What do you need to do?
The transition to IFRS 16 has many obstacles and each company will need to take a different approach. The broad stages of getting your business ready are:
1 Get your data in order
When starting an IFRS 16 project, the key question is inevitably whether you have complete and accurate information on your leases. You may have an up-to-date lease database ready to go, but we typically find that that clients have outdated lease data, that is missing key information, or none at all.
The initial exercise is to collate the information that is readily available (even if in filing cabinets) and then ask your business units if they have further information. Lease data is then extracted either manually or by using artificial intelligence (AI) and optical character recognition (OCR) software. The result is typically a spreadsheet containing various subsets of data points that the finance team can use as a crucial step to IFRS 16 compliant data in the system. For clients with existing lease data, we’ve also found its useful to complete an independent extraction of a sample of leases to confirm that what’s in the database is accurate.
2 Make accounting judgements
Once your data is in order, the focus moves to making accounting judgements. IFRS 16 judgements include:
- determining the suitable lease portfolios
- determining the lease term, including any renewal, termination and purchase options, as well as rent-free periods
- accounting for various types of lease payments (variable and fixed)
- accounting for lease incentives, initial direct costs and dismantling costs
- treatment of non-lease components
- treatment of onerous leases.
One of the key considerations is discount rates. This can be difficult to calculate as the judgements are complex and typically raise questions such as:
- What inputs do I need and where can I source them from?
- What is my incremental borrowing rate?
- Why can’t I just use my weighted average cost of capital as the discount rate?
- Is this a one-off exercise or do I need to do this for every lease going forward?
3 Quantify the impact
Some companies may choose to implement a new software solution while others use an Excel model to quantify the impact of IFRS 16 on transition and beyond. Either way, your lease data and key accounting judgements will form the foundation of your quantification.
We recently helped a large UK retailer calculate discount rates for its 200+ property lease portfolio using an Excel based model. We supported the finance through the transition and equipped them with the knowledge on how to calculate any new discount rates in the future.
4 Implement suitable controls, systems and processes
Once you’ve made your way through the IFRS 16 transition process, the journey continues. Keeping your lease data accurate and complete, maintaining up to date accounting judgements, and routinely quantifying IFRS 16 journal entries will need to become business as usual.