IFRS 16 Early Adoption: Is It Right For Your Company?
With the effective date of IFRS 16 creeping ever closer, transitioning to the new lease accounting standards in good time is becoming a critical consideration for businesses.
But although the new standards only officially come into effect on 1st January 2019, laying the groundwork for IFRS 16 compliance should be a priority for any business with a lease portfolio. As such, there are options for early adoption of the IFRS 16 standards for businesses to ease the official transition early next year.
Here’s a quick look at what early adoption of IFRS 16 entails and what your options are for implementing it.
Why Should You Consider Early Adoption Of IFRS 16?
IFRS 16 is the most significant revision of lease accounting standards in a generation. Accordingly, it’s likely that making the change will require a lot of hard work and a significant investment in time. However, the new standards won’t affect every business equally: the scope of the work required on your part will depend on how much your organisation depends on leases and the types of leases you deal with.
Additionally, IFRS 16 includes exceptions and modifications in order to minimise the cost and operational requirements of transitioning, for example, short-term leases that span 12 months or less. It also includes exceptions for small ticket assets that are neither dependent on nor highly interrelated with other leased assets, or within the suggested threshold of $5000 as the value of the underlying asset when new.
It’s important to note that early IFRS 16 adoption isn’t inherently ‘good’ or ‘bad’. If your business deals mainly with short-term leases or those under the $5000 threshold, early adoption might not be a priority for you, as the exceptions mentioned above will result in an easier transition. However, if your business handles a large number of these leases, early adoption might be a good idea in order to make a head-start on the substantial task of moving these to the new standard.
For businesses with large leases over the $5000 mark, or long-term leases that extend beyond 12 months, early adoption should be considered a priority, particularly for leases that will still be in effect at the time of IFRS 16’s implementation in January 2019.
Should Every Business Undertake Early Adoption Of IFRS 16?
During a webinar hosted by Bloomberg Accounting, Ernst & Young Partners spokesperson Betty Davis suggested that the results indicating low levels of early IFRS 16 adoption were unsurprising: enterprises with large real estate assets and liabilities on their balance sheet as a result of the rules governing lessee involvement in construction would be among those needing to consider early adoption of the standards most seriously.
“These companies would really like to take those assets off and just have the present value payments on. They’ve expressed that maybe they would consider adopting early if they didn’t have a lot of other lease activity,” Said Davis.
In addition, she reported a significant correlation between leases and revenue recognition standards and has consulted with many firms who would, ideally, like to adopt both IFRS 16 and the revenue recognition standards simultaneously.
She continues: “But often when they think about the volume of activity on their lessee side, and you have to adopt this as a full-entity standard, that’s kind of pushed them off a lot.” This makes it clear that the need for early adoption of IFRS 16 is well understood by the majority of organisations needing to do so, but there is a clear lack of initiative to implement these standards early in most.
If your business depends on large leases - like real estate assets and liabilities, for example - you should already be making plans for a proactive transition. There’s no getting around it: adopting IFRS 16 will involve some hard work and those organisations who make a start early are bound to be in a better position to achieve compliance when the deadline of January 2019 hits.
Now that we’ve considered the reasons you might begin adopting IFRS 16 early, let’s look at how you can get started.
How does an organisation go about implementing early adoption of IFRS 16?
The most complex aspect of the transition is the period in which lessees must account for leases that extend past the implementation of IFRS 16. Lessees will need to produce retrospective reports for these agreements in order to provide a clear comparison of how their balance sheets have changed and ensure continued compliance. Businesses have two options for early adoption of IFRS 16:
- Modified Retrospective Approach
The modified retrospective approach allows organisations to account for leases using IFRS 16 from their chosen date of initial application (DIA). This mitigates the need for comparative reports and republication of previous financial statements. However, it could result in less accurate financial statements and require more explanation alongside the modified figures.
- Fully Retrospective Approach
A fully retrospective approach requires companies to account for leases as if IFRS 16 had always been in effect from the inception of the lease. Although this requires more historic lease data, it will produce more accurate figures and does not require as many allowances and explanations as the modified approach.
Which Approach Is Best For Your Business?
When it comes to early adoption of IFRS 16, there’s no single, one-size-fits-all solution that applies to all businesses equally. It falls to CFOs and finance professionals to undertake a thorough investigation of their organisation’s relationship with leases and how these leases will be impacted under IFRS 16, and get an idea of how much time and work will be required to reach compliance.
Of course, this can be an intimidating challenge to undertake on one’s own, so it’s advisable to seek out partners with a good understanding of the requirements of IFRS 16 to ensure the smoothest transition possible.
Some Background On The Transition To IFRS 16
Before they can begin an impact analysis, all businesses affected by IFRS 16 will be required to undertake a review of their current active lease portfolio. Although the IASB has provided reliefs to limit the time and cost involved, companies will still be required to collect information on all their leases in order to identify the extent to which they will be affected and which reliefs would suit their leases.
Critically, businesses will be required to account for leases currently under IAS 17 and extend into the implementation of IFRS 16. This will require lessees to provide reports on these agreements detailing how their balance sheets have changed and that they will remain compliant under the requirements of IFRS 16. According to Bloomberg’s research, only three percent of companies surveyed had plans for early adoption of leasing rules before applying the 2014 standard on revenue recognition, while eight percent plan to early-adopt alongside revenue recognition.
Deciding on your transition method is just one of the steps involved in the IFRS 16 adoption process. If you’re looking for advice on the other steps involved, or if you have any other questions around the new leasing standards and how they’ll impact your organisation, download our free guide, 7 Steps to Lease Accounting Compliance Under IFRS 16.