On 1st January 2019, the IFRS 16 standard will be implemented, affecting the way companies report their leasing contracts on their balance sheets. Here's how they need to prepare for this.
In the world of big business, a year is not a long time – yet that is how long companies have before the new leasing standard will be implemented, at the beginning of January 2019. This will have a substantial effect on all companies that use leasing as a method to finance the acquisition of their assets. The biggest change is that from this date onwards right-of-use assets and lease liabilities will have to be included on balance sheets.
The purpose of this is twofold, namely to “represent lease transactions faithfully, provide a basis for users of financial statements to assess the amount, and timing and uncertainty of cash flows arising from leases”, according to the IFRS Foundation.
Much has been written about these changes, and the effects they are likely to have on businesses. These include higher initial accounting costs, possible retraining of staff, upgrading of accounting software, increased data collection, and a clearer overall financial picture. There will also be an apparent increase in costs, as liabilities not recorded before will now be included on balance sheets, and these will have an impact on reported profit performance.
A matter of urgency -
“If companies have not yet started their implementation activities, they need to do so soon,” says Gary Kabureck, member of the International Accounting Standards Board.
Companies that rely heavily on leasing could take months to locate and analyse all relevant leases and contracts.
The first critical steps companies need to take include forming a project team, gathering information to assess the impact of the standard, analyse the data, and prepare for the longer-term actions and decisions required.
But before any of this can be done, it is necessary to understand exactly what it is that is changing, form an idea of what the impact is likely to be on your particular business, and exactly how the new classification of lease agreements will be differentiated from service agreements. Additionally, the planning stages of any project need to be laid down with definite timelines before any steps can be taken to implement the proposed changes.
The first two major steps, according to the experts here at Innervision are, first, making sure that everyone in the organisation understands what is changing, (also that the transition is imminent and likely to have a substantial impact), and second, to start the process of collating and reviewing the complete lease portfolio of the business onto one centralised platform.
Key activities within this preparation phase, according to Deloitte, include:
- establish project governance
- understand the standard
- understand transitional options, scope and recognition exemptions
- gather data
- assess the overall impact on the business
- assess the impact on business plans for the next three years
- identify stakeholders
- assess the impact on communications with investors and other stakeholders
- make key decisions and judgements, including defining accounting policy
- plan the remainder of the project.
The steps companies need to take in preparation
Establish Project Governance
This refers to the management framework within which decisions will be made with regards to this particular project. This requires careful thought and planning, as existing management frameworks might not be able to simply absorb additional duties and responsibilities should they turn out to be extensive. This governance also needs to be logical, robust and repeatable, to provide the organisation with a structured approach to managing the changes. One of the key duties of these managers will be to publish a timeline with milestones along which this project needs to be completed.
Understand The Standard
It is essential to understand what exactly is changing (in essence, the off-balance sheet accounting for lessees) and how this might affect the business in the future. These include covenants (formal debt agreements), credit ratings, the actual costs of borrowing, and the perception stakeholders might have of your company.
Understand Transitional Options, Scope And Recognition Exemptions
When the transition to IFRS 16 was initially announced, three years were allowed for implementation - but that was two years ago. Companies can choose between two options: the full retrospective approach (where the measurement provisions for IFRS 16 are applied in full for all leases held at the time of the transition, the comparative financial information restated, and the adjustments made to equity right from the beginning) and the modified retrospective approach (the restatement of financial information is not required and is only accounted for from the start of the current accounting period). Those managing the project must also be aware of the exemptions that exist for short-term leases (less than 12 months) and where an asset is of low value. These leases will need to be identified and specified.
If a company relies heavily on leasing as a way to finance assets, this could be a time-consuming and laborious process. However, for the new system to function most efficiently, it needs to be done accurately. This information could currently be held by different departments and will need to be centralised for this going forward. This will include lease agreements (and their net present value), all information with regards to lease payments, and the exact depreciation cost associated with leased assets. Ultimately, this will provide the company with a better overall picture of their leasing arrangements and more accurately reflect their financial situation.
Assess The Overall Impact On The Business
The new standard may affect the business models and offerings of lessors, as well as the behaviours of lessees, as both become more aware of the actual costs/savings involved in leasing assets. Additional staff, new accounting systems/software, and stakeholder perceptions of the changed balance sheets may all affect the business.
Assess The Impact On Business Plans For The Next Three Years
This might be easier to do once data has been gathered and project governance has been established. This impact assessment should be modified on an ongoing basis.
These would include employees of a company, lessors, lessees, suppliers, customers, shareholders and investors. It is also important that stakeholders understand the likely changes in a company's performance metrics and financial ratios.
Assess The Impact On Communications With Investors And Other Stakeholders
This needs to be done well in advance of the implementation of the new accounting regulations, as changes will not only affect stakeholder perceptions, but might necessitate changes in the way suppliers operate their businesses. They need to be given timely warning to give them the opportunity to assess the differences and initiate any changes.
Make Key Decisions And Judgements, Including Defining Accounting Policy
This will differ from business to business, depending on the nature and the scale of their operations, and the extent to which they rely on leasing as a way to finance assets. It will also depend on the expertise of the current staff and their possible level of input.
Plan the remainder of the project
Again, this will be business-specific. An efficient project governance team will know by the end of this process which of the above processes require further input. There is no time to lose as these ten steps still need to be taken well before 1st January 2019.
If it is to be yourself who will be forming the governance team and beginning preparation for IFRS 16 in earnest, help yourself to a copy of our seven-step guide to compliance by pressing the button below or forward the link to the person who will need it.