Most finance directors are too busy to find time to read the new lease standard in full. Here we outline the key impacts FDs should start thinking about now.
In January 2016 the International Accounting Standards Board (IASB) issued IFRS 16 Leases, which will fundamentally change how current operating leases are accounted for, bringing many leases onto the balance sheet of a lessee.
Is your company affected?
If your company applies EU-adopted IFRS then you will have to apply the new standard on the assumption it is endorsed for use in the EU. Many aspects of lease accounting will radically change – so this is a big deal for many companies.
When and how should you implement IFRS 16?
It applies for accounting periods commencing on or after 1 January 2019, again assuming endorsement for use in the EU. For companies with a 31 December year-end the implementation date may seem some way off. However, given retrospective application, companies will need to complete a transition project for at least their 31 December 2017 balance sheet, which is less than two years away.
Why care now?
Unlike the current lease accounting model, for a lessee there is no distinction between an operating and a finance lease under the new standard. Many of your company's operating leases will be brought onto the balance sheet. This is a big change from current practice for operating leases.
What is the key accounting change?
On the balance sheet there will be:
- a credit entry – this is a lease liability presented separately from other liabilities and calculated as the present value of the expected lease payments over the lease term. Payments reduce the liability.
- a corresponding debit entry – a right to use asset (but not the underlying asset) is capitalised and presented adjacent to similar non-leased assets.
Profit is reduced by:
- interest expense being the unwinding of the discount on the liability (thus the finance cost will be higher in earlier years).
- reductions in the carrying amount of the right to use asset (including depreciation or impairment).
Your company's gearing will increase due to recognising more lease liabilities. Its financing structure will look different. Banking covenants (and any future arrangements) will require consideration.
To get a feel for the impact of the new standard a calculation of the present value of the current future minimum operating lease commitments will provide a rough estimate of the additional liability to be booked, although this exercise would not be an accurate accounting assessment. Potential future lease transactions would also require consideration.
Interest-based covenants might be affected in earlier years but EBITDA will look better.
Must all leases go on the balance sheet?
Not all leases are required to be capitalised. Practical expedients allow the following leases to be expensed on a straight-line basis:
- leases with a maximum duration of 12 months
- where the underlying asset is of low value.
What is low value?
Property, cars and any items that are subleased (or expected to be subleased) are not considered to be low value but items such as personal computers, furniture, telephones and tablets can be. For low-value items a $5,000 threshold is indicated in the IASB's basis of conclusions (which is not part of the standard).
What about agreements with maintenance contracts?
Where contracts contain both lease (right to use) and non-lease components (eg, a service) a practical expedient allows such contracts to be treated as a single lease contract. Embedded derivatives must be separated.
Are there any short-cuts?
A practical expedient allows application to a portfolio of leases with similar characteristics only where it is reasonably expected that the result would not differ materially from accounting on a lease-by-lease basis.
Practical considerations to consider now
- Implementation costs (including new systems and training)
- When to communicate effects to stakeholders
- How to identify all leases, including those you lease out
- Will practical expedients help?
- How an indicative $5,000 threshold for low-value items might apply in practice
- What transition reliefs will benefit
- Dilapidations, onerous leases and transaction costs.
More complex issues to be addressed at some stage
- When there are options to break or extend a lease, how is the lease term estimated?
- What about modifications to leases and re-estimating payments?
- What discount rates must be used to unwind the liability?
- How to gather all of the detailed data for this key implementation project.
Find out more
To understand more on how IFRS 16 will affect your company, please read our IFRS alert [ 259 kb ] or our detailed special edition IFRS News. Also, please contact your usual Grant Thornton adviser or Jake Green, Director of Financial Reporting.