With the implementation date of IFRS 16 fast approaching, companies are working hard to comply in time.
With the implementation date of IFRS 16 fast approaching, companies are working hard to comply in time. However, the job doesn’t end on 1 January when the new standard comes into force. The need for companies to manage leases in a way that meets the new standard will continue indefinitely.
The lifecycle of your leases will look very different under IFRS 16. Compliance will require involvement across a number of functions – firstly to identify and capture arrangements meeting the accounting definition of a lease, and then to reassess judgements on an ongoing basis (for example, the lease term), and finally to reconcile the payments into the lease liability.
The diagram below shows how the new processes will likely operate:
To become – and remain – compliant, businesses need to address seven key challenges in the life cycle of a lease
1. Identifying leases
Controls over completeness of your lease portfolio are now paramount. When entering into new contracts, such as supply or outsourcing agreements, you’ll need a process to identify whether that contract contains a lease. It may fall to a team outside finance (e.g. procurement) to make this initial assessment, with finance then validating.
2. Opex versus capex, and approvals
The distinction between opex and capex has been moved - will all leases now be within ‘capex’ budgets and approval processes? Total budgets are unlikely to change, but now that the arrangements are on-balance sheet, management might take a different perspective. Finance and Treasury will increasingly be asked about lease versus buy strategy as these costs become more visible.
3. Maintain multiple books
Many companies will need to maintain dual books either for tax purposes or for local GAAP (e.g. where subsidiaries in a listed group follow FRS 102). You may therefore still need systems and processes in place to distinguish between finance and operating leases (along with associated accounting).
4. Which systems are you using?
Most organisations are purchasing IFRS 16 software. Beyond the configuration, you need to decide which leases and payments you enter into the systems - both at transition and in the future.
The main decision you need to take is whether “off-balance sheet” items such as low-value and short-term leases, non-lease components and variable payments are included in the system. Although on the surface it may be easier to exclude these payments when inputting the data, in practice using the system to allocate the on- and off-balance sheet elements may simplify disclosures and reconciliations later in the process.
5. How are you going to record your leases?
When it comes to posting lease entries, businesses can take one of two routes. You could continue to post purchase ledger journals for lease invoices as usual, with the IFRS 16 journal reversing and replacing these entries at month end. Alternatively, you might decide to post the lease invoices and IFRS 16 journals into a control account.
Both approaches have pros and cons in terms of management accounts and purchase ledger reconciliation processes. Which one you take will mostly depend on which GAAP you want to use to monitor your business’ performance.
6. Reconciling your purchase ledger is more complex than many realise
Many companies have failed to appreciate how complex it will be to reconcile invoices against the IFRS 16 journal entries. For example, variable lease payments, indexation or rent reviews, and non-lease components on invoices some will need to be allocated between P&L and the lease liability, and some will trigger a re-assessment. Many of these reconciling items will need to be manually resolved.
7. This is now an ongoing process
Your Finance team will need to continuously review the judgements and assumptions across the lease portfolio. This includes reviewing expectations over break clauses, extensions and purchase options.
Overall, it is clear that beyond the technical requirements of the standard, there are some significant practical considerations that you need to consider in your implementation project.