The Financial Reporting Council (FRC) recently (September 2020) published a thematic review of disclosures made in the first year of IFRS 16 application, as a follow up to their November 2019 report which looked at disclosures in interim accounts following the implementation of the new leases standard by lessees.
The review aims to help companies improve the quality of their corporate reporting in relation to IFRS 16 ‘Leases’.
The FRC review highlighted that when explaining the impact of adopting IFRS 16 in their reports that many companies provided a good explanation. However, the review also highlighted that the quality of disclosures in future reporting requires improvement.
Key concerns raised in some instances included –
- Over-reliance on “boilerplate language” when setting out accounting policies for leases rather than specifics relating to the lessee’s actual circumstances.
- Inadequate explanations of judgements made by lessees in the application of the adopted accounting policy.
- An absence of the broader disclosures, such as detail on the nature of variable lease rentals or the potential impact on lease liabilities of the exercise of extension options. Too often disclosures required by paragraph 53, relating to amounts recognised for leases, were not in a single note or cross-referenced.
The report did recognise that this was “the first full year of application and that disclosures will continue to develop over time”.
Here we will look at best practice concerning policies, judgements and disclosure reporting under IFRS 16.
Compliance with IFRS 16 should result in companies making available enough relevant information in their annual reports and accounts to ensure interested parties can fully appreciate the effect of the new standard on the financials.
“IAS 1.55 requires presentation of separate line items on the face of the balance sheet where such presentation is relevant for the reader’s understanding of the financial position (determined by reference to an item’s size, nature or function). “
Under IFRS 16 a lease is accounted for by -
- a right-of-use asset and associated lease liability
- the interest expense component of the lease liability
- a depreciation expense for the right-of-use asset
With the exception of investment property right-of-use assets (which are presented as investment property), the right-of-use asset and lease liability must be presented or disclosed separately from non-lease assets and liabilities. If a lessee chooses not to present its right-of-use assets separately on the face of the balance sheet, then the lessee must present them in the same line item that would be used if the underlying asset were owned.
Best practise would be to break down and itemise total lease payments into –
|Description of payment||£0000||Included Within|
|Principle Lease Payments||xxxx||Cashflows from financing activities|
|Interest Payments on Lease||xx||Cashflows from operating activities|
|Payments on short-term leases||x||Net operating costs|
|Payments on low value leases||x||Net operating costs|
|Variable Leases component costs||x||Net operating costs|
|Total Lease Payments||xxxx|
- Ensure that the accounting policy regarding any sale and leaseback transactions is fully explained describing both how they are treated both now in the year of their execution, making clear any material gain or loss.
- Explain fully why any “operating leases” are now considered outside of the scope of IFRS 16 because of either materiality or sizeable non-lease components.
- Set out policies under the new leases standard in terms of IFRS 16 rather than relying on previously used IAS 17 terminology.
Best Practise would include a full description of a sale and leaseback transaction giving full details of the date, the actual assets, the cash proceeds, the gain or loss and the period of the lease.
“IFRS 16 does not require additional disclosures about significant judgements on top of those contained in IAS 1. However, the judgements made or sources of estimation uncertainty in relation to leases may assume greater significance upon adoption of IFRS 16. IAS 1.122 requires disclosure of the judgements made that have the most significant effect on the amounts recognised in the financial statements. IAS 1.125 requires additional disclosures in relation to judgements involving estimation uncertainty.”
Here best practice would include a full explanation of lease periods and why, where applicable, there were extension and break clauses in the lease. The lessee needs to explain the degree of certainty that an option will be taken up or otherwise and the judgements used to reach the decision – past behaviour and economic incentives such as penalty clauses, views on future rentals and leasehold improvements made by the lessee.
“The disclosure requirements for lessees in IFRS 16 include a disclosure objective (16.51), guidance on how this information should be presented (16.52, in a single note, or through cross-reference), specific information which is required to be disclosed (16.53), and guidance on the additional qualitative and quantitative information that may be required to meet the disclosure objective (16.59).”
The FRC report highlighted the failure of certain businesses to make clear and meaningful disclosures around the adoption of IFRS 16 positing that in following best practise a lessee should seek to ensure quantitive information is available in the form of –
- Explanation of gains or losses from sale and leaseback transactions
- The interest element of any lease liabilities
- The methodology of establishing the discount rate applicable to leases
- Expenses and outstanding commitments where the lessee has opted for expedients and exemptions around low value or short term leases.
- Depreciation charge and carrying amount of any right of use assets by class of underlying asset
- Cash outflow for leases
Best practise would include maturity analysis of all leases (in one year time bands), a comparison of current (IFRS 16) and prior (IAS 17) period results, the possible effect of future index or rate linked rental adjustments and future possible cashflows not included in lease liability which may arise due to extension options being exercised.
Innervision would encourage all adopters or potential adopters of IFRS 16 to review the FRC report in more detail and to engage with their auditors to ensure best practise in implementing and complying with IFRS 16.
For additional information on the new IFRS 16 standard and guidance on how to comply, download the '7 Step Guide to Lease Accounting Compliance' – just follow the link below to access your copy.
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.