Updated: Nov 28, 2018
Upcoming “IFRS” Standards in 2019
IFRS 16 (Leases)
The International Accounting Standards Board (IASB) issued IFRS 16, in January 2016. IFRS 16 will replace the previous standards IAS 17 Leases; IFRIC 4 Determining whether an Arrangement contains a Lease; SIC-15 Operating Leases—Incentives; and SIC-27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease. IFRS 16 is effective for annual periods beginning on or after 1 January 2019. Earlier application is permitted for entities that apply IFRS 15 – Revenue from Contracts with Customers at or before the date of initial application of IFRS 16.
Virtually every company uses rentals or leasing as a means to obtain access to assets and will therefore be affected by the new standard.
Redefines commonly used financial metrics
The new requirements eliminate nearly all off balance sheet accounting for lessees and redefine many commonly used financial metrics such as the gearing ratio and EBITDA. This will increase comparability, but may also affect covenants, credit ratings, borrowing costs and your stakeholders’ perception of you.
The new standard may affect lessors’ business models and offerings, as lease needs and behaviours of lessees change. It may also accelerate existing market developments in leasing such as an increased focus on services rather than physical assets.
Business data and processes
Changes to the lease accounting standard have a far-reaching impact on lessees’ business processes, systems and controls. Lessees will require significantly more data around their leases than before given the on balance sheet accounting for almost all leases. Companies will need to take a cross-functional approach to implementation, not just accounting.
The earlier you begin to understand what impact the new standard may have on your organisation the better prepared you will be to iron out potential issues and reduce implementation costs and compliance risk.
The impact of the new leases standard
Leasing is an important and widely used financing solution. It enables companies to access and use property and equipment without incurring large cash outflows at the start. It also provides flexibility and enables lessees to address the issue of obsolescence and residual value risk. In fact sometimes, leasing is the only way to obtain the use of a physical asset that is not available for purchase.
Under existing rules, lessees account for lease transactions either as operating or as finance leases, depending on complex rules and tests which, in practice, use ‘bright-lines’ resulting in all or nothing being recognised on balance sheet for sometimes economically similar lease transactions. The impact on a lessee’s financial reporting, asset financing, IT, systems, processes and controls is expected to be substantial. Many companies lease a vast number of big-ticket items, including cars, offices, power plants, retail stores, cell towers and aircraft.
Therefore, lessees will be greatly affected by the new leases standard. The lessors’ accounting largely remains unchanged. However they might see an impact to their business model and lease products due to changes in needs and behaviours.
The new standard will affect virtually all commonly used financial ratios and performance metrics such as:
gearing, current ratio, asset turnover, interest cover, EBITDA, EBIT, operating profit, net income, EPS, ROCE, ROE and operating cash flows.
These changes may affect loan covenants, credit ratings and borrowing costs, and could result in other behavioural changes.
These impacts may compel many organisations to reassess certain ‘lease versus buy’ decisions.
• Balance sheets will grow, gearing ratios will increase, and capital ratios will decrease. There will also be a change to both the expense character (rent expenses replaced with depreciation and interest expense) and recognition pattern (acceleration of lease expense relative to the recognition pattern for operating leases today).
• Entities leasing ‘big-ticket’ assets – including real estate, manufacturing equipment, aircraft, trains, ships, and technology – are expected to be greatly affected. The impact for entities with numerous small leases, such as tablets and personal computers, small items of office furniture and telephones might be less as the IASB offers an exemption for low value assets. Low value assets meeting this exemption do not have to be recognised on the balance sheet.
• The cost to implement and continue to comply with the new leases standard could be significant for most lessees. Particularly if they do not already have an in-house lease information system.
• Lessees and lessors may need to consider renegotiating or restructuring existing and future leases.
• Business and legal structures supporting leases should also be reassessed to evaluate whether these continue to be effective (for example, joint ventures and special purpose entities).
• Lessor accounting remains largely unchanged from IAS 17 however, lessors are expected to be affected due to the changed needs and behaviours from customers which impacts their business model and lease products.
The pervasive impact of these rules requires companies to transform their business processes in many areas, including finance and accounting, IT, procurement, tax, treasury, legal, operations, corporate real estate and HR.