Key takeaways
- Lessees applying TFRS 16 recognise an ROU asset and a lease liability for almost all leases.
- Lessors must still classify each lease as a finance lease or an operating lease.
- Long-term leasing of condominium units with payment received upfront has no single accounting answer. It depends on the facts of the contract, and tax must be considered separately from accounting.
- Before setting a leasehold policy, confirm it with the auditor and a tax adviser.
What TFRS 16 changes
Thai Financial Reporting Standard No. 16, Leases, is aligned with IFRS 16. The key change is that lessees must bring almost all leases onto the statement of financial position as a right-of-use asset and a lease liability.
1. Why the change is so significant
Under the previous approach, many operating leases were shown as rent expense in the P&L with no liability on the balance sheet. Businesses that leased buildings, retail space or large long-term assets therefore appeared to carry less burden than they really did. TFRS 16 gives users of the financial statements a clearer view of these obligations.
| Issue | Previous approach | TFRS 16: lessee side |
|---|---|---|
| Operating lease rent | Expense in the P&L | ROU asset and lease liability |
| Statement of financial position | No increase | Both assets and liabilities increase |
| Expense pattern | Rent Expense | Depreciation and interest expense |
| EBITDA | Total rent included in expenses | Generally higher |
2. Definition of a lease
A lease is a contract that gives the right to control the use of an identified asset for a specified period in exchange for consideration. The key points are: there is an identified asset, the lessee obtains substantially all of the economic benefits, and the lessee has the right to direct how the asset is used.
| Nature of the contract | Initial view |
|---|---|
| Leasing a specific room in a building | Lease |
| Co-working space with no specified area | Service |
| Leasing a specified car for 3 years | Lease |
| Taxi or ride-hailing service | Service |
| A specific server whose use the lessee directs | Control rights must be assessed |
| General cloud services | Generally a service |
3. Lessee accounting
A lessee may elect the exemptions for short-term leases of no more than 12 months with no purchase option, and for low-value assets. In practice, the low-value threshold is usually taken from IFRS guidance at about USD 5,000 when new. Cars generally do not qualify as low-value assets.
ROU asset = lease liability + lease payments made at or before commencement + initial direct costs + estimated dismantling costs − lease incentives
Lease liability = PV of lease payments not yet paid at the commencement date
The discount rate is the rate implicit in the lease if it can be readily determined; otherwise use the incremental borrowing rate. After commencement, the liability increases with interest and decreases with payments, while the ROU asset is depreciated.
4. Example: a 5-year office lease
Rent is THB 1.2 million per year, paid at the start of each year, with an IBR of 6%. The total PV of the 5 payments is THB 5.358 million. In the accounts, the first payment made at the commencement date is included in the ROU asset but leaves no liability. This table shows the total balance before payment to illustrate the mechanics.
| Year | Opening balance | Payment | Interest 6% | Closing balance |
|---|---|---|---|---|
| Y1 | 5.358 | (1.200) | 0.249 | 4.408 |
| Y2 | 4.408 | (1.200) | 0.192 | 3.400 |
| Y3 | 3.400 | (1.200) | 0.132 | 2.332 |
| Y4 | 2.332 | (1.200) | 0.068 | 1.200 |
| Y5 | 1.200 | (1.200) | 0.000 | 0.000 |
ROU depreciation = 5.358 ÷ 5 = THB 1.072 million per year
| Year | Depreciation | Interest | Total under TFRS 16 | Rent paid |
|---|---|---|---|---|
| Y1 | 1.072 | 0.249 | 1.321 | 1.200 |
| Y2 | 1.072 | 0.192 | 1.264 | 1.200 |
| Y3 | 1.072 | 0.132 | 1.204 | 1.200 |
| Y4 | 1.072 | 0.068 | 1.140 | 1.200 |
| Y5 | 1.072 | 0.000 | 1.072 | 1.200 |
| Total | 5.358 | 0.642 | 6.000 | 6.000 |
Total expense is the same, but TFRS 16 is front-loaded, so profit in the early years falls slightly.
5. Effect on the financial statements and ratios
Assets and liabilities increase. EBITDA is generally higher, and depreciation and interest increase. Total cash is unchanged, but the principal portion of lease payments is shown in financing activities, which makes operating cash flow look better.
| Ratio | Direction | Reason |
|---|---|---|
| EBITDA Margin | Increases | Rent moves out of OPEX |
| D/E Ratio | Increases | Lease liability increases |
| Asset turnover and ROA | Usually decrease | Assets increase |
| Interest Coverage | Depends on the definition | Interest increases |
| Operating Cash Flow | Usually increase | Principal goes to financing |
A Covenant in a loan agreement should state whether it is calculated before or after the effect of TFRS 16, so that a change in definition does not cause a breach.
6. Impact across different businesses
Retail and restaurants
Long-term space leases with stepped rent increases bring a large ROU asset and liability onto the balance sheet. The effect on D/E and EBITDA must be examined separately.
Factories and warehouses
Leasing warehouses and machinery increases both assets and liabilities. Interest coverage may affect a Covenant.
Businesses that lease out large assets
Long-term leases result in a high lease liability and lower first-year profit because of front-loading.
Hotels on long-term leased land
For a 30-year land lease at THB 200,000 per month, or THB 2.4 million per year, assuming a 6% annual discount rate, the lease liability is about THB 33 million. If there is a renewal right that is reasonably certain to be exercised, that period must be included and the liability remeasured.
Vehicle fleets
Leased cars are leases if the conditions are met, and the low-value asset exemption generally does not apply. Consider each car individually, the right of control and the lease term.
7. Lessor accounting
Lessors still classify leases as finance leases or operating leases. A finance lease is one that transfers substantially all the risks and rewards incidental to ownership, for example where ownership transfers at the end of the lease, there is a purchase option at a very low price, the lease term covers most of the economic life, or the PV of lease payments is close to fair value. Numerical thresholds such as 75% or 90% are only guidance used in some places, not fixed criteria in the standard.
For an operating lease, the lessor continues to recognise the asset on the balance sheet and recognises income over the lease term.
8. Complex issues
- Variable lease payments: Lease payments that vary with an index or rate are included in the initial liability at present value. Sales-based rent is not included.
- Renewal options: Include the renewal period when it is reasonably certain that the option will be exercised.
- Lease modification: Remeasure the lease liability according to the nature of the modification and an appropriate rate.
- Sale and leaseback: First assess whether the transfer qualifies as a sale under TFRS 15.
- Sub-lease: Classify by reference to the ROU asset from the head lease.
- Developer land lease: Separate the right to use the land from the building, and consider the lease term together with the useful life.
9. Developer leasehold: accounting and tax must be separated
Where a developer leases condominium units or villas on a long-term basis, for example 30 years, and receives almost all the payment upfront, the arrangement may be marketed as a leasehold sale. However, the label should not be taken to mean that it is a sale of real estate under TFRS 15.
It should not yet be assumed that there is a single answer
Some preparers consider the transaction a lease under TFRS 16 and may recognise a profit on the lease where it qualifies as a finance lease, whereas on other facts it may be an operating lease that must be recognised gradually over the lease term. Whether to recognise the full amount in the year of registration or spread it over 30 years therefore depends on the substance of the contract. The same formula should not be applied to every project.
Accounting perspective
- Check that the arrangement meets the definition of a lease and determine the lease term.
- Separate the land and building components if they are held separately.
- If it is a finance lease, derecognise the asset whose risks are transferred and recognise a receivable or profit under the rules for a lessor who is also a seller.
- If it is an operating lease, keep the asset on the balance sheet and recognise income over the lease term, with advance receipts treated as a liability.
Tax perspective
- The Revenue Department has previously answered a ruling request on a 30-year land lease, stating that advance rent must be spread over the lease term on an accrual basis.
- That ruling depended on the facts of that case. Check whether the contract is for rent, a right-to-use fee or another type of transaction.
- If accounting and tax recognise the item at different times, consider deferred tax under TAS 12.
- Rent on real estate qualifies for VAT exemption under Section 81(1)(ta), but other services in the contract must be analysed separately.
Before setting the profit and tax budget, have the auditor and a tax adviser read the actual contract, and test the worst case under both full recognition and recognition over time, because the effects on profit, backlog, dividends and Covenants differ greatly.
10. Tax issues
| Item | Accounting (TFRS 16) | Tax |
|---|---|---|
| Rent | Depreciation and interest | Generally rent on an accrual basis |
| Front-loading | Yes | No direct effect |
| Over the lease term | Totals are equal if there are no other differences | Totals are equal if there are no other differences |
In the example, the accounting expense in year 1 is THB 1.321 million but the rent is THB 1.200 million. The difference of THB 0.121 million gives rise to a net deferred tax asset (DTA), which reverses in the later years.
11. Disclosures
- Carrying amount of ROU assets by class
- ROU depreciation and interest on the lease liability
- Total cash outflow for leases
- Maturity Analysis
- Variable lease payments not included in the lease liability
- Short-term and low-value leases for which the exemptions are used
- Lease commitments not yet commenced
12. Example: a mid-sized retailer
Leases of 50 stores at THB 100,000 per month each, with an average term of 7 years and an IBR of 5%. Annual rent is THB 60 million and PV is 60 × 5.786 = THB 347 million.
| Item | Before | After |
|---|---|---|
| Total Assets | 500 | 847 |
| Total Liabilities | 300 | 647 |
| Equity | 200 | 200 |
| D/E Ratio | 1.50x | 3.24x |
| Income statement, year 1 | Before | After |
|---|---|---|
| Revenue | 1,000 | 1,000 |
| OPEX | (820) | (760) |
| EBITDA | 180 | 240 |
| Depreciation | (40) | (89.6) |
| EBIT | 140 | 150.4 |
| Interest Expense | (15) | (32.4) |
| EBT | 125 | 118.0 |
| Tax 20% | (25) | (23.6) |
| Net Income | 100 | 94.4 |
13. Common mistakes
- Not identifying all leases
- Using an inappropriate discount rate
- Ignoring lease renewal options that are reasonably certain to be exercised
- Including variable lease payments linked to sales in the lease liability
- Not remeasuring the lease on a contract modification
- Applying the short-term exemption to leases expected to be renewed
- Not considering deferred tax
14. Checklist for the CFO
- Prepare a lease inventory
- Test for lease vs service contract
- Set a discount rate policy
- Use a controlled PV calculation tool
- Track contract modifications
- Prepare a disclosure table
- Reconcile accounting to tax
- Analyse the effect on covenants
- For leasehold, obtain the auditor's view before determining revenue recognition
Conclusion
TFRS 16 brings lease obligations onto the balance sheet and changes the picture of EBITDA, debt and profit. For a developer, leasehold contracts must be analysed separately for accounting and for tax before the figures are used in the feasibility study and in communications with investors.