The new IFRS 16 standard, drawn up by the International Accounting Standard Board (IASB) in 2016, provides a new lease accounting model that removes the previous dual model for lessees, which consisted of separating operating leases from financial leases. IFRS 16 requires lessees to recognize a right-of-use asset and a lease liability for all leases unless the lease term is 12 months or less or the underlying asset has a low value.
What changes for lessors and lessees?
While IFRS 16 doesn’t bring many changes for lessors, who should continue to classify leases as operating or finance leases, lessees will be impacted by:
- An increase of the total balance sheet by recognizing assets (right-of-use assets) and lease liabilities;
- ‘Front loading’ effect in profit and loss (P&L): recognition of more expenses in the early periods of a lease and less in later periods unlike the linear flow in IAS 17 corresponding to the lease payment;
- A change in lease expense classification: from operating expenses (lease payment) in IAS 17 to financing costs and amortization.
Under the previous IAS 17 rules, a large part of a company’s lease contracts could be classified as operating leases and therefore not be reported in the balance sheet. A global analysis by the IASB of approximately 14,000 listed companies and applying IFRS and US GAAP, found that the future lease payments for off-balance sheet leases for those companies totaled USD 2.86 trillion (on an undiscounted basis).
With IFRS 16, this off-balance treatment now belongs to the past. Indeed, the recognition of an asset and a corresponding liability in the balance sheet results in a more accurate representation of reality.
Lease vs. buy?
Depending on the activity and economic sector, lessees’ commonly used financial ratios and performance metrics will be virtually affected under IFRS 16. The table below provides an overview:
Companies leasing important assets (e.g. real estate, aircraft, trains, technology…) are expected to be most affected. Companies with small leases (e.g. computers, small furniture, telephones…) should see less impact because of an exemption for low value assets, which do not have to be recognized on the balance sheet.
These impacts may compel many organizations to reassess certain ‘lease versus buy’ decisions. But the main benefits and reasons to contract a lease remain substantially the same after IFRS 16 as the table below shows:
New data structure, new axis for value
Implementation of the IFRS 16 standard poses some important challenges for companies in terms of processes, and particularly if they do not already have an in-house lease information system. While the additional resources and costs relating to its implementation may feel like an obligation, IFRS 16 also presents several opportunities. The standard will introduce a new data structure, allowing companies to manage their lease contracts in a more value-adding way. This will enable them to more easily compare contracts, evaluate the number of lessors, identify the most favorable contracts, and make decisions that increase their negotiating power.
Want to know more about how Accenture can help your company manage the challenges and opportunities of IFRS 16? Don’t hesitate to contact us for a chat!