How To Prepare A Construction Business For IFRS 16
Any business that uses leasing as a method to finance their assets is bound to feel the impact of the upcoming implementation of IFRS 16. Having to prepare for the new lease accounting standards is a tough ask for most businesses, but it could have a more significant impact on certain industries, such as in construction.
As an industry that can typically lease out equipment such as scaffolding, general construction tools and heavy machinery, companies operating in this sector are going to see some big changes as we edge closer to January 1, 2019.
In fact, the whole business could be reliant on it, so it’s important to stay on top of the changes and see how these businesses can stay prepared by following these lease accounting preparation tips.
Organise Your Plan For The Impending Changes
Yourself or somebody involved in your business will have been aware of IFRS 16’s impending arrival and the upcoming changes to lease accounting standards for some years now; it’s not something that has sprung up as a massive surprise. Nobody can be blamed for putting the task at the bottom of the priority pile, though, as it’s always seemed like you’d have enough time to tackle the issue.
When you consider the size of the task at hand, it’s now about that time where this issue is finally taken into consideration and preparation officially begins, so here are some steps your construction business should go through so it can achieve compliance.
- Your business needs to find an individual or a group who will be responsible for your organisation achieving compliance. Their job will be to undertake a full audit of the lease portfolio in regard to the procurement and the management.
- You then have to identify every single lease that your company holds and then collect all of that information and the relevant documents. Depending on the size of your business, this process can end up taking approximately two years if you’re a larger organisation, so it’s crucial that this process begins soon.
- At the same time, it’s important that your business gains a genuine understanding of the changes that IFRS 16 will bring, including the potential positive and negative impacts it could have on your company.
- Key members of the business such as stakeholders and those working in finance who will stay on top of this task must then be informed of the new implications and standards which are being applied to the company’s lease portfolio,
- Another useful tip would be to make a decision on whether you will want to adopt the process earlier, while transition reliefs are available to reduce financial burdens, as well as the types of exemption that may or may not be applied. However, early adoption is only available alongside IFRS 15 ‘Revenue from Contracts with Customers.’
- Then, preparing an ongoing strategy for closer lease portfolio management and continued compliance is a good way to stay on top of more changes in the future.
Understand What's Going To Change
Assuming you have already followed the practices outlined in IAS 17, you and your business need to be aware of the upcoming changes in lease accounting as a result of IFRS 16, and it’s important that all stakeholders and investors appreciate the size of the task at hand as they’ will want to know whether it’s worth injecting more money into a company where they might not end up making a required return because of these changes. The big change to take on board is that all leases will need to be included on a balance sheet, meaning that one of the end results will see operating leases no longer existing once they are all moved to a balance sheet, even if a lease agreement is broken.
Although, there are two cases where this reporting can be classed as exempt. These considerations are first, whether it’s a short-term lease agreement of under 12 months and secondly, whether it’s a low-value ticket asset - estimated around just under a $5,000 list price. These exceptions can be particularly helpful to smaller business who negotiate shorter term lease agreements for items with a smaller value.
The changes are important to take into account, as they affect all companies which lease any and all assets to function as a business, and the changes take into account all of the leased asset agreements and in this case, it can range from everyday construction tools from drills and saws, to the heavy machinery in tower cranes and excavators. Other big impacts and changes this will bring is that the new standard will impact a company’s asset turnover, interest cover, EBIT, operating profit, net income, cash flows and financial ratios, and more.
The new standard will be replacing IAS 17; although lessor accounting remains mainly unchanged the IASB estimates that 1 in 2 listed companies will be affected by the upcoming changes, with an estimated $2.8 trillion expected to be brought onto balance sheet.
For a simpler understanding of the differences between a finance lease and an operating lease - check out this back to leasing basic blog.
If the lease agreement and the value of the asset in question meets one of the two conditions mentioned above and is also not part of a much wider lease agreement, it can be exempt from the new IFRS 16 regulations. If we apply this to a construction business, for example, a company might lease four tyres to use on a leased wheel loader; it cannot be exempt from the conditions because the wheel loader has been leased for over the five-year period and is worth more than the small value ticket price of over $5,000, meaning it cannot be exempted. In addition to that, a wheel loader cannot operate without the specialist required tyres to function, and is dependent on all four, meaning the leased tyres won’t be exempted either.
This is just a basic overlook, though, and you can click here to read through a more comprehensive overview of lease accounting and the changes IFRS 16 is going to bring.
How Will This Impact Construction Businesses?
Some don’t even realise that construction businesses can be heavily impacted by the changes in lease agreements, primarily because the common assumption is that a tradesperson's tools, for example, are their own property - but that isn’t always the case.
Every day construction tools can be leased by construction or maintenance teams, while larger organisations can lease heavy machinery for much bigger tasks. Even though tools will have a relatively low-value ticket price compared to the larger items, they’re still a popular choice to lease instead of an outright purchase. The reason for this is that new improvements are constantly created in the construction and engineering industry, and the frequency of these developments allows firms to continue bringing in the best and most effective tools, without having to break the bank whenever there’s a new release.
As the construction industry is one that has a wide variety of equipment, big and small, this sector is one that will be most affected by the IFRS 16 implementation. Even the smallest of a construction company’s leases will now be large ticket items, as they’re likely to have agreements which span the maximum short-term duration and go well beyond the low-value figures quoted.
This does depend on the type of work a construction company does, though, as a solo tradesperson might only lease tools to use for six months, while much larger organisations who are working on big city buildings, for example, might need to exceed the maximum short-term duration.
The analysis phase can take a while, as discussed above, construction companies will need to identify every single lease the company holds and if it’s a larger organisation, then this can be a two-year task. The more leases a construction company will have, the longer it will take for the relevant team to gather them, which means the lease portfolio will need to be managed much closer.
The construction industry is just one of the many sectors that are going to be impacted by IFRS 16, and delaying the process is putting your business at risk.
Decide How To Manage Your Lease Portfolio Following IFRS 16
The level of work that needs to go into assessing the impact of IFRS 16 is tough, but there are tools that can help in the future and make the process much easier. Before you think about lease management beyond 2019, it’s more crucial to prepare for achieving compliance as soon as possible.
Take a look at this free seven-step guide to help achieve compliance: