It is now time for listed companies that are not yet IFRS 16 compliant to actively implement the new rules for lease accounting. The International Accounting Standards Board (IASB) created the new standard to increase transparency by requiring all lease contracts to be shown on the balance sheet. As I wrote in “Getting from here to there: The steps to transition from IAS 17 to IFR 16”, this standard will have a major impact on financial reporting.
White Paper – Getting from here to there: The steps to transition from IAS 17 to IFRS 16
Becoming compliant with IFRS 16 needs a robust project plan. This requires the Finance, Real Estate, and IT departments to get organized, to understand the impact, and to make some important decisions.
The implementation of the new standard will require ample time, money and energy because lease contracts need to be collected and the figures need to be correctly interpreted, streamlined and processed. Therefore, organizations that are starting implementation face the important decision of choosing which method to use when transferring lease data.
Listed companies have two options:
- the Full Retrospective Approach (FRA)
- the Modified Retrospective Approach (MRA)
But what's the difference between the two? How does an organization make its choice? What are the pros and cons of each option? And how can an organization look at the transition to IFRS 16 as an opportunity instead of a requirement?
FRA and MRA
To summarize, the FRA is a more comprehensive version of the MRA. The FRA manages the lease contracts as if IFRS 16 had always been integrated, meaning that all data from existing contracts must be reconstructed and entered into the system. With the FRA, it will seem as if you have been keeping shadow accounts for years.
The FRA is therefore a timely and expensive process, as many contracts have changed throughout their life cycle. Changes may include altering lease amounts, shortening or lengthening of the contract, the execution of an embedded option, indexation and revaluation of the leased objects.
For the MRA, the data requirements are less demanding. In fact, with this method the idea is that IFRS 16 becomes effective on January 1, 2019. From that moment on, you will be entering lease contracts in the balance sheet. In doing so, the finance manager looks at which contracts are active on the date of the introduction of IFRS 16 and migrates the data from only those contracts.
Weighing the options
Although the MRA is simpler, cheaper, and less tedious, it does not mean that companies should automatically choose this option. The major disadvantage of this method is that you do not have comparable figures since prior lease amounts were processed off the balance sheet. If comparative figures cannot be included, the information has less value for the users of the annual report.
The best method depends on the company’s ambition and how they think the outside world will read their annual report. For example, if it is important for stakeholders, analysts, investors, the media and banks to be able to compare and understand the figures, it is better to go for the extensive FRA method.
It is important to involve people who will have to directly interact with the new standard in the planning process. Consider the Chief Financial Officer (CFO) or the accountant and the number of lease contracts that need to be reviewed. For example, are there hundreds or tens of thousands of contracts? Is everything recorded in a uniform and digital way? Is the MRA more reasonable to meet the deadline?
Opportunities can arise
My advice is to select one method. Do not start with the MRA and switch to the FRA later. This will only require extra time, money and effort. It does not make sense to keep both options open.
Finally, I would like to emphasize that, even though IFRS 16 feels like an obligation for many companies, the new reporting standard also presents various opportunities. Using IFRS 16, you establish lease contracts in a more structured manner, which can be valuable because it's easier to compare contracts and look at the number of lessors. You may ask yourself, “which contracts turn out to be most favorable?” Perhaps it would be better to reduce the number of lessors so that, as a larger buyer, you have more negotiating power.
Whether a company opts for the FRA or MRA, structuring the figures can lead to gains. In that case, IFRS 16 will no longer feel like a chore, but also an opportunity.
Learn more what there is to consider when implementing IFRS 16, download the joint white paper between Accenture and Planon.
Managing Director Finance & Risk at Accenture