance sheets. This means that companies that previously entered hire purchase agreements will need to adjust their financial reporting to comply with the new standard.
So, what is a hire purchase agreement?
A hire purchase agreement is a financing arrangement where a company can acquire an asset, such as a vehicle or equipment, by paying for it in installments over a specified period. The company takes possession of the asset immediately, but ownership only transfers to the company once the final installment is paid. Under IFRS 16, hire purchase agreements are considered leases, and the associated liability and right-of-use (ROU) asset must be recognized on the balance sheet.
When a company enters into a hire purchase agreement, it must carefully review the terms and conditions of the agreement to determine whether it meets the definition of a lease. According to IFRS 16, a lease is defined as “a contract, or part of a contract, that conveys the right to use an asset for a period of time in exchange for consideration.”
To determine whether a hire purchase agreement is a lease, the company must consider the following:
1. Does the agreement convey the right to use an identified asset?
2. Does the company have the right to control the use of the asset during the lease term?
3. Does the company have the right to obtain substantially all the economic benefits from the use of the asset during the lease term?
If the answer to all three questions is yes, then the hire purchase agreement is considered a lease.
Once a hire purchase agreement is determined to be a lease, the company must recognize a lease liability and ROU asset on the balance sheet. The lease liability represents the company`s obligation to make lease payments over the lease term, while the ROU asset represents the right to use the leased asset over the same period.
The recognition of lease liabilities and ROU assets under IFRS 16 can have a significant impact on a company`s financial performance and position. As a result, companies must ensure that they have effective systems and processes in place to capture and report the necessary lease information accurately.
In conclusion, the adoption of IFRS 16 has brought significant changes to the accounting treatment of lease agreements, including hire purchase agreements. Companies that enter into hire purchase agreements must now recognize lease liabilities and ROU assets on their balance sheets. To comply with the new standard, companies must carefully review their hire purchase agreements and ensure that they have effective reporting systems and processes in place.