specifies how an IFRS reporter will recognise, measure, present and discloses leases. The standard provides a
single lessee accounting model, requiring lessees to recognise assets and liabilities for all
leases unless the lease term is 12 months or less or the underlying asset has a
low value. Lessors continue to classify leases as operating or finance, with
IFRS 16’s approach to lessor accounting substantially unchanged from its
predecessor, IAS 17 (iasplus.com).
IAS.17 is different in its approach on the different types
of lease, between financial and operation leases. Where financial lease is the
lease that transfers substantially all the risk and rewards in the ownership of
an asset and all other leases where classified operational lease.
In this article, we are going to understand exactly what
IFRS16 is and its impact on business.
International financial reporting standard (IFRS)16 was
issued in January 2016 to replace the earlier leasing standard (IAS17) with
significant improvements to the way leasing transactions are been recorded in
the financial statements of lessees. This new standard brings about added
transparency to the balance sheet as it obliges companies to recognise new
assets and liabilities from lease transactions which they normally would hold
off balance sheet.
A lease is a contract where by one party; (the lessor)
grants the right to use a particular asset for a period of time to another party
(the lessee) in exchange for a consideration.
The approach of IAS17 in classifying leases between
operating and finance leases was subjective and there was the incentive by
preparers of lease financial statements to argue that leases should be
classified as operating in order to keep it out of their balance sheets.
IAS 17 – Focus on whether lessor or lessee carries the
reward and risk. Both lease and non-lease components are accounted for off the
IFRS 16 – Places focus on who controls the ROU asset,
linking with IFRS 15. Non-lease components still excluded, but lease components
will need to be reported on the balance sheet.
WHAT IS DIFFERENT
The IFRS16 introduces a single accounting model similar to
the finance lease model which eliminate the distinction between operating and
finance leases. This new standard will apply to every new lease from the 1 of
January 2019 as well as to existing lease. As a general rule, these changes
will mean that all leases will now have to be recorded on the balance sheet. A
contract will be defined as a lease if it involves the right to control and use
a specified asset. That is to say, agreements that were not initially
considered as lease will now be classified as such and included in the in the
balance sheet if they fulfil these criteria. These assets will now be treated
as if they were (owned). Rental expense will be replaced by depreciation and
interest cost and Companies will be required to recognise a lease liability for
the present value of future lease payments. However, the Lessors accounting
treatment remains similar to current practice – i.e. lessors will continue to
classify leases as finance and operating leases.
CONSEQUENCIES ON THE ASSETS, THE LIABILITIES AND THE EQUITIES.
IFRS16 requires that organizations recognise in their
balance sheet the right to use the assets and the obligations associated to all
lease contracts but for leases with duration of less than 12 months and those
with support assets of low value. As consequence, the application of IFRS 16 will generate significant increase in the
liability and assets of organizations with current leases of significant value.
CONSEQUENCES ON THE
PROFIT OR LOSS OF THE PERIODE
Over the period of the lease, the value of the expenses of
according to IFRS 16 will be the same as the value of the expenses accounted
for by IAS 17 in the case of an operating lease, yet the value. However, the
nature and value of expenses will be different. IAS 17 involves the usual
straight line method of operating rental expenses. Whereas under IFRS 16 the organization will recognise operating
expenses alongside the amortisation of the right to use the asset and also the
finance cost. The implicit interest rate, the marginal interest rate or the
payment deadline . Yet as a general rule, when the lease is amortised on
straight line basis, the total expenses of the lease decreases over time and so
does the interest expenses decrease as payments are being made.
THE IMPACT OF IFRS 16
For lessees, the lease becomes an on-balance sheet liability
that attracts interest, together with a new asset on the other side of the
balance sheet. In other words, lessees will appear to become more asset-rich
but also more heavily indebted. (Kpmg.com/leases).
The impacts are not limited to the balance sheet. There are
also changes in accounting over the life of the lease. In particular, companies
will now recognise a front-loaded pattern of expense for most leases, even when
they pay constant annual rentals.
All companies will need to assess the extent of the
standard’s impacts so that they can address the wider business implications –
and can expect analysts to take a close interest. Areas of focus may
include: the effect of the standard on
financial results; the costs of implementation; and any proposed changes to business practices.
Generally, the new standard (IFRS 16) will affect almost
every financial ratio as well as performance metrics such as the ROCE, ROI,
operating cash flow current ratio, asset turn over etc. which may compel
certain organisations to reassess certain lease VS buy decisions. as the se
impacts may affect borrowing cost, credit ratings and loan covenants.
Capital ratios will decrease, gearing ratios will increase
and Balance sheets will grow. There also will be a change in the recognition
pattern (acceleration of the lease expense relative to the recognition pattern
for operating leases presently).
COST OF THE
IMPLEMENTATION OF (IFRS 16)
The comply and implementation cost with the new leases
standard (IFRS 16) could be significant for most lessees. Particularly if they
do not already have an in-house lease management system or a lease accounting
software to deal with continues implementation.
Those leasing ‘big-ticket’ assets – such manufacturing
equipment, as real estate, aircraft, ships and , trains. Also,
Technology sector – are expected to be greatly affected. The
impact for entities with several small leases, such as tablets, personal
computers and small items of telephones and office furniture might
be less as the IASB offers an exemption for lower value assets (assets with a
value of $5,000 or less when new). Low value assets meeting these exemptions do
not have to be recognised on the balance sheet.
THE IMPACT OF IFRS 16
LEASE ON BUSINESS
Even though virtually every industry uses lease to enable
obtaining the access to assets,the volume and type of assets each industry
leases and the terms and structure of this lease differ significantly. For
instance a professional services firm leases office buildings/space and cars, a
retailer leases stores and a utility company leases power plants, a telecom
company leases fibre optics and cell towers while an airline company leases air
crafts- all with very different characteristics, pricing, regulatory frame
implications will arise for different industries when using the new lease standards.
According to a survey by Price Water House, the retail industry is the most
impacted by the new lease standard along with the aviation industry.
Currently, many leases use spread sheets manage
their lease. With the introduction of the new more complex lease standard
,bringing all leases on the balance sheet via spread sheet may just not cut it
as it is not going to be cost efficient and may give room for errors in the
financial reporting. Lessees may have to implement contract modules to manage
data and for lease engines to perform the lease calculations as required by the
new lease standard. Organizations need to start thinking of implementing lease
soft wares that are sustainable solutions capable of dealing with the new
complex lease accounting requirements.
IMPACT OF THE NEW STANDARD ON A HIGH VALUE ASSET
Take the aviation industry for instance where lessors will
have to respond to customer behaviour as a result of the IFRS 16 impacts on
lessees, as not only will the airlines wish to renegotiate lease contracts to
address the issues of the changes on lease but lessors may also experience some
contractions in the sale and lease back market since those air lines which
operated sorely for the purpose of participating and keeping their air crafts
off the balance sheet will seize from the market.
The introduction of the IFRS 16 will have a greater impact
on airlines using IFRS as their financial reporting frame work as they now have
to recognise all air craft leases on the balance sheet and as a results will
account for a substantial increase on the balance sheet of assets and
liabilities which in turn impacts reported profit and performance measures.
According to IASB chairman Hans Hoogervorst, “These new
accounting requirements bring lease accounting into the 21st century, ending
the guesswork involved when calculating a company’s often-substantial lease
obligation. The new standard will provide much-needed transparency on
companies’ lease assets and liabilities, meaning that off balance sheet lease
financing is no longer lurking in the shadows. It will also improve
comparability between companies that lease and those that borrow to buy.