When it comes to the new leasing standard, there isn’t a single factor – it’s several things that make the standard so complex. With its exceptions and complexities, we have to take a close look at IFRS 16 to see how its implications will affect our business when it comes into effect next year.
Forward-thinking companies are focusing on IFRS 16 to stay on top of new leasing standards. We have to be in-the-know and on top of it to avoid ‘off-balance sheet’ financing.
What is it about this standard that has everyone up in arms?
This is the first of a 3-part series article that discuss the New Leasing Standard, IFRS 16, that goes into effect on January 1 2019. Here, we will explore the new guidelines and how they will affect your financial processes.
When we look at IFRS 9, it’s not-too-distant cousin, it gives the promise of having an enormous impact on financial statements. Many companies are scratching their head about when and how they will be affected.
If you’re out of the loop with its practical implications, this is a good opportunity to listen in to see which types of leases will be most affected. Here’s the round-up:
- A lease with a termination and renewal option
- A lease with a variable payment
- Subleasing agreement
- An intercompany lease
- Lease payments with service charges
- A lease with a restoration provision on property
If many of these apply to you, don’t fret. This just means that you have to think about the standard a bit more than the rest of us.
Let’s explore three of the above lease scenarios and highlight why each one poses its own challenges:
- A lease with a termination and renewal option
A lease term is tricky because it is subjective. The lessee has to decide if the lease term will extend beyond a renewal or termination option. However, IFRS 16 states only if this is “reasonably certain.” As you can see, it’s not clearly defined. There are additions in section IFRS16 B34-41 where this is stated in further detail.
Pay careful attention here, because an accurate assessment of the lease term is critical in order to determine the discount rate of the present value of the future lease payment.
- Subleasing agreement
As the head lease and sublease are separate contracts, you will be dealing with two accounting models. The right of use (ROU) asset that arises from the head lease is finance versus the operating lease classification (of the sublease).
For example, say you’re leasing a building for a ten-year period with the option to extend for five years. At the commencement date, you conclude that it is not reasonably certain that you will exercise the extension option. It determines the lease term to be ten years. After using the building for five years, you decides to sublease the building to another party, and they enter into a sublease contract with a term of ten years.
Entering into a sublease is an event that is within the control of the lessee, and it affects your assessment of whether it is reasonably certain to exercise the extension option. Accordingly, the lessee has to reassess the lease term of the head lease upon the event.
- Intercompany leases
While intercompany lease arrangements were previously classified as operating leases by both the lessee and the lessor, this didn’t attract equal and opposite accounting in each group entity’s accounts – that is, the lessor continued to operate lease accounting, but the lessee did not recognize an ROU asset and a lease liability. This increases the complexity of internal reporting and consolidation systems and processes.
You have to make sure that all your intercompany leases have been properly identified and catalogued. In addition to knowing what the lease terms are, since the lease term is a key estimate for the leasees, you need to make sure that the way you document all of this information makes it easy for you to retrieve it when you need it.
Wrapping your head around what the new standard is, and how it applies to your business will ensure that you will be on your way to ensuring your company reaches a higher level of transparency.
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