After more than
five years, the International Accounting Standards Board (IASB) has finally
issued International Financial Reporting Standards (IFRS) 16, Leases, which is
the new standard that will replace International Accounting Standards (IAS) 17,
Leases.
IFRS 16 was issued to address the criticisms surrounding IAS 17, primarily around the fact that many leases are off balance sheet, thereby making it difficult for users to get an accurate picture of an entity’s lease assets and liabilities; to compare companies that lease assets with those that buy assets; and to estimate the amount of off balance sheet obligations.
The changes that
will be brought about by IFRS 16 are expected to address many of these
criticisms and will better facilitate capital allocation by enabling better
credit and investment decision-making by both investors and companies.
IFRS 16 was issued as part of the IASB’s joint project with the Financial Accounting Standards Board (FASB). Although FASB has yet to issue its revised leases standard, it is expected that like IASB, FASB will require lessees to recognize most leases on the balance sheet. However, since both standard-setting bodies made different decisions during the deliberations, differences are expected to arise between the two new standards.
Among the key changes to the current lease accounting that will be brought about by IFRS 16 are the definition of a lease, the lease accounting models, and the separation of the lease and non-lease components of lease contracts.
DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE
IFRS 16 defines a lease as a contract (or part of a contract) that conveys the right to control the use of an identified asset for a period of time in exchange for a consideration. This retains the requirements of IAS 17 but emphasizes the concept of “right to control the use of an identified asset.”
Determining when a customer has the right to direct the use of an identified asset may require significant judgment, particularly for arrangements that include significant services. Most contracts that qualify as leases under the current IAS 17 are generally expected to be considered as leases under the new standard; however, it is expected that IFRS 16 will exclude from its scope some service contracts that may have been considered leases under IAS 17 (e.g., supply contracts).
LESSEE ACCOUNTING
Perhaps the most significant change that will be brought about by IFRS 16 is lessee accounting. IFRS 16 prescribes a single lessee model that will be applied to generally all leases. IFRS 16 requires all leases to be put on the lessee’s balance sheet, resulting in the recognition of a right-of-use asset and a corresponding lease liability.
The lease liability is measured at the present value of the lease payments to be made over the lease term. The right-of-use asset, on the other hand, is measured at the amount of the lease liability, adjusted for lease payments, lease incentives received, lessee’s initial direct costs and any estimate of restoration and dismantling costs.
The amounts that will be capitalized are generally based on the fixed lease payments, including inflation-linked payments. This means that variable lease payments linked to sales, or use of the underlying asset, or optional payments where extension of lease term is not reasonably certain, will be excluded from the capitalized right-of-use asset.
Subsequent to initial recognition, the right-of-use asset will generally be depreciated over the lease term, applying the depreciation requirements in IAS 16, Property, Plant and Equipment. Meanwhile, the lease liability will be increased to reflect interest accretion and decreased to reflect lease payments over the lease term.
The right-of-use asset is subject to impairment testing in accordance with IAS 36, Impairment of Assets.
EXEMPTIONS
Relief is provided under IFRS 16 in that lessees have the option not to recognize on their balance sheets short-term leases (i.e., a lease that, at the commencement date, has a lease term of 12 months or less and that has no purchase option) or those leases for which the underlying asset is of low value (e.g., a lease of a personal computer). A lessee that opts to invoke the exemption shall recognize lease payments associated with those leases similar to the accounting for operating leases under IAS 17 (i.e., as expense on a straight-line basis or another systematic method that is representative of the pattern of benefit derived by the lessee).
As the relief is optional as far as short-term leases are concerned, this can be an area where judgment may be involved and can pose structuring opportunities. Another area of judgment is determining whether a lease is “low value.” IFRS 16 does not specify what “low value” means, although the Application Guidance to IFRS 16 gives direction on how to determine if an underlying asset is of low value to the entity.
LESSOR ACCOUNTING
The IASB decided not to change the lessor accounting as it has gathered that the cost of currently changing lessor accounting would outweigh the related benefits. Instead, the principles for lessor accounting under IAS 17 are carried forward under IFRS 16. This means that for lessors, there will still be a dual model approach applying either operating lease accounting or finance lease accounting. The IASB, however, decided to enhance the disclosure requirements for lessors, particularly disclosures on the exposure to residual value risk, in response to concerns regarding the lessor’s risk exposure and the lack of information of such exposure.
While it is perceived that lessors will not be as affected by the new standard as the lessees will be, the IASB acknowledges that the change in lessee accounting might have an impact on the leasing market if companies decide to buy more assets and as a consequence, lease fewer assets. However, it is expected that the reasons why companies lease their assets will continue to exist even after the effectivity of IFRS 16.
SEPARATING THE COMPONENTS OF A LEASE CONTRACT
IFRS 16 also provides for the separation of lease from non-lease components based on the relative stand-alone prices of those components. This is highly relevant to contracts that contain a lease coupled with an agreement to purchase or sell other goods or services (i.e., non-lease components such as maintenance).
As a practical expedient, however, a lessee may elect (by class of underlying asset) not to separate the non-lease components, and instead account for each lease component and any associated non-lease component as a single lease component. This practical expedient may result in differences considering that treating a non-lease component as a lease may put it on the balance sheet which could be avoided had it been treated otherwise. The practical expedient is not available for lessors who are required to allocate the consideration among the various components in accordance with IFRS 15, Revenue form Contracts with Customers.
KEY EFFECTS OF IFRS 16
From a lessor standpoint, because IFRS 16 carries the key features of IAS 17 (aside from the additional disclosure requirements), no significant effect is anticipated.
On the other hand, from a lessee standpoint, since current operating leases will be capitalized and accounted for similar to finance leases under IAS 17, the financial statements are expected to significantly change. On the balance sheet, right-of-use assets will increase, financial liabilities will increase, while equity is likely to go down. On the income statement, the general effect on net income before tax is not expected to be significant because while operating expenses are expected to go down (i.e., no operating lease expense but depreciation of leased assets), finance costs will go up because of the accretion of lease liability.
EBITDA (earnings before interest, tax, depreciation and amortization) and operating profit are expected to increase for companies with material off balance sheet leases. Finally on the cash flow statement, operating cash outflows will go down and financing cash outflows will go up.
On the lessee’s performance metrics, debt-to-equity ratio is expected to increase. On the other hand, asset-based ratios like asset turnover are expected to decrease because of the bulking up of the assets. EBITDAR (EBITDA and rent), on the other hand, is not expected to change.
The use of off balance sheet leases is highly concentrated within some industry sectors and within some companies. Among the industries identified by the IASB that have significant operating leases are airlines, retailers, travel and leisure, transport, telecommunications, energy, media, distributors, information technology, and health care. It is expected that IFRS 16 will significantly affect these industries.
EFFECTIVE DATE
IFRS 16 is effective for annual periods beginning on or after 1 January 2019. Early application is permitted but only if IFRS 15 is applied at or before the date of initial application of IFRS 16.
A lessee can apply IFRS 16 either:
a) Retrospectively to each prior reporting period presented, following IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors; or
b) Retrospectively with the cumulative effect of initial application recognized at the date of initial application.
In case Option b) is applied, a lessee shall not restate comparative information.
On the other hand, a lessor is not required to make any adjustments on transition for leases in which it is a lessor, and shall account for those leases applying IFRS 16 from the date of initial application.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
John T. Villa is a partner of SGV & Co.
IFRS 16 was issued as part of the IASB’s joint project with the Financial Accounting Standards Board (FASB). Although FASB has yet to issue its revised leases standard, it is expected that like IASB, FASB will require lessees to recognize most leases on the balance sheet. However, since both standard-setting bodies made different decisions during the deliberations, differences are expected to arise between the two new standards.
Among the key changes to the current lease accounting that will be brought about by IFRS 16 are the definition of a lease, the lease accounting models, and the separation of the lease and non-lease components of lease contracts.
DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE
IFRS 16 defines a lease as a contract (or part of a contract) that conveys the right to control the use of an identified asset for a period of time in exchange for a consideration. This retains the requirements of IAS 17 but emphasizes the concept of “right to control the use of an identified asset.”
Determining when a customer has the right to direct the use of an identified asset may require significant judgment, particularly for arrangements that include significant services. Most contracts that qualify as leases under the current IAS 17 are generally expected to be considered as leases under the new standard; however, it is expected that IFRS 16 will exclude from its scope some service contracts that may have been considered leases under IAS 17 (e.g., supply contracts).
LESSEE ACCOUNTING
Perhaps the most significant change that will be brought about by IFRS 16 is lessee accounting. IFRS 16 prescribes a single lessee model that will be applied to generally all leases. IFRS 16 requires all leases to be put on the lessee’s balance sheet, resulting in the recognition of a right-of-use asset and a corresponding lease liability.
The lease liability is measured at the present value of the lease payments to be made over the lease term. The right-of-use asset, on the other hand, is measured at the amount of the lease liability, adjusted for lease payments, lease incentives received, lessee’s initial direct costs and any estimate of restoration and dismantling costs.
The amounts that will be capitalized are generally based on the fixed lease payments, including inflation-linked payments. This means that variable lease payments linked to sales, or use of the underlying asset, or optional payments where extension of lease term is not reasonably certain, will be excluded from the capitalized right-of-use asset.
Subsequent to initial recognition, the right-of-use asset will generally be depreciated over the lease term, applying the depreciation requirements in IAS 16, Property, Plant and Equipment. Meanwhile, the lease liability will be increased to reflect interest accretion and decreased to reflect lease payments over the lease term.
The right-of-use asset is subject to impairment testing in accordance with IAS 36, Impairment of Assets.
EXEMPTIONS
Relief is provided under IFRS 16 in that lessees have the option not to recognize on their balance sheets short-term leases (i.e., a lease that, at the commencement date, has a lease term of 12 months or less and that has no purchase option) or those leases for which the underlying asset is of low value (e.g., a lease of a personal computer). A lessee that opts to invoke the exemption shall recognize lease payments associated with those leases similar to the accounting for operating leases under IAS 17 (i.e., as expense on a straight-line basis or another systematic method that is representative of the pattern of benefit derived by the lessee).
As the relief is optional as far as short-term leases are concerned, this can be an area where judgment may be involved and can pose structuring opportunities. Another area of judgment is determining whether a lease is “low value.” IFRS 16 does not specify what “low value” means, although the Application Guidance to IFRS 16 gives direction on how to determine if an underlying asset is of low value to the entity.
LESSOR ACCOUNTING
The IASB decided not to change the lessor accounting as it has gathered that the cost of currently changing lessor accounting would outweigh the related benefits. Instead, the principles for lessor accounting under IAS 17 are carried forward under IFRS 16. This means that for lessors, there will still be a dual model approach applying either operating lease accounting or finance lease accounting. The IASB, however, decided to enhance the disclosure requirements for lessors, particularly disclosures on the exposure to residual value risk, in response to concerns regarding the lessor’s risk exposure and the lack of information of such exposure.
While it is perceived that lessors will not be as affected by the new standard as the lessees will be, the IASB acknowledges that the change in lessee accounting might have an impact on the leasing market if companies decide to buy more assets and as a consequence, lease fewer assets. However, it is expected that the reasons why companies lease their assets will continue to exist even after the effectivity of IFRS 16.
SEPARATING THE COMPONENTS OF A LEASE CONTRACT
IFRS 16 also provides for the separation of lease from non-lease components based on the relative stand-alone prices of those components. This is highly relevant to contracts that contain a lease coupled with an agreement to purchase or sell other goods or services (i.e., non-lease components such as maintenance).
As a practical expedient, however, a lessee may elect (by class of underlying asset) not to separate the non-lease components, and instead account for each lease component and any associated non-lease component as a single lease component. This practical expedient may result in differences considering that treating a non-lease component as a lease may put it on the balance sheet which could be avoided had it been treated otherwise. The practical expedient is not available for lessors who are required to allocate the consideration among the various components in accordance with IFRS 15, Revenue form Contracts with Customers.
KEY EFFECTS OF IFRS 16
From a lessor standpoint, because IFRS 16 carries the key features of IAS 17 (aside from the additional disclosure requirements), no significant effect is anticipated.
On the other hand, from a lessee standpoint, since current operating leases will be capitalized and accounted for similar to finance leases under IAS 17, the financial statements are expected to significantly change. On the balance sheet, right-of-use assets will increase, financial liabilities will increase, while equity is likely to go down. On the income statement, the general effect on net income before tax is not expected to be significant because while operating expenses are expected to go down (i.e., no operating lease expense but depreciation of leased assets), finance costs will go up because of the accretion of lease liability.
EBITDA (earnings before interest, tax, depreciation and amortization) and operating profit are expected to increase for companies with material off balance sheet leases. Finally on the cash flow statement, operating cash outflows will go down and financing cash outflows will go up.
On the lessee’s performance metrics, debt-to-equity ratio is expected to increase. On the other hand, asset-based ratios like asset turnover are expected to decrease because of the bulking up of the assets. EBITDAR (EBITDA and rent), on the other hand, is not expected to change.
The use of off balance sheet leases is highly concentrated within some industry sectors and within some companies. Among the industries identified by the IASB that have significant operating leases are airlines, retailers, travel and leisure, transport, telecommunications, energy, media, distributors, information technology, and health care. It is expected that IFRS 16 will significantly affect these industries.
EFFECTIVE DATE
IFRS 16 is effective for annual periods beginning on or after 1 January 2019. Early application is permitted but only if IFRS 15 is applied at or before the date of initial application of IFRS 16.
A lessee can apply IFRS 16 either:
a) Retrospectively to each prior reporting period presented, following IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors; or
b) Retrospectively with the cumulative effect of initial application recognized at the date of initial application.
In case Option b) is applied, a lessee shall not restate comparative information.
On the other hand, a lessor is not required to make any adjustments on transition for leases in which it is a lessor, and shall account for those leases applying IFRS 16 from the date of initial application.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
John T. Villa is a partner of SGV & Co.
Walang komento:
Mag-post ng isang Komento