This white paper provides an overview of the IFRS 16 standard, the impact it will have on your organization, and what to consider as you begin your transition from IAS 17 to IFRS 16.
Lease accounting standards: ASC 842, GASB 87, and IFRS 16
FASB, GASB, and IASB have been reviewing the lease accounting rules called US Generally Accepted Accounting Principles (US GAAP) and International Financial Reporting Standards (IFRS). The key objective is to enhance financial transparency by having the liabilities that asset and property leases incur be represented on the balance sheet. The latest lease accounting standards relevant for compliant property and asset lease accounting management are ASC 842, GASB 87, and IFRS 16. They were published by FASB, GASB and IASB in February 2016, and are effective for public companies since the fiscal year 2019.
What are the important lease accounting changes?
1. Operating lease on balance sheet
The latest ASC 842, GASB 87, and IFRS 16 standards incorporate changes in the way properties, tangible and intangible assets are recognized for leases. In the previous situation, as described in ASC 840 (FASB) and IAS 17 (IASB), operating lease obligations are not on the balance sheet whereas capital leases are on the balance sheet. Operating leases were only disclosed in the footnotes at the organization’s financial statements. The latest lease accounting standards ASC 842, GASB 87, and IFRS 16 ensure that lease liabilities are reflected in a more uniform way. All asset and property leases with lease terms of more than 12 months are under IFRS 16 recognized as a right of use and liability on the balance sheet. Under ASC 842 and GASB 87, leases need to be classified and recognized on the balance sheet as operating leases or finance leases.
PwC research showed that the increase in interest bearing debt will increase to 58% on average but could increase by more than 200% for industries with many leased properties and assets. Related financial indicators like company's Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), leverage and solvency will change accordingly. The lease accounting standards leave some space for interpretation but require an assessment as part of the lease management process and clear documented reasoning and decision frameworks to ensure compliant reporting. Download our white paper for a more detailed summary of the changes FASB causes to your lease accounting.
2. Capitalization of more cost factors
In the previous IASB, FASB and GASB lease accounting rules, only basic rent was included in capitalization, however, the IFRS16, ASC 842 and GASB 87 standards also include additional amounts. Cost factors like variable rent, bargains or compelling renewal rents, contingent rentals, residual value obligations, amounts for purchase options, lease acquisitions costs and costs for investments to remove tenant improvements after the lease are included in the right of use and capitalization of these amounts on the balance sheet.
3. Inclusion of lease extensions and indexations
Optional extension periods need to be included in capitalization when “reasonably certain.” This leaves space for interpretation and a significant compliance risk at the same time. During the assessments of the financial reporting by accountants, the reasoning for eventual exclusion needs to be accepted. Specific attention is required on the impact of indexations. Any changes in the index require under IFRS 16 a complete recalculation, which can elevate the volatility of lease accounting figures of right of use and liability.
4. Disclosures and SOX compliance
In addition to the recognition of leases on the balance sheet, the latest ASC 842, GASB 87, and IFRS 16 accounting standards by FASB, GASB, and IASB also require additional disclosures. These are designed to help investors and other stakeholders to understand property and asset related lease liabilities, the timing of financial commitments and aspects of uncertainty around cash flows from leases. In most cases, this additional information has to be Sarbanes Oxley (SOX) compliant, which in turn implies the need to track and record all changes on lease contracts.
5. ASC 842, GASB 87, and IFRS 16 requires more accuracy in the lease administration process
The ASC 842, GASB 87, and IFRS 16 lease accounting rules require the capitalization of almost all real estate, property and asset leases. They also require registering additional lease related information. This will impact the day-to-day business of lease administration and associated IT solutions. The requirement to disclose information on the timing and uncertainty of cash flows requires a more detailed registration of lease data. Since the financial impact of lease renewals has changed fundamentally, lease scenario planning, balance modeling, and assessments are important in the decision making process that will include involvement from the controller and CFO.
Are you already compliant with ASC 842?
The ASC 842, GASB 87, and IFRS 16 standards became effective for public companies since the beginning of fiscal year 2019, but also included the demand to report on its regulations over the financial years starting in 2017. During the transition period between 2017 and 2019, the reporting requirements as defined by ASC 840 and IAS17 are still effective, so a twofold lease calculation and reporting is required, without a double payment and accounting.
Lease accounting in IWMS
With the upcoming changes in lease accounting, organizations need an instrument that enables them to make integrated considerations on their portfolio and asset strategy, lease renewals and lease proposals presented in the language of senior business management, controllers, accountants and other financial professionals. The impact of a lease renewal on the costs and liabilities can be significant and needs to be calculated and reported in a compliant way.
The lease accounting changes under ASC 842, GASB 87 and IFRS 16 require a precise administration of all lease contract related costs and payments, with the ability to know who did what when. This calls for a professional lease administration as available in mature Integrated Workplace Management Systems (IWMS). Lease accounting is an important additional solution that can be used as a specific accounting system for controllers, or that is implemented on top of the lease administration software in IWMS. In both cases with seamless integration to your financial system.