The IASB has issued IFRS 16 Leases, effective for annual reporting periods beginning on or after January 1, 2019.
Here’s an extract from the news release:
- (IFRS 16) replaces accounting requirements introduced more than 30 years ago that are no longer considered fit for purpose and is a major revision of the way in which companies account for leases.
- Leasing provides an important and flexible source of financing for many companies. However, the old lease accounting Standard (IAS 17 Leases) makes it difficult for investors and others to get an accurate picture of a company’s lease assets and liabilities, particularly for industries such as the airline, retail and transport sectors.
- Listed companies using IFRS Standards or US GAAP are estimated to have around US$3.3 trillion of lease commitments; over 85 per cent of which do not appear on their balance sheets. That is because leases to date have been categorized as either ‘finance leases’ (which are reported on the balance sheet) or ‘operating leases’ (which are disclosed only in the notes to the financial statements).
- This somewhat arbitrary distinction made it difficult for investors to compare companies. It also meant that investors and others had to estimate the effects of a company’s off balance sheet lease obligations, which in practice often led to overestimating the liabilities arising from those obligations. IFRS 16 solves this problem by requiring all leases to be reported on a company’s balance sheet as assets and liabilities.
- Hans Hoogervorst, IASB Chairman, commented:
- These new accounting requirements bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligations.
- The new Standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off balance sheet lease financing is no longer lurking in the shadows. It will also improve comparability between companies that lease and those that borrow to buy…”
One imagines the IASB must be breathing a sigh of relief at finally getting here. Back in 2008, for instance, then-Chair David Tweedie commented in a Canadian speech: “One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet” (I’m sure he’s in excellent shape, but given the 2019 effective date, fulfilling that ambition perhaps can’t quite be regarded yet as a sure thing, for any of us). I remember that at the first Canadian accounting conference I attended, which must have been in 1995 or thereabouts, several speakers spoke about how the arbitrariness of the old Canadian GAAP model impeded constructing a clear sense of an entity’s financing structure. I was certainly involved in situations where an arrangement was meticulously structured to bring the present value of minimum lease payments below 90% of the fair value of the leased asset (if only by the merest percentage), this often being treated in the bad old days as a “bright line” between finance and operating lease treatment. The transition to IFRS should have eased the most egregious practices in this regard, but the model still runs the considerable risk of allowing dramatically different accounting treatments between arrangements with largely similar strategic intents and economic substance.
On the other hand, it won’t be hard to find entities – perhaps those for which the resulting change in their relative liabilities won’t be that significant, or for which the focus of users is overwhelmingly on cash flows – that will regard the new standard as imposing a lot of additional work for not much value, or as raising various new levels of complication and inconsistency. An article a few months ago mused: “It must be fairly depressing to labour at something for nine and a half long years only to find that the results of all your deliberations and revisions are regarded as misguided by key sections of the constituency you hoped to win over. Yet this is the fate the leasing standard seems almost certain to suffer when it is finally issued…” The IASB has heard all these arguments of course, observing among other things that once the initial changes to systems are in place, the costs of the new standard will be “only marginally higher compared to those incurred when applying IAS 17.” Among other accommodations, the standard allows that a lessee may elect not to apply the new model to short-term leases (a lease that at the commencement date has a term of twelve months or less) or to leases for which the underlying asset is of low value – examples provided in the standard include tablet and personal computers, small items of office furniture and telephones. Overall though, the IASB still expects the standard to affect the amounts reported by almost half of listed companies (while noting that of some 30,000 listed companies analyzed, just 3.8% of them account for over 80% of the present value of total off balance sheet leases).
Anyway, we’ll look at various aspects of IFRS 16 in greater detail in future articles.
The opinions expressed are solely those of the author