On January 13, 2016 the International Accounting Standards Board (IASB) finished its long-standing project on lease accounting and published IFRS 16, Leases, which replaces the current leasing Standard IAS 17 and related interpretations. IFRS 16 is likely to have a significant impact on the financial statements of a number of lessees and also on the long-term lease negotiations.
1. Objective
IFRS 16 sets out principles for the recognition, measurement, presentation and disclosure of leases in IFRS financial statements, with the objective of ensuring that lessees and lessors provide relevant information for those transactions. Especially the provision of a single lessee accounting model, requiring lessees to recognise right-of-use-assets and liabilities for virtually all leases, unless the lease term is 12 months or less or the underlying asset has a low value, on the balance sheet, is intended to improve the quality of financial reporting and the comparability of financial statements of lessees.
2. Scope
IFRS 16 applies to all leases, including subleases and sale and leaseback-transactions, except for leases related to the exploration of mineral resources, biological assets, service concession arrangements and certain rights within the scope of IFRS 15, Revenue from Contracts with Customers, and IAS 38, Intangible Assets.
3. Identifying a lease
At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. 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. Control is conveyed where the customer has both the right to direct the identified asset’s use and to obtain substantially all the economic benefits from that use.
4. Separating components of a contract
For a contract that contains a lease component and additional lease and non-lease components, such asthe lease of an asset and the provision of a maintenance service, lessees shall allocate the consideration payable on the basis of the relative stand-alone prices, which shall be estimated if observable prices are not readily available. As a practical expedient, a lessee may elect not to separate non-lease components from lease components and instead account for all components as a lease
5. Effective date and transition
An entity applies IFRS 16 for annual reporting periods beginning on or after 1 January 2019. Earlier application is permitted if IFRS 15 has also been applied (prematurely if before 1 January 2018). As a practical expedient, an entity is not required to reassess whether a contract is, or contains, a lease at the date of initial application. A lessee shall either apply apply IFRS 16 with full retrospective effect or alternatively not restate comparative information but recognise the cumulative effect of initially applying IFRS 16 as an adjustment to opening balance of retained earnings (or other component of equity, as appropriate) at the date of initial application.
6. Impact of IFRS 16 on long-term lease contracts
The most significant effect of the new requirements of IFRS 16 will be an increase in lease assets and financial liabilities. In 2014 listed companies using IFRS or US GAAP disclosed almost USD3 trillion of off balance sheet lease commitments. Accordingly, for companies and industries with material off balance sheet leases, and particularly with long-term lease negotiations, such as airlines, retailers, travel and leisure and transport, there will be a significant change to key financial metrics derived from the company’s reported assets and liabilities, for example, leverage (gearing), current ratio, asset turnover (sales/total assets), EBIT, EBITDA. It is expected that the terms and conditions of future debt covenants will change. The IASB does not expect the effect on equity to be significant for most companies – the effect will depend on the company’s financial leverage, the terms of its leases and the ratio of lease liabilities to equity. As described above the new accounting model for lesses is expected to increase the operating profit and the finance costs and will result in a higher EBIT and EBITDA.
In particular IFRS 16 is likely to have a significant impact on the long-term lease negotiations since the amount of the lease liabilities depends among others on the amount fixed payments, therefore on the lengthof the non-cancellable period of a lease under consideration of an extension option, whose exercise is reasonably certain.
However, it should also be noted that the amount of lease liabilities also depends on
- variable lease payments that depend on an index or a rate
- variable lease payments that are not included in the measurement of the lease liability (such as lease payments linked to sales)
- lease incentives receivables
- residual value guarantees oft he lessee
- reasonably certain payments of a purchase option
- reasonably certain payments of penalties for terminating the lease
IFRS 16 might provide incentives to structure transactions to achieve desired accounting outcomes. Examples include reducing the length of lease terms and making lease payments variable, all in an attempt to recognise smaller lease liabilities.
Nonetheless, the IASB acknowledges that the change in accounting might have an effect on the leasing market, if companies decide to buy more assets and, as a consequence, lease fewer assets. However, it can be observed, that a lease typically provides financing of assets without any supplementary guarantees, ongoing renewal of assets based on latest available technologie, services provided with leases (for example, maintenance of assets), a way of sharing risks and profits between a lessee and a lessor (for example, via variable lease payments linked to sales) or the ability to use an asset for only the needed portion of the asset’s total economic life.
CONCLUSION:
Lessees as well as lessors should re-examine their leasing activity as a result of applying IFRS 16. This may result in changes to the length of leases or changes in payment terms or in the offer of additional services by the lessor.
Though the effective date seems far away, entities should ensure that they have implemented systems and processes to identify all lease contracts, to capture the information needed to determine the measurement of the right-of-use asset and the lease liability, and to prepare the new disclosures.