Even though the official implementation date for IFRS16 lease accounting changes is 1st January 2019, there is a large amount of work involved in preparing the business and becoming compliant.
The Changes to Lease Accounting as a Result of IFRS16
The new standard introduces a new definition of a lease. Due to this, companies will need to spend time deducing what forms a lease under the new legislation and determine (in some cases) where it should be accounted for. That is because the definition of what constitutes a lease and what forms a service contract is being changed. As a result of this, when applying the new guidelines, contracts formally recognised as a lease under IAS 17 may be recognised as a service under IFRS16.
In short, all leases will have to be accounted for on balance sheet, barring a couple of exclusions. It’s estimated that this will bring $2.8 trillion USD of lease commitments onto balance sheets across the world.
A major reason the change has come about is in order to get a fairer representation of the financial state of a company, by improving the comparability, clarity and accuracy of financial information that is essential for the effective analysis of a company’s financial statements.
The change is due to affect half of all listed companies – because it affects all companies who operate any size lease portfolio. Just how much work you and your team need to complete will depend on the value of and number of your lease agreements.
The main changes included under IFRS16 are:
Operating and finance leases will effectively cease to exist because all leases (barring exemptions) will be accounted for on balance sheet.
- Only short term (under 12 months) and low-value asset (roughly under 5,000 USD purchase value) can be left exempt from being on balance sheet.
- Leases will be categorised based on who controls the right of use of an asset. Therefore largely ending the scenario whereby some companies can take assets off balance sheet even though such assets are vital to the running of the company.
- The definition of what constitutes a lease is changing. So, your team will need to assess all service, lease and potential lease agreements to see where they will need to be accounted for once IFRS 16 takes effect.
- IFRS 16 will cause changes to cash flow presentations and change the measurement and recognition of lease liabilities and leases expenses.
- The inter-relationship between lease rights of purchase, subleases and master leases is also changing.
- Although there are some transitional reliefs, retrospective reporting for comparative purposes will be needed. That is why 2017 is the latest time to start preparing.
This gives an idea of the scale of the task at hand and why it is time to start getting prepared.
How To Prepare For IFRS 16
Your business will need to start by reviewing the current lease portfolio, as well as checking other agreements against the new definition of a lease. The IASB has taken under consideration major concerns from lessees, investors and stakeholders and agreed that this stage of becoming compliant is likely to be the biggest area challenge for accountancy departments, due to the timely, costly and intricate nature of assessing all lease agreement terms and conditions.
Once the data from your lease agreements, across the entire lease portfolio of the business, has been sourced and collated, it is only then that you can assess what the impact will be on the company reports and which accounting reliefs/exemptions (keeping certain leases off balance sheet) will be taken up. When making such decisions, companies will need to apply judgement and consider whether they intend to utilise certain exemptions that have been included in the new standards that are aimed at reducing both the cost and complexity of application and compliance.
Having said that, every day products new to leasing are being developed that may help you achieve your business goals. Have a chat to us if you want to know more about these, especially “as a service” products.
Check out our free PDF which outlines how to ensure IFRS 16 compliance in seven steps.