Many organisations worldwide depend on leasing as one of the most significant financial solutions for their operation. This technique helps institutions to make use of assets, plant, and paraphernalia without spending a colossal amount of capital expenditure and cash outflow to acquire such assets. In January 2016, the International Accounting Standards Board (IASB) published an innovative standard, namely, the IFRS 16, which substitutes the IAS 17 and any related interpretations.
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IFRS 16 presents a lease as ‘a contract, or part of a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration’ (Deloitte Global Services Limited 2017, para.3). This new standard will begin operating right from 2019. The implementation of the new lease standard will have a substantial influence on real estate properties and vehicles, for instance, lorries, cars, and some water vessels. The new standard will also affect the area of plant and equipment.
Major Changes in the New Standard
Through the new standard, IASB has changed the manner in which leases are presented in financial reporting metrics deployed in systems such as IAS 17. Although operating lease accounting approaches have been attractive to some organisations due to their avoidance of liabilities coupled with asset recognition, this situation will change upon implementation the IFRS 16 (Lapointe-Antunes & Moore 2013).
The capitalisation of operating leases will have the effect of shifting financial metrics, especially for organisations that have such large leases. In addition, the new standard will most likely result in decreased operating expenses and asset and equity turnover. The new IFRS 16 standard will lead to changes in shareholders’ relationships coupled with business agreements. Hendrie (2016, p. 8) emphasises this position by noting, ‘With a change in financial metrics, ratios, and liabilities, companies will need to take extra care with their disclosures to explain the shift figures.’ However, this scenario has the danger of creating possibilities of breaching financial contracts coupled with pacts.
The new IFRS 16 standard ensures that most of the leases are brought in the balance sheets of all lessees by deploying only one model. Opposed to the previous model, the new framework eliminates the necessity of making a distinction between finance and operating leases in the lessees’ balance sheets. However, consistent with the IAS 17 standard, lessor accounting should retain the distinction between operating and the finance leases.
The old approach to lease accounting made it incredibly difficult in comparing organisations that offer lease assets and their purchasers. For example, in IAS 17, a clear reflection of all operating leases is largely left out in the equation. IFRS 16 alters this approach to lease accounting. It requires balance sheets of the lessee to identify assets that are classified as right-of-use (ROU) (Bascom & O’Donovan 2016). The new standard also demands the recognition of lease liabilities, a plan that encompasses one of the biggest changes to lease accounting under the new IFRS 16 standard.
Comparison Between the New Standard and the Old One
|IAS 17 ‘Leases’||IFRS 16 ‘Leases’|
| ||Operating leases are treated as expenses in the off-balance sheet||Operating leases incorporate both liabilities coupled with assets in on-balance sheet preparation|
| ||Finance leases are included in the balance sheet||Operating leases report interest and any depreciation in a separate manner|
| ||IAS 17 standards complicate the process of making comparisons between those who are purchasing leases and/or those who are making them||Users of financial statements have an opportunity to clearly investigate the impacts of various operating leases|
| ||Liabilities and assets in operating leases are referred in report footnotes. This practice leads to challenges of inaccuracies in presenting organisations’ outstanding expenses||The leases guarantee accuracy in the presentation of organisations’ outstanding expenses|
| ||Meeting off-balance sheet obligations translates to overestimations||Their capacity to separate liabilities and assets eliminates the threat of overestimation|
| ||It pays its main attention to whether the lessor and/or lessee assumes rewards or risks if any||Focus on the party controlling ROU assets. This category links such concerns to IFRS 15|
| ||Off-balance sheets are done for lease coupled with non-lease items||Non-lease items are not included in this class. However, all lease items must be reported|
Benefits of Implementing IFRS 16 on both Company and Shareholders
Companies and shareholders are interested in transparent and easy-to-understand information that can help them in decision-making processes (Morris et al. 2014). The new standard provides companies with the capacity to acknowledge new assets coupled with liabilities. This situation has the benefit of increasing transparency in balance sheets. Such intelligibility is necessary when it comes to influencing the commitment of more shareholders’ capital. Indeed, under the old standard, alterations are made to financial statements to the extent that all transactions force companies to retain off-balance sheets.
The new standard provides an opportunity for organisations to assess their lease liabilities, which are arrived at by following a particular methodology mandatory to all reporting conducted using IFRS 16 accounting approaches (Morris et al. 2014).
The new standard may spur additional costs such as implementation and staff education. However, companies operating in real estate stand to benefit. Corporate real estate has been experiencing complexities in areas that range from cost management, development, and management of outsourcing systems, including the design of workplaces. Despite these challenges, PWC (2016) notes that the strategic function of a corporate real estate has received minimal attention in terms of congruent changes when compared to other aspects of an organisation.
This observation suggests that organisational directors and executives have not fully embraced the contribution of the real estate department in driving business success. However, under the IFRS 16, any increment in assets would underline the necessity for the re-evaluation of capital committed to the department of real estate. Such effort is necessary for maximising investment returns.
The Cost of Implementing the New Standard in both Company and Shareholders
Accounting departments have the responsibility of deploying their professional knowledge coupled with skills to prepare and present financial information in a manner that makes it possible to arrive at requisite decisions on policy formulation, planning, and control (Romney & Steinbert 2012). The increased amount of work in executing this responsibility consumes an organisation’s time and monetary resources. The introduction of a new standard implies that time will be required for all accounting departments to learn and optimise the utilisation of the standard.
In the course of the first year, beginning January 2019, an increased cost of running organisations is anticipated. Accounting departments that will be tasked with implementing the new standard in terms of the inclusion of required new practices would experience a lower work completion rate since they will not have become fully conversant with the new IFRS 16.
IAS 17 treats operating leases in a simpler manner when compared to finance leases. This situation lowers the operation costs of the standard have costs. In other words, the operating leases exist in lower volumes compared to finance leases. Deloitte Global Services Limited (2017) supports this argument by noting that accounting departments that are currently deploying IAS 17 encounter few challenging calculations due to the lower volume of operating expenses. Upon the introduction of the new IFRS 16 standard, all leases will have equal accounting treatments, a situation that implies an augmented volume of work within accounting departments, hence calling for the need for the departments to increase their human resources and the necessary tools and equipment for data processing to yield valid reporting information.
Tips for Auditors to Enhance Compliance with the New Standard Implementation
- Auditors should recognise the pattern of lease expenses from a front-ended approach. They should accomplish this agenda even in the situations where yearly rentals are paid.
- Organisations need to address and assess the impact of the new standard with the objective of understanding the wider organisational implications. Hence, accounting analyses need to take close and objective interests of the new approaches to lease accounting.
- In the implementation process, companies need to conduct extensive analysis on the implications of the new standard to their financial results, the execution costs, and the overall alteration of business practices.
- Auditors should treat the right-of-use assets in the same manner as any other financial asset. ROU assets should be depreciated accordingly. Liabilities need to accrue interests.
Leasing encompasses an important financial solution available to many organisations around the globe. Recognising this position underlines the need for accounting institutions such as IASB to continuously develop and upgrade standards that provide guidelines on how to treat leases during reporting. IFRS 16, which is scheduled for implementation from January 2019, is one of such efforts. The new standard replaces IAS 17. IFRS 16 ‘leases’ require the use of only one model in the treatment of leases in the ‘on-balance sheet’ in the case of lessees. This strategy eliminates any distinction made between financial and/or operating leases. Nevertheless, in lessors’ accounting, the distinction remains.
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Bascom, K & O’Donovan, B 2016, New leases standard–introducing IFRS 16. Web.
Deloitte Global Services Limited 2017, IASB issues new leasing standard. Web.
Hendrie, R 2016, The difference between IAS 17 and IFRS 16: how lease accounting is changing, Innervision, New York, NY.
Lapointe-Antunes, P & Moore, J 2013, ‘The implementation of IAS 16 and IAS 41 at Andrew Peller Limited’, Accounting Education, vol. 22, no. 3, pp. 268-281.
Morris, R, Gray, S, Pickering, J & Aisbitt, S 2014, ‘Preparers’ perceptions of the costs and benefits of IFRS: evidence from Australia’s implementation experience’, Accounting Horizons, vol. 28, no. 1, pp. 143-173.
Romney, M & Steinbert, P 2012, Accounting information systems, 12th edn, Pearson, New Jersey, NJ.