Who has to adopt IFRS 16 and from when?
The change effects business entities who compile their individual financial statements according to IFRS, and who prepare group reports for consolidation under IFRS. They will have to adopt the new standard for the first time for financial years beginning on or after 1 January 2019, or if they are early adopters of IFRS 15 Revenue from Contracts with Customers, they may use the opportunity to apply IFRS 16 early too.
What changes does IFRS 16 bring?
The new standard will not trigger any substantial change in the definition of either operating or finance leases compared to the previous regulation (IAS 17 Leases). In terms of accounting practices, the lessor side of lease contracts is not affected either. However, lessees will have to face major changes. One such change is that increased emphasis will be given to the acquisition of control over assets. If a contract regulates the control of a certain asset for a given period in exchange for compensation, the contract is considered a lease contract or a contract containing a lease component. As a result of the changes, the lessee has to include the leased asset and the right of use thereof among its own assets, and the lease (rent) obligation derived from the lease contract under its liabilities. The cost of a lease obligation is the present value of the lease (rent) payment, whereas the cost of the right of use amounts to the initial value of the lease obligation, any fees related to acquiring the lease, any related direct expense and the costs of recovery, less any reimbursements. Depreciation must be booked over the lease term and/or the expected useful life of the asset.
What exceptions are there?
The new provisions are not applicable for short-term lease contracts and low-value asset leases: these can still stay off the balance sheet, any related cost must be accounted for against the reporting year profit. A lease contract is considered short-term if its term does not exceed 12 months. Any contract involving purchase options shall not be deemed short-term even if its term does not exceed 12 months. The accounting policies must define what assets qualify as low-value, and the individual contracts shall be assessed against this threshold.
How should companies prepare?
Companies will need to harmonise their accounting policies with the new standard, and the necessary decisions have to be made. Furthermore, companies need to review their existing contracts and assess whether the individual contracts necessitate the adoption of the new accounting practice or whether the exemption rules might apply to them. While it may seem so at first glance, in truth lease contracts are not the only type of contracts that can contain lease components, so it might be justified to review all contracts. The new requirements may even necessitate improvements to systems of records as well. It must also be kept in mind that other contracts might be affected too owing to the accounting practices in accordance with the new rules. For instance, incorporating liabilities derived from rental fees for an entire rental period into the balance sheet will impact adversely on previous indebtedness ratios, which in extreme cases can lead to non-compliance with credit covenants, and in turn render it necessary to renegotiate terms with financiers.
If you have questions about leasing or specifically about the adoption of the new IFRS 16, please contact our financial consulting experts!
