Many companies wonder how their bottom line will be affected when the new leasing standard (IFRS 16) is implemented on 1st January 2019. It can, however, be turned into an opportunity for most businesses.
There are many changes looming when the new leasing standard is implemented in 2019, but it holds not just challenges but also opportunities and advantages for many companies.
Until the introduction of IFRS 16, operating leases have not been required to be reflected in the balance sheets, but this is changing. This could present some challenges for companies, as they will have to choose between making the transition to the new accounting standard by full retrospective application, or by a cumulative catch-up methodology. Many companies are concerned that the new leasing changes will lead to an increase in a business’s recorded debt as well as an increase in assets and liabilities, but it has to be remembered that this will be true for all companies that use leasing, so should not be detrimental to anyone in particular.
In order to prepare for an IFRS 16 implementation, “companies will have to form a project team, gather information to assess the impact of the standard, analyse the data, and prepare for the longer-term actions and decisions required,” according to Deloitte UK. The transition can present opportunities for companies mainly in these five areas:
- Better portfolio visibility
- The ability to develop enhanced processes and controls
- Help in identifying data and systems gaps
- Proactive lease management
- Driving savings and compliance
Better Portfolio Visibility
This is possibly the biggest opportunity affored by the implementation of IFRS 16: namely the provision of a single source of information (a single lessee accounting model) which includes operating leases, and makes it easier to get a clear view of a company's financial position. This is not just important to people such as shareholders, but also to those inside the firm who need to make decisions with regard to leasing agreements and methodologies. This change in lease accounting will improve transparency, comparability and financial reporting.
The Ability To Develop Enhanced Processes And Controls
Many companies will have to institute new systems and processes to manage the change in lease accounting. The formation of a project team, which has a detailed understanding of the transition options, is crucial. A clear financial picture, as a result of increased in-house accounting knowledge and implementation strategies, can only be to the benefit of the company, since it will assist in future decision-making with regards to leasing.
Help In Identifying Data And Systems Gaps
The changes in lease accounting might lead to extensive data requirements from both staff and exisiting accounting systems. It is possible that they might not be able to bridge this divide if much information is missing or outdated, staff do not have the required skills, or in-house systmes are not up to the task. Companies might have to rethink their technology strategy when it comes to their leasing portfolio. Also, under the new standards, information will need to be accurate, detailed and regularly updated, in order to reflect the true liability of an organisation. Whether a company enlists outside help or not, it will ultimately lead to the existence of more useful and complete data on all leasing agreements, making analyses and future decisions easier.
Proactive lease management
The implementation of IFRS 16 will provide managers with a clearer picture of the true costs to the business of their leasing agreements. As the data is regularly updated, changes will also become apparent earlier, enabling well-informed decisions to be made with regards to current or future management of leases.
Driving savings and compliance
A more robust internal financial accounting system could lead to a significant reduction in risk, offsetting the possible costs of staff training and acquiring the use of more technologically advanced equipment. The design, implementation and monitoring of effective controls within a business can only be beneficial in the long run.
IFRS 16: A quick summary
In January 2016 the International Accounting Standards Board (IASB) issued an International Financial Reporting Standard (referred to as IFRS 16) to be implemented by all companies that report under IFRS by January 2019. It replaces the earlier leasing standard IAS 17.
The main difference between the two leasing standards is the fact that operating leases were not necessarily shown on balance sheets before, but now they will have to be. “IFRS 16 establishes principles for the recognition, measurement, presentation and disclosure of leases, with the objective of ensuring that lessees and lessors provide relevant information that faithfully represents those transactions”, according to IFRS 16:1.
Under the new regulations, the company that is the lessee must recognise as an asset the right to use a leased item, and as a liability the item’s present value of future lease payments. It is important for companies to distinguish between a lease and a service contract – the main differentiating factor here would be whether the asset is controlled by the customer, or not.
The new standard is aimed at providing a single lessee accounting model, requiring lessees to recognise assets and liabilities for all leases, unless the lease term is a year, or less, or the underlying asset has a low value (such as office furniture or computers), according to Deloitte UK.
The main challenges for companies when implementing the IFRS 16 are:
- All operating leases will have to be reflected on balance sheets
- Staff will have to be trained in implementing the new IFRS 16 and complying with regulations
- Shareholders will have to become accustomed to an increase in recorded operating debts, assets and liabilities
Why leasing remains popular with many businesses
Leasing remains a popular way of freeing up cash in a business, while still having the use of necessary assets, without the attendant costs and responsibilities of outright ownership.
“For the fifth consecutive year since the global economic crisis, the leasing industry has expanded…” says Brendan Gleeson, CEO of the White Clarke Group.
Operating leases refer to leases of equipment, where the lessee has the right of use, but the lessor retains ownership of the asset beyond the end of the lease agreement. This option is often chosen by companies who need to make use of assets, such as high-tech equipment, cars, or office equipment which they do not necessarily want to own outright. Technical developments in the field often mean these assets become obsolete, or reduced in value within a fairly short period of time and do not make good long-term investments.
For instance, by the time a car or a computer is four or five years old, its value has reduced substantially, and it often needs to be replaced.
Many companies opt for operating leases, even though this still means they have to pay for the operational costs of the asset for the duration of the lease, as they do not want to own the asset by the end of the contract.
With a finance lease, the company or person leasing out the asset (lessee) is responsible for maintenance and insurance for the duration of the lease agreement. By the end of the contract, the lessee (company or person leasing the asset) will have paid in full for the value of the asset, and ownership is then often transferred to that person or company (the lessee) at a nominal fee. ‘Hire purchase’ comes down to the asset acquirer paying for the use of equipment (owned by a finance company), and when the last instalment has been paid, ownership transfers.
Although the implementation of the new leasing standard might appear daunting to many people, it must be remembered that it will, in the long run, be of great financial benefit to companies.
To ensure you achieve compliance in just seven easy steps, take a look at this free how to guide: