IFRS 16 Lease standard targets big ticket items in major overhaul of £2.2trn market
The much-debated leasing standard, IFRS 16, Leases, has been released by the International Accounting Standards Board (IASB) and is set to transform the accounting rules for lease agreements with a major impact on the P&L, key performance indicators (KPIs) and reporting when it comes into force in 2019, reports Sara White
13 Jan 2016
Under the new standard, which will affect half of listed companies reporting under IFRS, leases will be accounted for on the balance sheet as assets and liabilities, affecting P&L, although the accounting mechanism will be relatively straightforward.
One of the major issues for companies will be to identify and define leases, with the likelihood that many will wish to renegotiate lease contracts to split the costs between true leases and service provision.
The standard will have a major impact on companies with volume leasing commitments, particularly airlines, telecoms, retail, shipping, utilities and information technology.
There are a number of exceptions with a $5,000 (£3,333) cap for small ticket items, thereby excluding leasing of personal computers and telephones, for example, while short-term leases of less than 12 months will also be excluded.
Listed companies using International Financial Reporting Standards (IFRS) or US GAAP are estimated to have around £2.2 trillion of lease commitments with the majority - over 85% - omitted from company balance sheets.
It is estimated that future payments of off balance sheet leases for airlines, retailers and travel/leisure companies account for up to 30% of total assets.
Veronica Poole, global IFRS leader and UK head of accounting, Deloitte said: ‘It is going to change practice. There is going to be a significant impact on KPIs The real trick going forward is to identify leases; you are going to have to look for leases in other contractual agreements. The rules of how you determine a lease are going to change – it will be quite different from the interpretation under IFRIC 4 (Determining whether an Arrangement contains a Lease). The thinking has changed from IFRIC 4 and that is challenging.
‘This will produce very different numbers, very different P&L,’ she added. ‘There are problems on a number of points. It is good to see that we will have more comparability and the double entry accounting is quite straightforward, but there are many differences in identifying leases. The more pervasive challenge is to identify all those leases – in the past they were transactions that they [companies] didn’t need to worry about. You will have lots of judgment to see what is in scope – that is going to be an interesting and challenging area.’
IFRS vs US GAAP versions
Despite attempts to create a single standard for IFRS and US GAAP reporters, the two standard-setters were unable to converge although the basic principle of bringing assets on to the balance sheet will be adopted across all juridictions.The major difference is that the US will have two-model approach for operating leases and financing leases.
‘If I go back two or three years, we wouldn’t have expected something so simplified to catch big ticket items and the decision to ignore lessor accounting,’ says Brian O’Donovan, partner in the international standards group at KPMG. ‘For me, the big story has been simplifying the standard. The single objective of bringing big ticket leases onto the balance sheet has been achieved, but there is a divergence between the IASB and US FASB approach – there are two quite important differences.’
‘Under IFRS there will be a big jump in EBITDA, but this will not happen in the US GAAP version as P&L will not be affected,’ added O’Donovan.
The FASB has not published the US GAAP version of the standard as yet.
Christine L Klimek, senior manager at FASB told Accountancy: ‘The FASB leases standard is complete and in production. We expect to publish the final standard in February 2016.’
Addressing the issue of differences between the IFRS and US version at an IFRS 16 launch webinar, an IASB spokesperson stressed: ‘IFRS 16 and the new US standard are expected to be similar – they will both require asset liabilities to be recognised on the balance sheets, requirements for definition of a lease are expected to be the same and the new US standard will retain substantial lessor accounting.
‘The standards are not completely aligned – the main difference is in terms of how leases flow through the income statement. All leases will be recognised on the balance sheet in terms of the income statement and cashflow statement.
‘The income statement will be a single straight line operating expense in the US version. In IFRS 16, it will be separated into separate depreciation and asset liability. The FASB has also decided not to include a recognition assessment.’
As a result, the FASB lessee accounting model will continue to account for two types of leases. One type of lease (the capital lease) will be accounted for in substantially the same manner as capital leases are accounted for under existing GAAP. The other type of lease (the operating lease) will be accounted for in a manner similar to operating leases under existing GAAP, except that lessees will recognise a lease liability and a lease asset for all of those leases.
‘Currently many investors have been making their own adjustments, multiplying yearly lease payments by seven or eight times which is a very rough calculation.’
Definition of leases
The practical definition of leases is an area of concern and will be one of the most difficult aspects of the new standard.
Andrew Marshall, senior technical partner at KPMG, said: ‘The most complex area of the new standard will be determining whether a lease exists in the first place. The definition of a lease is a contract that conveys the right to use an asset for a period of time in exchange for consideration. This focuses on control over the use of an identified asset.
‘Given that the lessee will no longer be able to target getting just under the old 90% test, this may well become the area where we see the most structuring to avoid lease accounting treatment. It may be possible that in certain circumstances the contractual arrangements could result in a service contract, rather than a lease.’
In practice, telecoms and utilities contracts, as well as property leases are likely to be most affected, with the likelihood that companies will consider renegotiating leases to split out provision. For many businesses, property releases will be one of their largest costs after staff.
Reviewing lease structure will be an issue, particularly on utility leases. Poole explains: ‘Quite often a company has to buy some transmitting capacity, so for example they may buy 30% capacity of fibre optic cable – that is a provision of service as long as the capacity can be delivered. But if the company has a contract which states that capacity will be delivered through a particular colour cable, for example, and therefore the customer has specific access, then it is a contract.
‘Energy utilities are going to be very much in scope – take a new factory which is being built in a remote location where there is nothing else. The factory will need an energy supply but there is no power infrastructure so an energy company will have to build a substation to support the factory. As the energy is provided for only one customer, this is a lease, but if the area develops further with more companies relocating there, the energy contract will change as it is not exclusive to one company.’
The high volume of property leases will also be under review with companies considering premise leases, splits between rental and services, particularly for bricks and mortar costs versus ancillary services like building security, insurance, utilities, and so forth.
Poole explains: ‘There will be lots of different challenges with property leases – some will be service provision, ie, the right to use of a service, rather than a lease. Depending on how the interest is recorded, you will get a very different profile.’
In the cost effects analysis released to support the new standard, IASB estimates that bringing leases onto the balance sheet will increase earnings before interest, taxes, depreciation and amortisation (EBITDA) by 10%.
First proposed over a decade ago, IFRS 16 faced extensive re-consultation in the preparation of the standard as company reporters were critical of initial plans which were restrictive and unworkable.
The primary objective of the new standard is to make it easier for investors, credit rating agencies and key stakeholders to compare companies and have a clearer picture of off-balance sheet lease obligations.
Hoogervoorst added: ‘I am absolutely convinced that the standard will not put the leasing companies out of business as leasing will remain a very attractive instrument for many companies. It is a very flexible way of financing assets and on the other hand it is a very good way of owning assets without having the full risks of ownership – leases will remain an interesting business proposition and we will certainly not put the leasing industry out of business.’
The final standard is a joint IFRS developed with the Financial Accounting Standards Board (FASB) in the US, although there are variations in the US approach with different exceptions to the IASB version although the basic principle of bringing leases onto balance sheet have been retained.
The existing rules mean that leases are currently categorised as either ‘finance leases’ (which are reported on the balance sheet) or ‘operating leases’ (which are disclosed only in the notes to the financial statements).
The IASB confirmed that the new leases standard will not affect IFRS for SMEs and further information on the consequences for SMEs has been addressed in the effects analysis, which reviews the cost implications of the standard change.
IFRS 16, Leases, is effective 1 January 2019. Early application is permitted for companies that also apply IFRS 15, Revenue from Contracts with Customers. It will replace the current IAS 16, Leases.
There are no plans to set up a transition resource group for the new IFRS standard.
Under the US GAAP version, for public companies, the upcoming standard will be effective for fiscal years (and interim periods within those fiscal years) beginning after 15 December 2018; for private companies, the standard will be effective for annual periods beginning after 15 December 2019. Early adoption will be permitted for all companies and organisations upon issuance of the standard.
Live web presentations - 13 January 2016
To coincide with the release of the standard, the IASB will hold two live web presentations on the new leases standard on 13 January on the same day the standard is issued.
Both presentations will provide an overview of the new requirements, followed by a Q&A session. Each presentation will last approximately 45 minutes.
To register for the webcasts, go to.
9am Wednesday 13 January 2016 Click here
3pm Wednesday 13 January 2016 Click here
Detailed information about IFRS 16, Leases, is available here
Watch the YouTube video of IASB’s Hans Hoogervorst talking about leases , click here
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