IFRS 16: Leases – the impact on your business
IFRS 16 is a new international accounting standard for Leases. This is effective for periods commencing 1 January 2019 if your business is preparing its accounts under International Financial Reporting Standards (IFRS) or FRS 101.
If your business is preparing its accounts under FRS 102 you can be forgiven for turning a blind eye.
Whilst the FRC has not set a target effective date for incorporating the recent IFRS changes into FRS 102, it is widely expected to be included within the next FRS 102 triennial review (due 2022).
Yes, this is a few years away, but the implications of IFRS 16 should be considered well in advance of this. And as with any changes in accounting standards, the forward planning should commence no later than the opening balances of the comparative period in case restatements are required (i.e. for a 31 Dec 2022 year end, this would be 31 Dec 2020).
Operating leases on the balance sheet
IFRS 16 requires companies to capitalise their assets held under operating leases and recognise the corresponding liability.
For readers of the accounts this will provide greater transparency, as operating lease finance will no longer be kept ‘off-balance sheet’. However, there are several implications businesses need to consider.
Implications to consider
- Is it a lease? Need to consider the terms of the contract and the ‘right to use’ aspects of the arrangement.
- What is the lease term? How certain is it that extension or termination options will be exercised?
- A shift in P&L expense classification – lease costs (operating costs) become finance costs and depreciation.
- More lease expenses recognised in the earlier years of a lease and less in later years (i.e. the finance costs are ‘front-loaded’ like a loan, compared to straight line treatment currently)
- Key metrics – given the P&L expense will be classified and phased differently, this could affect key metrics, such as operating profit, EBIT or EBITDA. This could then impact bank covenants or management bonus calculations.
- Tax (!) – if the treatment of a lease for tax purposes is based on its treatment in the accounts.
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