The IASB has now issued IFRS 16: Leases setting out the principles for the recognition, measurement, presentation and disclosure of leases for lessees and lessors . It makes significant changes to lease reporting, particularly for lessees. They will be required to bring all leases within the scope of IFRS 16 on balance sheet – increasing assets and liabilities and recognising an amortisation charge and an interest cost in profit or loss rather than an operating lease cost.
IFRS 16 applies to accounting periods beginning on or after 1 January 2019. It replaces IAS 17, SIC 15, SIC 27 and IFRIC 4. Early application is permitted provided that IFRS 15: Revenue from Contracts with Customers is also applied. The standard has been several years in development, the original discussion paper having been issued in 2009. The detailed proposals have changed since then but the ‘right of use’ model has been retained.
IFRS 16 is yet to be endorsed for use by those entities applying EU IFRS.
Impact on lessees
Lessees will bring all leases within the scope of IFRS 16 on balance sheet, showing an asset for the right of use and a liability for the discounted amount of future payments. There are exemptions for short-term leases (ones that have a lease term of 12 months or less at the commencement date) and leases for which the underlying asset is of low value.
For leases that are currently accounted for as operating leases, the single amount currently included within operating results as lease costs in profit or loss will be split into operating (amortisation of the asset) and finance (interest on the liability) components.
This will result in a front loaded expense profile (similar to finance leases) compared to the straight line expense profile associated in the past with operating leases. There will also be an effect on key performance indicators, eg EBITDA and operating profit.
While total cash flows will remain unchanged, there will be a change in analysis as principal repayments will be included in financing cashflows and interest payments will be included in operating or financing cashflows in accordance with IAS 7.
Impact on lessors
IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17. A lessor continues to classify its leases as operating leases or finance leases, and to account for those two types of leases differently.
- Transition - there are various transitional provisions for both lessees and lessors, many of which are based on the date of initial application (the beginning of the annual reporting period in which an entity first applies the Standard).
- UK tax - as it stands, s53 Finance Act 2011 is intended to 'freeze' the existing tax rules by providing that references in the tax rules to accounting standards will ignore IFRS 16. However, this is likely to increase complexity for those companies that adopt the new standard as they will, in future, need to keep separate accounting records for tax purposes in relation to their leases. We await further announcements from HMRC.
Entities should consider as soon as possible what the effects will be on their balance sheet and results. There may be agreements (eg debt covenants, management agreements, remuneration and share based payment schemes) that are linked to reported numbers that will change (eg net debt, EBITDA or operating profit). Changes may be needed to systems and processes to obtain the information needed to comply with both the accounting and disclosure requirements of the new standard.
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