The New Lease Accounting Standards: The Story So Far
On the 1st January 2019, IFRS 16 will usher in a new era of business practice with an updated lease accounting standard.
And while many organisations remain unaware of the new lease accounting standard or its details, the ubiquity of rentals and leasing in the international business environment means its impact will undoubtedly be felt across industries and borders alike.
IFRS 16 has been in the works for over a decade, ever since it was first added to the IFRS agenda in 2006 as a joint project between the International Accounting Standards Board (IASB) and their counterpart in the United States, the Financial Accounting Standards Board (FASB).
From its inception, the goal of IFRS 16 has been to improve the quality and comparability of financial reporting by providing greater transparency about leverage, the assets an entity uses in its operations, and the risks to which it is exposed from entering into lease transactions.
According to current lease accounting practices, any lease which does not qualify as a finance lease—where the risks and rewards of ownership are effectively transferred to the lessee — can be left off the organisation’s balance sheet and, as a result, isn’t included as an official financial liability.
What Does The New Lease Accounting Standard Entail?
According to the FASB, IFRS 16 will require organisations that lease assets to recognise on their balance sheet the assets and liabilities for the rights and obligations created by those leases.
Simply put, this means that no longer will any business be able to “report” operating leases as being “off balance sheet”. As a result, investors and third parties will have a much clearer view of a company’s actual financial status. When operating leases are undisclosed, any given account of the financial state of an organisation will inevitably be approximated, with intentional adjustments being made on a whim in the name of a more accurate representation.
Not only does IFRS 16 eliminate the guesswork inherent to the existing system, it also makes company accounts understandable and comparable across regional and international boundaries.
Given that IFRS 16 has been in the making for over a decade, it can be helpful to consider the various stages in development. Its story is a window into the seldom-recognised world of international lease accounting, as well as an interesting showcase of how the various stakeholders have worked to safeguard their interests in the ever-changing globalised business climate.
A Timeline Of The New Lease Accounting Standard:
Let’s take a look back at the development of the new lease accounting standards:
It was back in 2006 when the need for a new and transparent accounting standard first reared its head, with the IASB and FASB initiating the discussion and adding the lease project to the IFRS agenda.
Things only started to properly happen in 2009, when a discussion paper on the reformation of lease accounting rules was published in order to gather feedback from eminent figures.
The discussion paper led to the creation of the initial Exposure Draft (ED) in 2010. This was met with widespread outcry from figures in business and finance all around the world. Over the next two years, the IASB received more than 780 letters from lessors, lessees, accounting bodies and financial institutions complaining about the unnecessary complexity and lack of consistency throughout the draft.
2010 to 2012:
Driven by widespread criticism of the ED, the IASB and FASB held hundreds of discussions, working groups, outreach sessions and revisions—all with the purpose of honing and improving the draft. By September 2012, the board concluded their deliberations and announced that a revised draft would be formally published in early 2013.
The Revised Exposure Draft (RED) was published in May 2013, based on the response to and criticism of the original draft. Once it was released, stakeholders had four months, until September, to voice their feedback and concerns. IASB held numerous roundtable discussions during this time and spoke to 270 global investors and analysts.
2014 to 2015:
Following the feedback period, the board reconvened in 2014 for further deliberation, focusing on the more complex and controversial areas of the new lease accounting rules. Despite the exhaustive discussion, IASB and FASB failed to reach a consensus on how the new lease accounting standard should treat small ticket leases. Nevertheless, they reached tentative decisions on many aspects of the project and finished re-deliberation by the beginning of 2015.
In January of 2016, the new lease accounting standard—IFRS 16—was finalised and officially announced. News of the standard was met with some trepidation, as businesses were given three years to prepare and make necessary adjustments to their internal processes and accounting practices. But to many it was still 3 years off!
2017 to 2019:
The big date to remember is the 1st January 2019, when, after 13 years of development and deliberation, the new lease accounting rules will finally come into effect. But, in reality, the hard work to achieve IFRS 16 compliance needed to have begun in 2017. With retrospective and transitional reporting required, besides the numerous intricacies of IFRS 16 which need to be examined and applied, achieving compliance cannot be left until the immediate run-up to 2019.
Challenges arising From The Announcement Of The Standard
Gathering relevant leasing information is one of the biggest challenges facing companies following the announcement of the new standard. According to Rich Stuart, a partner with audit firm RSM, organisations need to compile an inventory of all their lease contracts as soon as possible. This can be difficult for a company that hasn’t formally maintained and stored its leases in an accessible database. As such, they will need to dedicate time and resources to creating processes to discover, analyse and store all existing and historical leases. In some cases, a company might find it necessary to reclassify some leases—from operating lease to capital lease—to better reflect the actual transfer of ownership of the asset and accommodate the new standards.
Another perspective challenge of including all lease costs as balance sheet liabilities is the potential impact on credit rating and asset risk. However, while this may affect investment prospects for some companies, the benefit of increased transparency will tend to reward good practice with heightened investor confidence.
Is your organisation ready for the challenges and opportunities of IFRS 16? With the right guidance and foresight, you can leverage the new lease accounting standard for increased value, efficiency and long-term business success. For a handy guide to the upcoming changes, download our free e-book, IFRS 16 at a Glance: A Brief Overview.