This article discusses the public sector adoption of the new lease accounting standard - IFRS 16. It aims to explore some of the more prominent implementation challenges and considerations facing UK public sector bodies.
Ongoing issues around public sector compliance with new lease accounting standard, IFRS 16, have been recognised by the Financial Reporting Advisory Board (FRAB), the body charged with overseeing accounting framework compliance across the public sector.
Every UK public sector entity that utilised leasing as a form of asset finance will be impacted by the implementation of and compliance with the new lease accounting standard. Throughout the UK public sector, the Treasury, Department of Health and Social Care, NHS Improvement, the Executive Committee of the Northern Ireland Assembly, Scottish Government, Welsh Government and the Chartered Institute of Public Finance and Accountancy (CIPFA) have all been planning for the transition to the new standard.
Whilst across the UK corporate sector entities are generally adopting IFRS 16 for accounting periods starting from January 1st, 2019. For public sector entities, however, they are afforded more time as the IFRS 16 standard is being applied by HM Treasury (HMT) in the Government Financial Reporting Manual (FReM) from 1st April 2020 (with a limited option for early adoption from 1st April 2019).
IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases and replaces the previous Standards IAS 17 Leases and related IFRIC and SIC Interpretations. The IASB published IFRS 16 with the aim of improving the recognition of assets in use and the associated liabilities for those assets by requiring lessees to treat assets and liabilities arising from operating leases just as they would for finance leases. This single lessee accounting model means that though an entity’s balance sheet and P&L might both be impacted the result would give a more faithful and transparent picture of the lessee’s financial leverage and capital employed.
How many leases are extant in the sector, how many assets are the subject of those lease agreements and what is the value of the associated liabilities are questions open to conjecture. Some initial work estimates 75,000 leases in the public sector with 55,000 in central government but with £18.2 billion of future operating lease commitments disclosed in the 2015-16 Whole of Government Accounts leases are certainly material within the public sector (https://www.gov.uk/government/publications/whole-of-government-accounts-2015-to-2016).
Regarding local government, a CIPFA/LASAAC statement said:
"CIPFA/LASAAC would encourage local authorities to continue to progress with their plans for implementation and ensure that they have the relevant information, processes and systems in place.
Local authorities will also want to ensure that they understand the impact on their capital financing arrangements including, for example, their prudential indicators."
For sure no entity should consider this additional time to implement the new standard as a reason to put off their plans for a year – the message is that any and all public sector bodies should use the available time to be that much better prepared for compliance from April 1st 2020.
There are plenty of blogs, publications and downloads available on this subject, and HMT IFRS 16 Application Guidance (April 2019) is particularly recommended but 3 areas of consideration, among many others, have to be these:
- impact modelling to assist with disclosures prior to 01/04/2020
- policy on available exemptions
- determining and application of an appropriate discount rate
If you currently rely on leasing as a form of asset finance generally and undoubtedly, if you use operating leases in particular then IFRS 16 will impact the way your financial statements and prudent indicators are viewed by all interested parties including lenders, lessors, auditors and the public. IFRS 16 requires a lessee to recognise assets and liabilities for leases with a term of more than 12 months unless the underlying asset is of low value. A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments. As a consequence, a lessee also recognises depreciation of the right-of-use asset and interest on the lease liability and classifies cash repayments of the lease liability into a principal portion and an interest portion and presents them in the statement of cash flows applying IAS 7 Statement of Cash Flows.
In order to understand the entire scope of how these changes will impact public sector bodies, it is advised that they conduct a full and comprehensive impact assessment to determine to what extent implementing the new standard will have on financial metrics and critical performance indicators.
When conducting such assessments, public bodies must first centralise all relevant lease data onto one unified platform/database. With all the data secure in one place, they will then be in a position to proactively model the data based on various leasing accounting scenarios. The outcomes of which can then be used to form the basis of transition strategies and used to update stakeholders on the financial implications.
Such assessments will often also help provide a wider analysis into the bodies overall leasing activity, provide insight into how the current lease portfolio is performing and highlight any inefficiencies present in leasing processes.
There is software modelling available that will help simplify the process. One such well proven and trusted solution is Innervision’s LOIS Lease Accounting (LLA). Such a solution can allow you to load leases, compare the effect of available expedients, cater for the whole life of a “right of use asset” (including upgrades and extensions), reclassify leases, analyse exemptions and generate the reports and journal entries to enable correct recording in your ledgers. Impact modelling allows you to choose the suitable path within the guidelines and alert those interested parties via disclosures in the 2018-2019 accounts.
IFRS 16 provides two optional recognition and measurement exemptions: for short-term leases and for leases for which the underlying asset is of low value. Short Term leases are generally an agreement with a set period of 12 months or less and no option to continue beyond that period. According to HMT “short term leases currently within central government include some property leases, software licences, specialised equipment and hire cars. These leases generally meet a short-term need, where longer leases or purchasing the asset would not constitute value for money.” HMT policy is that all entities must apply the recognition and measurement exemption for short-term leases in accordance with IFRS 16 paragraphs 6-8.
Under the new standard, the suggested threshold of what constitutes low-value is roughly $5,000 as the value of the underlying asset when new. IFRS 16 also explicitly excludes cars and cites as examples of low-value underlying assets tablets, personal computers, telephones and small items of office furniture. Lessees in the public sector will have many of these on lease as well as similar assets such as water coolers, franking machines and photocopiers.
Public Sector lessees should seek official guidance on how to recognise and measure assets and leases that might be subject to either exemption under IFRS 16.
IFRS 16 requires the lease liability to be discounted using the rate implicit in the lease, or where this is not readily determined, the lessee’s incremental rate of borrowing. The incremental rate of borrowing is defined as the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.
For the Public Sector where entities cannot readily determine the interest rate implicit in the lease, they will instead be required to use the HM Treasury discount rate promulgated in PES (public expenditure system) papers as their incremental borrowing rate, unless the entity can demonstrate that another discount rate would more accurately represent their incremental borrowing rate. In that case, they shall use that rate as their incremental borrowing rate.
The preparation of financial statements for the year ending 31/03/2019 and the ongoing assessments for the year 2019-2020 represent an excellent opportunity to prepare the disclosures for the financial statement for 2019-2020 necessary to set out the impact of IFRS 16 going forward from April 1st, 2020.
Seize that chance by engaging with a specialist lease consultancy or your auditors to look more closely at all of the below considerations, including the 3 above and to perform those impact assessments.
- Definition of a Lease
- Control of Use of an Asset
- Service Components
- Lease Term
- Lease Payments
- Discount Rate
- Lease Liability
- Existing Peppercorn Leases
- Intra public sector body agreements
- Practical expedients and options
- Transition methods
For further information on the effects and impact of IFRS 16 and for guidelines on how to comply today then download Innervision's 7 Step Guide to lease accounting compliance below:
Disclaimer: this article contains general information about the new lease accounting standards only and should NOT be viewed in any way as professional advice or service. The Publisher will not be responsible for any losses or damages of any kind incurred by the reader whether directly or indirectly arising from the use of the information found within this article.