The new leases standard, IFRS 16, brings with it both greater transparency and a number of challenges for businesses. It requires companies to bring all operating leases on to the balance sheet for accounting periods starting on or after 1 January 2019, those still getting to grips with IFRS 16 need to act quickly to ensure compliance.
Most companies uses leases in some capacity, so the impact of IFRS 16 has been wide-ranging, impacting not just financial reporting, but also business models and processes in many departments.
What’s the issue?
Any company that prepares its accounts under International Financial Reporting Standards (IFRS) and has an accounting period starting on or after 1 January 2019 is required to apply the new leasing standard (IFRS 16).
This requires operating leases to be reflected on the balance sheet as an asset and liability. This will have an immediate impact on earnings before interest, taxes, depreciation, and amortization (EBITDA), as well as many other financial ratios.
Not only is there a significant cost to implement and comply with the standards for existing leases, there is a knock-on effect on financing and reporting decisions across the board.
What do you need to do?
The transition to IFRS 16 has many obstacles and each company will need to take a different approach. The broad stages of getting your business ready are:
1. Get your data in order
When starting an IFRS 16 project, the key question is inevitably whether you have complete and accurate information on your leases. You may have an up-to-date lease database ready to go, but we typically find that that clients have outdated lease data, that is missing key information, or none at all.
The initial exercise is to collate the information that is readily available (even if in filing cabinets) and then ask your business units if they have further information. Lease data is then extracted either manually or by using artificial intelligence (AI) and optical character recognition (OCR) software. The result is typically a spreadsheet containing various subsets of data points that the finance team can use as a crucial step to IFRS 16 compliant data in the system. For clients with existing lease data, we’ve also found its useful to complete an independent extraction of a sample of leases to confirm that what’s in the database is accurate.
2. Make accounting judgements
Once your data is in order, the focus moves to making accounting judgements. IFRS 16 judgements include:
determining the suitable lease portfolios
determining the lease term, including any renewal, termination and purchase options, as well as rent-free periods
accounting for various types of lease payments (variable and fixed)
accounting for lease incentives, initial direct costs and dismantling costs
treatment of non-lease components
treatment of onerous leases.
One of the key considerations is discount rates. This can be difficult to calculate as the judgements are complex and typically raise questions such as:
What inputs do I need and where can I source them from?
What is my incremental borrowing rate?
Why can’t I just use my weighted average cost of capital as the discount rate?
Is this a one-off exercise or do I need to do this for every lease going forward?
3. Quantify the impact
Some companies may choose to implement a new software solution while others use an Excel model to quantify the impact of IFRS 16 on transition and beyond. Either way, your lease data and key accounting judgements will form the foundation of your quantification.
We recently helped a large UK retailer calculate discount rates for its 200+ property lease portfolio using an Excel based model. We supported the finance through the transition and equipped them with the knowledge on how to calculate any new discount rates in the future.
4. Implement suitable controls, systems and processes
Once you’ve made your way through the IFRS 16 transition process, the journey continues. Keeping your lease data accurate and complete, maintaining up to date accounting judgements, and routinely quantifying IFRS 16 journal entries will need to become business as usual.
How can we help?
Our approach to IFRS 16 blends our knowledge of a wide variety of clients with our expertise from the forefront of accounting. We can help with any stage of the transition including building or refining a lease database, helping prepare your audit documentation, calculating and quantifying the impact of discount rates and implementing any necessary system changes.
Helping you calculate discount rates
Our UK member firm has developed a cost-effective technology platform to help with the most complex part of IFRS 16 - calculating discount rates. It is flexible and can be tailored to your individual business and reporting requirements. The Excel-based tool can help you to:
- analyse your leases to identify consistent ‘buckets’ that can be used to assess your leases as a portfolio
- identify the best approach to calculate the discount rates for your different classes of leases
- determine and source the key inputs for the discount rates, factoring in your credit risk, financing options and lease characteristics
- provide a matrix of the concluded discount rates for each of your leases and lease portfolios
- forecast the impact of IFRS 16 on your future reporting periods (on a lease by lease basis, per location or per asset class)
- document our methodology, and judgements made, in a format that can be provided to your external auditors
- support in responding to any queries from your external auditors and other stakeholders.
to discuss your IFRS16 needs contact Yaser Abbas Salman