Everything A CFO Needs To Know About IFRS 16 Lease Accounting
Even though the official implementation date for IFRS 16 lease accounting changes is 1st January 2019, the amount of work involved in preparing the business and becoming compliant is huge.
Retrospective reporting, assessing your options and preparing paperwork are just three things which have led to there being a clamour for finding a speedy means of achieving compliance with the new rules, as far in advance as late 2016 and early 2017.
Here’s a summary of what’s changing and how a CFO can get prepared for IFRS 16.
A summary Of The Changes To Lease Accounting As A Result Of IFRS 16
Following years of consultations and planning, the accounting rules for leases stated under IAS 17 are being replaced. IFRS 16 will come into force as of 1st January 2019, but there will be a need to provide comparative retrospective reports up to a year in advance, so realistically the deadline is much sooner.
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 IFRS 16.
Furthermore, 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.
Given the intricacies of working out what forms a lease under IFRS 16, what can and can’t be kept exempt and off balance sheet and the management process of deciding whether the optional exemptions will be utilised; that is why the time is now to start getting prepared. Even though 2019 may seem an age away.
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 IFRS 16 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. But this is subject to further rules and regulations.
- Leases will be categorised based on who controls the right of use of an asset. Therefore, ending the extraordinary 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
First, as CFO’s will need to assign a team to be responsible for completing the process of reviewing the existing lease portfolio, collating the information, performing assessments and preparing data for board level decisions and assess the potential risks of future lease agreements.
However, before that, start with the redefining of what forms a lease. Here’s the definition of a lease under IFRS 16:
“A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.”
And the lease exists when the customer controls the right to use the item exclusively and is free to decide how to use it, just as if it was their owned item.
It’s suspected that some agreements classed as a lease under IAS 17 will cease to be a lease and others will become a lease, under IFRS 16, and vice versa.
“It's suspected that some agreements classed as a lease under IAS 17 will cease to be a lease and others will become a lease, under IFRS 16, and vice versa”
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.
For clarity, it may not be worth the time and resource keeping certain low value highly common leased assets exempt, such as mobile phones or laptops. It will be the individual businesses’ decision on where to account for such agreements, once it has been compared to the rest of the company accounts.
Apart from becoming compliant, it’s important that your team interrogates the lease agreements that the company has in order to target potential saving and avoid costly increases.
Penalty charges, auto renewals and other details of lease agreements should be sharpened and honed in order to keep the financial impact of where leases are accounted for is minimised.
But it’s likely that lease accounting compliance is the primary concern before you start looking at where savings can be found.
Check out our free ebook which outlines how to ensure IFRS 16 compliance in seven steps.
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