Implementing the new IFRS 16 Leases: next practical steps
Implementing the new IFRS 16 Leases: next practical ste
The effective date of IFRS 16 Leases is upon us. Eagerly expected by analysts, the standard requires companies to bring most leases on-balance sheet from 2019, contributing to enhancing transparency.
What is new?
At the simplest level, the accounting treatment of leases by lessees will change fundamentally. IFRS 16 eliminates the current dual accounting model for lessees, which distinguishes between on-balance sheet finance leases and off-balance sheet operating leases. Instead, there is a single, on-balance sheet accounting model. Lessor accounting remains similar to previous practice, i.e. lessors continue to classify leases as finance and operating leases.
For lessees, the lease becomes an on-balance sheet liability that attracts interest, together with a new asset on the other side of the balance sheet. In other words, lessees will appear to become more asset-rich but also more heavily indebted.
The impacts are not limited to the balance sheet. There are also changes in accounting over the life of the lease. In particular, companies will now recognise a front-loaded pattern of expense for most leases, even when they pay constant annual rentals.
Now that companies have overcome the preliminary challenges of IFRS 16 implementation encompassing data collection, systems and processes, they are on the verge of reporting their first quarterly financial statements under the new standard.
Here are some practical considerations that come to the fore in relation to its application:
- Identifying leasing agreements for which the new IFRS 16 is applicable as of 1 January 2019. The new leasing definition is the test whether an arrangement is on- or off-balance sheet for a customer.
- Smart use of the practical expedients for short term leases and leases of low-value items. Companies need to determine the period for which a contract is enforceable, i.e. consider the non-cancellable period of the lease plus any renewal period, as well as any potential explicit or implicit penalties in case of termination.
- Recognizing which variable lease payments are included in measuring a lease liability. ‘In-substance fixed payments’ or payments that are structured as variable lease payments, but which – In substance – are unavoidable, form part of the lease liability, unlike payments based on turnover or usage (e.g. percentage of revenue).
- What discount percentage the companies should use. Is the implicit rate of the lease readily available and if opting for incremental borrowing rate does the company satisfy the requirements of the definition.
- Choosing the most appropriate transition approach will be a decision between comparability of the financial statements or efficiency.
- How will the new IFRS 16 affect key performance indicators, even more so how will these affect finance covenants or other metrics watched closely by regulators and financing institutions.
And while companies are dealing with the initial transition, they will need to prepare for lease modifications that will take place after transition – a key ‘day two’ aspect of the new world of lease accounting.
How KPMG can help
To assist companies in their IFRS 16 implementation, KPMG has developed a tool which incorporates all functionalities needed to calculate lease liabilities, right-of-use asset, as well as interest and depreciation expenses. A useful feature of this tool is that it can calculate the effects of lease modifications as well.
To learn more about how KPMG’s IFRS 16 tool can help your company, get in touch with us.
Kalina Saltiel, Senior Manager, Audit, presented the topic at the 2019 KPMG Client Business Seminar.
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