Quick Guide to IFRS-16
IFRS-16 was introduced by the International Accounting Standards Board (IASB) and came into force on 1st January 2019. It’s a new International Financial Reporting Standard for handling lease accounting, replacing IAS 17.
As with all new changes IFRS-16 can seem complex and complicated to understand however in this quick guide we will give you the basics to help break down the complexity and make it easy to understand which should then give you an idea of the implementation process for your business.
What is IFRS-16?
IFRS-16 is a new approach to lease accounting standards, using the “right-of-use” model which means if an organisation has control and right of use of an asset, they are renting then for accounting purposes this is considered a lease and therefore under IFRS-16 must be considered and recognised on the company’s balance sheet.
Under previous rules, significant financial liabilities could be removed from the balance sheet, as permitted by operating leases, and therefore all companies must now report their leased assets increasing visibility and transparency on the companies’ assets.
IFRS-16 was introduced to ensure this information is reported in a standardised and compliant format. To achieve this it’s important to understand the objectives of the accounting standard.
It’s important to note that lessor accounting is largely unaffected by the introduction of IFRS-16.
The objectives of IFRS-16
There are a number of objectives of IFRS-16, largely to promote transparency and consistency of a business’s leased assets.
- Ensure that information provided by Lessees and Lessors is relevant and in a format that truthfully represents transactions.
- The information is presented in such a way as to give a basis for users of financial statements to assess the effect that leases have on financial reporting including amounts, timing, and uncertainty of cash flows.
- With IFRS-16 it is required for the organisation to consider all terms and conditions of the lease contracts as well as relevant facts.
- To apply the accounting standard consistently to contracts with similar characteristics and circumstances.
What organisations and/or businesses do IFRS-16 Leases apply to?
An Example of IFRS-16 Changes
A very simple example of the changes from IFRS-16 would be renting a small warehouse for a period over 12 months and the lifetime value of the lease is over £5000. It’s a small building only for storage of goods where you have the only access and exclusive use of the building throughout the contract term and therefore you have the “right to use”. This would need to be noted as an asset on your business balance sheet and any additional costs (maintenance, cleaning etc) would need to be separately noted in your accounts.
Why the changes from IAS-17 to IFRS-16?
IFRS-16 has been introduced to bring accounting for leases into the 21st century. Ensuring that all companies and organisations return information on leases in the same format this helps create financial transparency as previously businesses could keep leased assets off their balance sheets through operating leases which could then give an incorrect view of their overall financial situation.
What are the main changes from IAS 17 to IFRS 16?
The main change from IAS 17 to IFRS-16 is that IFRS leases must now be included as assets on the company’s balance sheets and have to be reported as lease liability.
The changes affect how accounting for leases is handled as before these would be split across two groups of leases: Finance leases and Operating leases. Previously operating leases would not have been included on the company’s balance sheets and would have likely been accounted for through profit and loss accounts.
Further complications are added into the equation as IFRS-16 means any costs associated with the leased assets must be accounted for if they’re included in the payments. For example, costs of servicing, cleaning, maintenance, and general upkeep must be separated. Further to this depreciation and interest on the leased assets must be presented through the company accounts.
Exceptions to the standards of IFRS-16
As stated above lessor accounting is virtually unaffected by these changes however for lessee accounting there is some exception to the rules, these are two very specific types of IFRS-16 leases:
As an example of this is if you were a business that required a new piece of machinery but the machinery was under £5000 then this wouldn’t need to be included under IFRS-16 or alternatively if the lease term was less than 12 months with no option to buy at the end of the lease contract.
The benefit here is that any maintenance costs would also not need to be calculated or reported separately.
How do these changes to IFRS-16 affect financial reporting?
Financial reporting of the lease liability and assets will need to be reported in a similar way as other financial (and non-financial assets) liabilities.
Balance Sheets – Lessees must report their right of use of the asset and their obligations to make lease payments as a liability.
P&L Accounts – The depreciation of assets and any interest on the lease liability will need to be reported.
The total impact of P&L accounts is likely to be bloated at the start as interest rates are generally higher even though the lease liability remains constant throughout the term as the depreciation value of the asset will be shown.
To be able to accurately report on IFRS-16 leases and ensure IFRS compliance businesses will need to:
- Identify any and all assets that will need to be defined as a lease under IFRS conditions (right to use throughout the lease period) – this could be machinery, vehicles, equipment, property and more.
- Collate all information regarding the leases including length of lease term, end of lease options, the interest rate of the lease and lease liability payable.
- With all the information in hand begin lease accounting to recognise assets and liabilities
This is a fundamental reporting change and IFRS implementation could be difficult at first however if you plan appropriately and implement the correct software systems to handle the calculations and the data then it can be a smooth transition. The main impacts of this change will be felt by businesses with multiple lease agreements as they will appear more “asset-rich” with higher financial burdens. This could impact potential investors and finance options as financial reports will show different accounting ratios.
Leasing is an integral part of running a business and for some businesses it’s essential, therefore it’s likely that businesses will continue to lease assets however it’s more important than ever to ensure you’re fully IFRS-16 compliant and have the right accounting for leases in place including the right software to suit your situation. If you need to implement software for IFRS-16 compliance then please contact us today.
Important Disclaimer: Aramar provides software and does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.