Analyst Reports
IFRS 16 came into effect in January 2019, replacing the old IAS 17 lease accounting standard, and has altered the way leases are recognised, measured and reported. The main change is that lease payments are no longer recognised as expenses, but assets and corresponding liabilities are calculated and reported on the balance sheet (except for low-value assets or lease terms of 12 months or less) using the single accounting model. IFRS 16 has removed the distinction between finance and operating leases for lessees.
In 2019, various companies completed projects to move from IAS 17 to IFRS 16 using a range of different tools. In this blog, I share a short recap of why IFRS 16 was introduced and its impact, where most companies stand in their IFRS 16 implementation project and the main challenges.
The need for and impact of IFRS 16
Implementation of IFRS 16 was needed to improve transparency and financial reporting of leases to help users of financial statements. This would also help with valuing a company and for M&As (mergers and acquisitions), by looking at overall debt of the entity and showing a complete and understandable picture of their leasing activities.
This has been the biggest change in decades, completely altering the way lease contracts are reported, which is significant for any company using rentals or leasing to obtain access to asset(s). Companies with large operating lease portfolios are affected the most. As a result of IFRS 16, lessees’ assets (right-of-use) and liabilities will significantly increase on their balance sheet while lease expenses will be removed, resulting in an increased EBITDA (earnings before interest, tax, depreciation and amortisation).
The current status of IFRS 16
This was the first year of the new accounting standard and many companies were already busy settling matters with IFRS 15 (Revenue from Contracts with Customers): another new standard with significant changes for many businesses, which became effective in 2018. Therefore, availability of resources, time and lack of detailed understanding of the complications attached to IFRS 16, have been a real challenge to a timely implementation.
However, it is crucial to be able to calculate and disclose a true and fair view of an entity’s financial affairs. It is understood that in the future, when there is no pressure to implement two significantly important and complicated standards (IFRS 15 and 16) at almost the same time, organisations will revisit their calculations and tools, including finding a better way to:
- Calculate and split into different categories
- Make future changes to their contract/data
- Produce snapshots of historical data and calculations
- Create an audit trail to help with the audit and legal requirements
- Include different users and authorisation categories
- Prepare reports
- Compare leases and KPIs through dashboards
Beyond 2019 IFRS 16 will apply to both the Public Listed Companies (PLCs) that have not yet completed their IFRS 16 implementation project and/or those PLCs who weren’t able to deliver the correct results with an adequate audit trail.
Main challenges of implementing IFRS 16
Based on my recent experiences, the single most challenging task when implementing IFRS 16 is the collection of data. Many people underrate the significance of obtaining the right data, falsely believing it’s simply a matter of extracting what they already have and moving it elsewhere.
Some common challenges related to data and its collection are:
- Volume (numerous contracts in different locations with varied terms)
- Specific information required by IFRS 16, which might not be readily available
- Formatting issues when transferring from one source to another
- Perception that it’s easy to collect data
- Availability of correct data
- Decisions needed e.g. discount rate to calculate present value
An entity may use MS Excel or other similar tools to calculate right-of-use assets, liabilities (split into short and long term), depreciation, interest, present value, lease payment including CPI etc. This is certainly possible and, in some cases, a good way to start implementing IFRS 16 and understand the overall impact of the new accounting rules for their lease contracts. However, the problem is that these tools are not very practical when managing large amounts of data and taking future changes into account e.g. change in reasonable certain date, scope or options.
The benefits of using an IWMS when implementing IFRS 16
For corporate real estate managers in particular, it’s an interesting opportunity to combine their lease accounting software with a real estate portfolio and asset management solution, called Integrated Workplace Management System (IWMS). Base data and contract data about leased properties and assets can be combined with data about costs, utilisation, maintenance or operational performances, which gives real estate and asset managers a true 360-degree view of their portfolio. And financial accounting parameters can also affect decisions about real estate transactions and contracting, space rationalisation and long-term lease or buy strategies.
Conclusion
IFRS 16 remains important for companies renting/leasing assets. Some have already completed the implementation, some are in the middle of it, some have found an interim fix and are now looking for a permanent solution like an IWMS, and a few are planning to start soon.
Companies that have (almost) completed IFRS 16 implementation have in common that they have realised its importance, set aside budget to complete this in time, found that data collection and calculations were more challenging than initially anticipated, performed regular checks to ensure accuracy of results, learnt from mistakes and have plans to improve in future years.
Sir David Tweedie may no longer be the Chairman of IASB, but his dream came true as he once said, ‘One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet.’ With useful lessons learnt and many successful IFRS 16 implementations, the journey continues…
