IFRS 16 – An Introduction

IFRS 16 was issued by the International Accounting Standards Board in January 2016 and will be effective from January 1^st, 2019. IFRS 16 will replace the previous leases Standard, IAS 17 Leases.  The new standard largely impacts the lessees and won’t have much influence on the lessors.

Many positive outcomes are expected out of the introduction of the new lease and the major ones are an increase in leased assets and financial liabilities on the balance sheet of the lessee.

IFRS 16 doesn’t make a distinction between finance leases and operating leases, as in all (material) leases will be treated as finance leases. Short-term and low value leases are exceptions. Under this new standard, you will have to recognize most leases on balance sheets, let your industry be any.

The new accounting treatment will lead to an increase in net debt, a higher EBITDA and a higher invested capital for the lessee. Moreover, it leads to increased visibility of all leases , which will help investors to make better informed investment decisions. Enhanced economic growth is also made possible by IFRS 16, as it improves capital allocation.

IFRS 16 replaces IAS 17, IFRS 4, SIC 15 and SIC 27 leases. If you look into the complete perspective of IAS 17, IAS 17  was introduced with the substance over form and present value concept which was not followed till that time and now it is unchanged almost 27 years.

IFRS 16 requires companies to bring lease commitments on to their balance sheets, which was not mandatory earlier. For instance, take a look at the listed companies that use IFRS or US GAAP, that have around $3.3trillion of lease commitments.  Over 85 percent of these lease agreement do not appear on their balance sheet. The reason is, till date, the  leases were categorized as either ‘finance leases’ or ‘operating leases.

That means the reader is not getting a real picture of how the company is operating, what their financial assets and liabilities are, apart from the leases.

When lease assets and liabilities are not accounted in the financial statements, purchasing of assets becomes difficult. An estimation of lease liabilities is always a difficult task. If you take a proportion of the actual debt related to the lease liabilities, it comes upto 6-10 percent of the liability, only in the balance sheet

With IFRS 16, this problem can be tackled to a greater extend.

So, we have discussed about the pros of IFRS 16, how it is going to bring more transparency to business. But, how difficult will it be for companies to comply with the new standard? It might be quite challenging.

If your company has well-organised lease administration and accounting functions, then this won’t be a difficult process. All you have to do is, evaluate whether adjustments are required in the existing systems to accommodate the changes. Understanding the impact IFRS 16 will have on your organization at an early stage will enable you to sort out issues and reduce implementation costs and compliance risk.