Local authority finance functions remain under pressure from all angles: over a sustained period we have seen the impact of funding pressures, increased service demand, an uncertain economy, commercial investments and delays in financial statements sign-off, increasing complexity, and reducing capacity within finance functions.
Recognising this – and principally the significant backlog in accounts sign-off – the implementation of IFRS 16 was delayed until 1 April 2024. But these pressures haven't gone away and, in the face of competing demands, many authorities may not have prioritised the implementation of this accounting change.
How resource-intensive your IFRS 16 implementation will depend on the number and complexity of leases, the completeness of records, accessibility of lease documents, prevalence of lease cancellation, or extension options and the need to obtain valuations. But what's certain is that it will require input from across the organisation, as well as engagement with internal and external stakeholders and users of financial information.
Where the authority is the lessee, the new requirements of IFRS 16 will mainly end the existing different treatments for leases as finance leases and operating leases.
Where an authority leases an asset, in most cases they'll need to recognise the 'right of use' (ROU) asset on their balance sheet together with the associated lease liability and impacts to income and expenditure.
The following considerations will help you prepare for the change.
The Chartered Institute of Public Finance and Accountancy (CIPFA) has issued an implementation plan (appendix 2: CIPFA Bulletin 14: Closure of the 2022/23 Financial Statements). It provides a helpful guide to what you need to consider (more on this below), although this plan assumed commencement in April 2023. Further guidance to support the implementation to IFRS 16 has been issued by CIPFA.
The readiness assessment provides management with an understanding of their current situation, and answers questions such as:
Based on our experience, this assessment will need to be completed by 31 March 2024.
It's also important to consider your project team. Does the capability and capacity exist internally to deliver the project plan? Are reporting mechanisms in place to engage with stakeholders?
As part of defining your approach and accounting policy for IFRS 16, key decisions and judgements will be needed on, for example, consideration of the de minimis level and any exemptions, treatment of rolling leases, options to break or extend, short-term leases, embedded leases, and the impact of peppercorn leases.
Deciding your approach to these areas early on will help provide focus to data collection and the project team's work. You'll also need to ensure that all key judgments and decisions are appropriately documented and supported to provide an effective audit trail.
IFRS 16 will lead to a change in the treatment of leases in the financial statements of the authority. You'll need training and organisation engagement to help build the understanding of the impacts and to allow stakeholders to make informed decisions for the authority.
Once lease information is identified the lease liability and 'right of use' asset will need to be calculated or obtained. The ROU asset may require the authority to commission a valuation.
It’s important that a reader can understand the implications of IFRS 16. Appropriate disclosure notes will need to be produced, firstly disclosing the anticipated impact of implementation within 2023/24 financial statements, subsequently transitional and then recurring disclosures for the 2024/25 financial year onwards.
Sale and leaseback, lease and lease back, or complex lease transactions can prove more difficult to get to the substance of the transaction – and therefore the appropriate treatment under IFRS 16. These often require more time and technical knowledge to draw appropriate conclusions.
You'll also need to review and measure liabilities arising from existing private finance initiative (and other IFRIC 12 arrangements) held by the authority in accordance with IFRS 16.
Consider also the potential impact of IFRS 16 on the prudential indicators and the implications that this may have for the capital and treasury management strategies. This will be relevant for the 2024/25 strategies so needs to be considered by 31 March 2024.
It's important that there's a plan to bring IFRS 16 into business as usual once implemented. Some example areas of consideration include:
While there's no getting away from the fact that finance teams will be further stretched by the implementation of IFRS 16, there are some potential benefits.
IFRS 16 will require leases previously held as operating leases to be recognised on the balance sheet through a 'right to use' asset, meeting the definition of capital expenditure. This could provide more flexibility for funding the lease cost.
The exercise for obtaining the information to support the IFRS 16 transition provides a great opportunity to create a central lease repository, providing information to support asset management. This could also hold easily accessible information on the full extent of leases and embedded leases held by the organisation, length of leases, expiry dates, options to extend or break, rent review and so on.
Getting a better understanding of the cost of leases against other available options can provide greater insight for capital decision making.
Notwithstanding the opportunities that IFRS 16 brings, the complexity and resource-intensive nature of implementing shouldn't be underestimated. We recognise the current capacity constraints in finance teams, as you try to balance how you deal with the running of the organisation, preventing financial failure, finalising financial statements, alongside the challenges of implementing a new financial reporting standard.
For guidance on any aspect of IFRS 16 transition, we're here and able to support authorities across the full implementation process, from readiness assessment and key judgements to consideration of complex transactions, review of specific leases to financial reporting and audit trail.
For more insight and guidance on this topic, contact Richard Thomas.
What causes local government to fail – and how this can be prevented? →
