Right-of-Use Asset
Right-of-Use (ROU) Asset in Singapore: A Brief Overview
What is a Right-of-Use (ROU) Asset?
A Right-of-Use (ROU) asset is a non-current asset recognized on a lessee's balance sheet under the new lease accounting standard, SFRS(I) 16/FRS 116. This standard requires lessees to recognize assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value.
The ROU asset represents the lessee's right to use an underlying asset for a specific period.
It's essentially the lessee's claim on the economic benefits from using the asset.
Key Points about ROU Assets in Singapore:
Recognition: A lessee recognizes a ROU asset at the commencement of the lease.
Measurement: Initially, the ROU asset is measured at the present value of lease payments plus any initial direct costs incurred by the lessee.
Depreciation: The ROU asset is depreciated over the shorter of the lease term and the useful life of the asset.
Impairment: Lessees need to assess the ROU asset for impairment regularly.
Impact of ROU Assets on Financial Statements:
The introduction of ROU assets has significantly impacted the balance sheets of companies in Singapore. It has led to an increase in assets and liabilities, which can affect financial ratios and overall financial performance.
Want to Know More?
If you're looking for more detailed information on ROU assets, here are some resources:
PwC: Quick read - New Leasing Standard under SFRS(I) 16/FRS 116: https://www.pwc.com/sg/en/publications/assets/ifrs16-new-leasing-standard-201909.pdf
Calculating the Initial Measurement of an ROU Asset
The initial measurement of a Right-of-Use (ROU) asset is a crucial step in lease accounting under the new lease standard, SFRS(I) 16/FRS 116.
The basic formula for calculating the initial measurement of an ROU asset is:
Initial ROU Asset = Initial Lease Liability + Initial Direct Costs - Lease Incentives
Let's break down each component:
1. Initial Lease Liability
This is the present value of the lease payments.
To calculate it, you need to determine the lease payments (including fixed and variable payments), the lease term, and the discount rate.
The discount rate is typically the lessee's incremental borrowing rate.
2. Initial Direct Costs
These are costs incurred by the lessee to directly negotiate and establish the lease.
Examples include legal fees and appraisal costs.
3. Lease Incentives
These are reductions in lease payments granted by the lessor to induce the lessee to enter into the lease.
They are deducted from the initial lease liability.
Example:
Assume a lease with the following characteristics:
Lease term: 5 years
Annual lease payments: $100,000
Discount rate: 8%
Initial direct costs: $5,000
Lease incentives: $2,000
To calculate the initial ROU asset:
1. Calculate the present value of lease payments:
Using a present value table or financial calculator, calculate the present value of an annuity due of $100,000 for 5 years at 8%.
2. Add initial direct costs: $5,000
3. Subtract lease incentives: $2,000
The result is the initial measurement of the ROU asset.
Important Notes:
The calculation of the initial lease liability can be complex, especially for leases with variable payments or lease term options.
After the initial measurement, the ROU asset is subsequently measured on a cost model, with depreciation and impairment testing applied.
Impact of ROU Assets on Financial Ratios
The introduction of Right-of-Use (ROU) assets under SFRS(I) 16/FRS 116 has significantly impacted the balance sheet and, consequently, various financial ratios.
Key Impacts on Financial Ratios:
1. Debt Ratios:
Debt-to-Equity Ratio: Increases due to the inclusion of lease liabilities in the total liabilities.
Debt-to-Assets Ratio: Increases due to the simultaneous increase in both total assets (ROU asset) and total liabilities (lease liability). However, the impact depends on the relative size of the increase in assets compared to liabilities.
2. Solvency Ratios:
Interest Coverage Ratio: May decrease as interest expense increases due to the recognition of interest on the lease liability.
Current Ratio: Generally unaffected as both the current asset (ROU asset) and current liability (lease liability) increase proportionally.
3. Profitability Ratios:
Return on Assets (ROA): Generally decreases due to the increase in total assets without a corresponding increase in net income.
Return on Equity (ROE): May increase or decrease depending on the company's capital structure and the impact on net income.
4. Efficiency Ratios:
Asset Turnover Ratio: May decrease due to the increase in total assets without a corresponding increase in sales.
Additional Considerations:
Industry-Specific Impact: The impact of ROU assets on financial ratios can vary significantly across industries. Companies with high lease commitments (e.g., retail, airlines) will experience more pronounced changes.
Comparative Analysis: It's crucial to compare financial ratios before and after the adoption of SFRS(I) 16/FRS 116 to assess the true impact.
Adjustments: Analysts and investors may need to make adjustments to financial ratios to account for the impact of lease liabilities and ROU assets.
Example:
Consider a company with the following balance sheet before and after adopting the new lease standard:
Ratio | Before Adoption | After Adoption |
Debt-to-Equity | 0.8 | 1.2 |
Current Ratio | 2.0 | 2.0 |
ROA | 10% | 8% |
As seen in the example, the debt-to-equity ratio increased significantly due to the inclusion of lease liabilities, while the current ratio remained relatively stable. The ROA decreased due to the increase in assets without a corresponding increase in net income.
Implications of ROU Assets for Different Industries
The impact of Right-of-Use (ROU) assets on financial statements varies significantly across industries due to differing lease profiles.
Industries with High Lease Commitments
Retail: Companies heavily reliant on leased properties (e.g., shopping malls, retail stores) will experience a substantial increase in both assets and liabilities. This can impact debt ratios and profitability.
Airlines: With a significant portion of their assets leased (aircraft, engines), airlines will see a considerable rise in ROU assets and lease liabilities, affecting financial ratios like debt-to-equity and asset turnover.
Oil and Gas: Companies with leased exploration and production equipment will face similar challenges, with implications for financial performance and risk assessment.
Industries with Lower Lease Commitments
Technology: While some tech companies lease office space and equipment, their overall lease commitments are often lower compared to other industries. The impact of ROU assets on financial ratios might be less pronounced.
Manufacturing: Depending on the company's business model, lease commitments can vary. Those with significant leased manufacturing facilities will experience a more substantial impact.
Key Implications Across Industries:
Increased Financial Complexity: The introduction of ROU assets adds complexity to financial reporting and analysis.
Impact on Credit Ratings: Changes in financial ratios due to ROU assets can affect a company's creditworthiness.
Investor Relations: Companies need to effectively communicate the impact of ROU assets on financial performance to investors.
Risk Management: Proper assessment and management of lease-related risks become crucial.
Specific Industry Challenges:
Retail: Challenges related to lease term variations, options, and potential impairment losses.
Airlines: Dealing with complex lease structures, including operating leases with purchase options, and the impact on asset turnover.
Oil and Gas: Managing lease-related risks, including volatility in oil and gas prices, and the impact on impairment testing.
It's essential for companies in all industries to carefully assess the impact of ROU assets on their financial statements, perform sensitivity analysis, and disclose relevant information to investors.
How Bestar Can Help with Right-of-Use Assets in Singapore
General Role of Bestar
Bestar can provide invaluable support in managing ROU assets. Here's how:
1. Implementation of SFRS(I) 16/FRS 116:
Assessment of lease portfolio: Identifying leases that fall under the new standard.
Transition to new accounting standard: Assisting in the adoption of the new standard and preparing necessary disclosures.
System implementation: Helping to implement new accounting systems or modify existing ones to accommodate ROU assets.
2. ROU Asset Measurement and Recognition:
Calculation of initial measurement: Determining the present value of lease payments and incorporating direct costs and incentives.
Ongoing measurement: Assessing the ROU asset for impairment and depreciation.
Disclosure requirements: Preparing the necessary disclosures as per the standard.
3. Financial Reporting and Analysis:
Impact assessment: Analyzing the impact of ROU assets on financial ratios and performance.
Financial statement preparation: Assisting in the preparation of financial statements incorporating ROU assets.
Investor relations: Providing support in communicating the impact of ROU assets to investors.
4. Risk Management:
Lease portfolio analysis: Identifying potential risks associated with lease obligations.
Hedge accounting: Evaluating opportunities for hedge accounting to manage lease-related risks.
Contingent liabilities: Assessing potential contingent liabilities related to leases.
5. Technology Solutions:
Lease accounting software: Recommending and implementing suitable software solutions.
Data management: Assisting in data collection, management, and analysis.
Benefits of Engaging Bestar
Expertise: Leveraging the firm's knowledge of accounting standards and industry best practices.
Efficiency: Streamlining the implementation process and reducing errors.
Compliance: Ensuring adherence to regulatory requirements.
Risk mitigation: Identifying and managing potential risks associated with ROU assets.
Focus on core business: Allowing the company to focus on its core operations while the firm handles the accounting complexities.
By engaging a firm like Bestar, companies can effectively manage the challenges associated with ROU assets and ensure compliance with the new lease accounting standard.
Comments