New IFRS Standard – IFRS 16 Leases
The International Accounting Standards Board has recently issued a new standard on the recognition, measurement, presentation and disclosure of leases in financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”) – IFRS 16 Leases. A lease is a contract that conveys the right to use an identified asset. Examples include a piece of machinery, a warehouse and a floor of a building.
The new standard will have an impact on most financial statements that are prepared under IFRS, particularly from the perspective of a lessee.
Accounting by Lessees (the party holding the lease / using the asset)
Under the existing lease standards, financial statement preparers were required to determine the classification of each lease as either an operating type lease or a finance (or capital) type lease. Only those that were classified as finance type leases have been recorded as assets on the balance sheet with a corresponding finance lease liability. Under IFRS 16, there is no longer a distinction between finance and operating leases. Lessees will be required to record a right-to-use asset on their balance sheet with a corresponding lease liability. Exceptions to this are:
- Instances where the lease term is 12 months or less; and
- Leases where the underlying asset has low value at the inception of the lease (e.g. a photocopier, desktop computer etc.)
The impact on the income statement will be the recognition of depreciation and interest expense where previously operating leases gave rise to a rent expense. Expenses recognized at the beginning of the lease may be higher than towards the end of the lease.
Many leases provide the lessee with both the right to use an asset as well as other services (e.g. customer support, maintenance, etc.). IFRS 16 provides guidance on how a lessee should separate the payments to the lease and non-lease components. An accounting policy choice is given whereby lessees can elect to attribute all of the payments to the lease component for a particular class of assets.
Accounting by Lessors (party leasing property to the lessee)
Lessors will continue to distinguish leases between operating and finance type leases. For finance leases, lessors will recognize a receivable equal to the net investment in the lease and then recognize finance income over the term of the lease. For operating leases, the lessor will recognize lease payments as income on a straight line basis unless another method is more representative of the pattern in which the benefit from the asset is diminished.
Sale and Leaseback Transactions
For sale and leaseback transactions, lessees and lessors will use the new IFRS standard on revenue (IFRS 15) to determine whether or not the transaction satisfies the requirements to be accounted for as a sale. If the transaction does not constitute a sale it will be treated as a financing transaction by both the buyer and the seller.
Effective Date and Transition
IFRS 16 is effective for years beginning on or after January 1, 2019. Early adoption is permitted provided that IFRS 15 Revenue from Contracts with Customers has been adopted. IFRS provides two options for transition:
- Full retrospective application; or
- Not restate comparative information, apply a modified approach to determining the value of the lease liability and possibly the right-of-use asset and record the cumulative difference as an adjustment to equity at the transition date.
Financial Statement Impact
The impact of IFRS 16 may be significant for some companies, particularly those that rent equipment or property that were previously accounted for as operating leases. Typical financial statement impacts are:
- Increases to the assets and liabilities
- Income statement classification
- Financial statement metrics (E.g. EBITDA, ROCE, Operating cash flows, Debt to equity ratios)
- Bank covenants
- Financial statement disclosure