IFRS 16 reporting lease contracts considerations for finance teams
The IFRS 16 standard introduces significant changes to lease accounting and clarifies the definition of a lease contract.
According to Timo Ihamäki* from PwC Finland, the definition hinges on who has control of an asset: ‘The new standard highlights the concept of control,’ Ihamäki explains, ‘in a lease, the lessee should be able to decide how an asset is used’. In general, the changes do not introduce any substantial changes for lessors. For lessees the situation is different: in future, the distinction between operating leases and finance leases disappears. All leases will be recognised on the lessee’s balance sheet, a substantial change from the current IAS 17 lease accounting standard. Balance sheets will grow when they to include these new assets and liabilities; according to Ihamäki, debts on the balance sheets of large companies may grow by hundreds of millions of Euros (or £ or Kr).
While the balance sheet effect of the new standard is intentional (and may simplify preparing and reading company accounts by removing the need for notes on leased assets), there’s a possibly unintended consequence: The cash flow benefits of using leases remain, but the Op-Ex aspect of an operating lease will be lost. So what before was an operating lease will now have a balance sheet impact. This may slow organisations’ investment decision making: decisions that have been routine, made by a manager using their department budget, will in future require board approval to agree an item affecting the balance sheet.
Some exemptions provide practical relief:
- The leasing contract for short-term leases, when the lease contract is for 12 months or less, can be handled in the same way that lease contracts are today.
- Leases for low-value assets can also be treated as operating leases.
In the IFRS 16 exemptions, assets with a value when new of USD 5,000 or less are considered low-value assets. In practice, IT device leasing deals almost exclusively with items in this category; for example, items like desktop computers, laptops, tablets and smart phones. These low-value assets are handled on an individual asset-by-asset basis rather than collectively. So, if a company leases many workstations, the lease is treated as a lease for multiple exempt items. 98% of all the devices in the 3 Step IT asset register were originally purchased at a price of USD 5,000 or less, so our customers can generally choose to apply this exemption, which is optional.
We will also be able to help our customers with their accounting and financial reporting in accordance with IFRS 16. Appropriate IFRS-compliant reports are provided as part of our Asset NG service, and our clients will be able to use these reports to prepare their accounts.
Our customers use our lease accounting reporting service to handle over 70,000 contracts and nearly half a million devices. This service for verifying your balance sheet will evolve to provide our customers with IFRS 16-compliant reporting services before the standard enters into force on 1st January 2019.
Our customers can decide
- if they want to recognise the lease of short-term contracts and low-value assets as expenses;
- which expenses according to the length of the lease will be included in the lease contract liability, and
- whether the rate applied should be the interest rate implicit in the lease or their incremental borrowing rate.
If you are using our Asset NG lease accounting service, your transition to the new standard should happen smoothly.
Jari Lemmilä, CFO, 3 Step IT
* Timo Ihamäki from PwC discussed the general points of the new lease accounting regulations at a customer briefing 3 Step IT organised. Timo Ihamäki is a member of the PwC expert group that specialises in implementing the new IFRS standards. It’s his view that the change will have substantial impacts on many companies. Ihamäki describes the implementation of IFRS 16 as an enormous exercise which will probably require deployment of new accounting systems.