IFRS 16 Leases: Big changes ahead
INSIGHT ARTICLE |
Recent changes to lease accounting in accordance with International Financial Reporting Standards (IFRS) will take effect in January 2019 and are set to have quite an impact on a number of companies. IFRS 16 introduces new guidelines and requirements; the significance of these changes will be felt in several key reporting areas, including working capital, debt levels and profit and loss. Prior to IFRS 16, operating leases were kept off the balance sheet while finance leases were reflected on the balance sheet. In the interest of transparency, IFRS 16 does away with these distinctions and now recognizes both under one model.
What to expect
Businesses that currently lease assets under an operating lease will be required to recognize a lease liability and a corresponding right-of-use asset on the balance sheet, which will then be amortized into the income statement. Entities should be aware that this change will likely result in the following:
- A portion of a current operating lease expense will be seen as a financing cost and not a lease expense;
- A higher charge to the income statement will arise at the front-end of a lease; and
- The EBITDA number, which many companies use as a multiple for the valuation of the business, will increase, due to the removal of a portion of lease expense and replacement with depreciation and interest expenses.
Understanding lease arrangements
So, what should be done to prepare for this new standard? First and foremost, develop a project plan to assist your organization in implementing the process. Transitioning to IFRS 16 will pose a significant amount of work and a project plan allows you to tackle that work in an organized and timely manner, over the course of 2018. It’s vital to understand what your current lease arrangements are and to know the pool of leases, whether they be for equipment, office space, or cars. If you currently have a database of all of your lease arrangements, this will be a great start and you will be ahead of many entities in this process. If you don’t currently track all of your lease arrangements then one of your first steps is to determine how to gather the information to put a listing together. Once completed, you then need to look at a sample pool of the lease arrangements and do a deeper dive to understand their key features and group the lease portfolio into leases with similar features. Areas of a lease that are more complex and require additional thought for accounting purposes are renewal options and variable payments.
Once you have assessed the technical accounting issues of your current lease arrangements, it’s time to integrate this information into your current financial reporting function. The changes coming with IFRS 16 will equate to an ongoing process that affects every quarter. You have the option to treat the lease arrangements as a quarterly project using manual Excel entries, or, similar to some companies, implement a new IT system that works with your current financial program. The choice depends on many factors; what works for one company may not work for another.
If your company has not commenced a project to implement the standard, a recommended approach would be to start the process now to meet the 2019 deadline.
Ensure a smooth transition
Complexity may arise in the implementation project. From experience, leases are not always structured the same. With that in mind, many companies seek help from accounting firms to assist them in adopting the new standard. Lease arrangements cross multiple departments within an organization, including finance, IT and procurement, and in many cases, advisors may need to serve multiple roles from technical accounting advisor to project manager.
As IFRS 16 will have an impact on different areas of the business, it might be beneficial to conduct a high-level impact assessment demonstrating the impact of the changes on key finance metrics. This can provide the business case for internal approvals for new IT or finance requirements needed to meet the deadline.
The sooner your company gets started, the better. Gather the required information and begin to analyze your lease contracts to determine which ones contain complexities.
Reach out to your advisor to learn more and review our IFRS 16 brochure here.