The first step in complying with IFRS 16 is to gather all of your lease agreement data and information in order to conduct a full and proper assessment. Then, and only then, can you move onto the next steps in achieving IFRS 16 compliance.
Some of the items which your company leases will be easy to identify. The fleet of company vehicles used by your sales reps and trucks used for deliveries haven’t been owned since before the days of the business’ first major expansion years ago. Warehousing or offices are other big ticket, easy to identify lease agreements.
But what about other less obvious lease agreements that are used within your operations?
IT equipment across your various sites, for example, or the machinery in one of your plants can both be less obvious agreements to capture as part of your preparations for IFRS 16 compliance. IT equipment leases can be difficult to collate and categorise when it comes to whether to elect for a possible exemption, and heavy plant or machinery could have been in operation for over a decade and still have plenty of years left in it yet. You may assume, albeit for different reasons, that both of these types of assets would be owned outright by the business.
Finding Leases Within The Business
Investigating all of these areas will give you a better chance of finding all the lease agreements your business holds and therefore ensures compliance is a smoother process:
- Property - offices, warehouses, storage yards, processing plants and factories.
- Transport - cars, trucks, vans, ships, freight train carriages, storage containers.
- Logistics - shipping yards, distribution plants, tracking equipment, pallets and packaging equipment.
- IT and Telephony Equipment - computers, laptops, associated hardware, security cameras, mobile telephones and office telephony, printers and scanners.
- Plant and Machinery - all manufacturing equipment from foundry furnaces to forklift trucks.
- Dependent Items - leased items which are used by another asset e.g. a separate agreement may be held for tyres and the vehicle itself.
Ensuring all of your company’s leases are captured may prove hard enough in terms of comparing agreements against historical lease definitions, but these definitions are altered with the advent of IFRS 16. The definition change only further complicates the process of achieving IASB compliance under IFRS 16 standards as another major change is where a lease should be accounted for – now essentially always on the balance sheet.
This could go a long way to explaining why almost half of all companies who have started their preparation for IFRS 16 implementation say that it’s harder than they envisaged. What’s more, a staggering 23 percent of companies are yet to begin preparations.
Knowing and understanding your leases is fundamental to achieving IFRS 16 compliance, given the change to the definition of a lease itself.
Understand Your Leases More By Understanding The New Definition Of A Lease
A major driver behind the formation of IFRS 16 was the fact that 87% of lease agreements do not appear on balance sheets. The popularity of operating leasing as a method of acquiring assets skews the usability and validity of balance sheets and undermines their entire purpose of stating the total liabilities of a business and the actual assets of a business. Flexibility, cash flow certainty and other benefits of a competitive leasing market have led to leasing being so popular that accounting standards were outgrown.
As said, a core part of these changes is the definition of a lease itself, albeit quite a subtle change at that.
Under IFRS 16, the IASB has agreed that the definition of a lease is as follows:
A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. A contract can qualify as a lease or as containing a lease if:
- The underlying asset is explicitly or implicitly specified.
- The underlying asset is physically distinct.
- The lessee has exclusive use of the item for a period of time and can decide how to use it.
- The lessee has the right to obtain substantially all economic benefits from use of the asset throughout the period of use.
Continuing, leases will be recognised on a straight line basis and the difference between operating lease or finance lease will no longer impact the leases presentation on financial statements. However, as service elements within a contract will not be affected by the change in lease accounting regulation and do not need recognition on a lessee’s balance sheet, there arose the necessity to give clear guidelines between what constitutes a lease.
Once You Know Your Leases, Stay On Top Of Managing Them
Achieving compliance is one reason to gather all of your lease portfolio information and data, but you will also need to assess the impact on many key financial reporting areas. Asset turnover, interest cover, key ratios, operating profit, net income and cash flows will all be affected under IFRS 16.
Your lease portfolio will need to be managed with much closer scrutiny in a post-IFRS 16 accounting world. Given that your business will be contributing to the billions of dollars which will appear on balance sheets as of 1st January 2019, it’s in your interest to stay on top of lease agreement performance. This means everything from minimising instalment amounts to ensuring there are no automatic renewals. Now you have gathered the facts, keep them up to date and use them. The majority of businesses are still hoping to do this manually.
But that will not be sufficient.
Find A Tool Which Makes Lease Accounting And Assessment Easy
Businesses should be looking to source a lease accounting tool which lets them optimise their portfolio, achieve IFRS 16 compliance easily and leave them to focus on other areas of the company.
Speak to your IT department about the tools you already have at your disposal and how they can be used to store, collate and present lease related data. There are a range of platforms on the market which offer this as part of their suite of features.
If you are still in the early stages of IFRS 16 preparation, although it’s getting close to the eleventh hour, you're not alone. However, time is running out.
Make sure you get up to speed with what needs to be done in order to meet the IFRS 16 implementation deadline of 1st January 2019 by downloading our complimentary 7 step guide to compliance.