IFRS 16: Are You Ready For The Big Change?

The International Accounting Standards Board (IASB) introduced IFRS 16 Leases in January 2016. IFRS 16 brings a new lease accounting system, changing the way companies report under IFRS.

Almost all companies utilize leasing in some form or the other, with some leasing retail spaces while others lease cars, cell towers, and aircraft. These changes are effective from 1 January 2019.

Our guide to IFRS 16 aims to simplify the key areas and prepare you for the potential changes in your business and accounting models.

• IFRS 16--the new lease standard affects companies that adopt International Financial Reporting Standards (IFRS) with effect from 1 January 2019.
• No scope for off-balance sheet accounting for lessees. Balance sheets will show all assets and liabilities, which impacts KPIs.
• There will be a significant impact on the business models of lessors, leading to more focus on services rather than tangible assets.
• Lessees will need more data around their leases.
• Understanding the new standards can prepare you for the potential issues and transition options.

The new accounting standard brings significant changes in lease arrangements and affects both lessees and lessors.

Lessee accounting will be most affected as they are required to identify all leases on the balance sheets. This shows their right on the allocated property for the lease period and makes them liable to all payments associated with that property.

However, lessor accounting does not undergo many changes. They may need to restructure the existing leases along with the lessees.

A 2016 study by PWC talks about the effect of IFRS 16 on financial ratios which differs significantly depending on the industry.

As the new system requires the lessee to identify all the leases on the balance sheet, separating lease and non-lease components becomes even more critical.

Under the new system, a contract is considered a lease only if the involved asset is identified.

For example, let's suppose a person enters into a two-year contract with a stadium owner for a stall near the entrance. The agreement only states that the person is allocated one among the many stalls inside the stadium premises.

The stadium owner can change the allocated stall any number of times during the contract. This is because this contract doesn't contain a lease, as the allocated property isn't "identified."

To analyze a contract, you need to go through the detailed guidelines in the IFRS 16 and check if the contract meets the definition of a lease. Assessing this early on is essential as it sets the base for future accounting of the contract. Lessors and lessees may need access to additional data to make the proper judgment.

Using the leased asset increases the value of the business. So, the lessee should identify it in their balance sheet, which shows their right on the leased property (ROU) along with the liabilities associated with the property.

The lease term can be defined as the non-cancellable period of the lease. It also includes the periods providing an option of extending or not extending the lease, depending on the lessee.

Initially, you can calculate the liability as equal to the value of payments over the lease term. You need to consider the payments under the lease depending on how the lease term is defined. As the lessee has both options, to extend or not extend the lease term, use your judgment to determine a likely possibility.

Lease liabilities are payments that are not paid on the date of commencement. This includes several ranges of payments:

• Fixed payments include those payments that are made after gauging the capability of the asset in generating revenue.
• Variable payments are initially determined using the rate or index on the date of commencement should also be included.
• If the lessee is likely to purchase the property at the end of the lease, you can include this price.
• You can also include penalty payments in case the lessee breaks the lease before its term.

Calculating an exact discount rate depends on many things like the implicit rate in the lease, the investor's IRR, or the lessee's borrowing rate. It also involves a significant amount of judgment, which can make the rate determination even more complex.

During the lease, the lessee has the right to the leased property. This is termed as the right of use (ROU) asset. You can calculate it, keeping in mind all the future payments under the agreement minus the incentives received and the initial costs.

The depreciation or annual review of the lease depends on how it is reviewed under the Cost or Revaluation model of IAS 16. Any changes made to the lease require careful consideration, as they can call for adjustments to the lease liability and the ROU.

Companies need to apply the new standards in a retrospective manner to make easier comparisons between periods.

A lessee has two options for retrospective transition: the full transition approach or the modified transition approach.

The full retrospective transition approach requires you to apply the new standards to all the prior reporting periods.

The modified retrospective approach involves several transitions, simplifying the accounting in the initial year of application. To make proper transitions, overall assessment of these options is required.

Almost every industry depends on leases in some form or the other. The type of leasing depends on the company's requirements. For example, utility companies will lease power plants, whereas airline companies lease aircraft and communication companies lease optic fiber networks. That is why IFRS 16 has impacted every industry differently.

There is a considerable impact on the real estate lessor and their business models due to the change in accounting by the lessees. A 2019 study by CMS says that IFRS 16 can influence the length of leases taken by tenants.

• Changing lessee needs: Due to changes in the system, short-term leases can become popular among lessees. They can also request a variable lease payment, which can be risky for lessors. Real estate lessors may find it impractical to ask for higher lease rates, which can directly impact the pricing. This means that the lessor's investment will perform poorly.
• New service opportunities: The changing needs of lessees provides opportunities for newer services into the real estate business. The new lease standards shift the focus on services, making a change in the business model an inevitable process.

There will be no significant impact on the accounting method followed by the lessors. Their main focus should be on redesigning their business models to suit the needs of the lessees.

According to a 2019 study by Dr. Fabian Wildenauer, the new lease accounting system introduces greater transparency. But, it also brings many challenges for businesses. If you are yet to follow the new system, it is better to ensure compliance by understanding the process.

According to IFRS 16, you should enter all the operating leases in the balance sheet in the form of assets and liability. Implementing the new standard has a high cost and can also impact the financing decisions of your business.

The stages of getting your business ready for IFRS 16 include:

Having accurate and up-to-date information about your leases is essential for this new system. It is difficult to find relevant information as most clients utilize outdated systems to store data.

The solution is to collect all the available data, even if it is in physical copies. To organize this data, you can use artificial intelligence or OCR software. It can create a spreadsheet containing all IFRS 16 compliant information. KriyaGo can help you by finding the right tools to build software according to your requirements.

After organizing the data, you have to make some judgments regarding the new system, which includes:

• Determination of lease terms, including termination and purchase options
• Determination of lease portfolio
• Accounting for variable and fixed lease payments

• Accounting for non-lease components

You can organize your data using spreadsheets. Or, you can use dedicated software meant to extract and categorize relevant data. You will find it easier to keep all the information up-to-date and store it securely.

IFRS 16 is a complex system, which makes finding the right software more difficult. KriyaGo finds solutions to such software problems by integrating the required tools according to your needs.

KriyaGo understands that leases can be complicated with all the different clauses and terms. With IFRS 16, it can be even more complex. KriyaGo can help with resource optimization, compliance, data verification, and validity checks using modern software.

By understanding your requirements, we will build the right tools for you by integrating the latest technologies in the industry.