The UK’s Financial Reporting Council recently issued a report on its “thematic review” of disclosures in the first year of application of IFRS 16 Leases.
Here’s how the news release summed it up:
- The FRC found that most companies provided a good explanation of the impact of adopting IFRS 16, which applies for the first time this year. However, the quality of their disclosures should improve in future reporting. The FRC expects companies to:
- tailor the descriptions of their leasing accounting policies to match their particular circumstances and to cover all material areas;
- provide detailed information about the significant judgements affecting their accounting for leases; and
- include sufficient detail to enable a good understanding of the financial reporting effects of their leasing arrangements on their financial position, financial performance and cash flows.
The report, which was based on a limited review of the annual reports of twenty companies, has the same general virtues of design and content that I mentioned recently in the context of the thematic review of IFRS 15. This includes examples of better disclosures in various areas, including in the strategic report/MD&A. The following plain language overview is from Whitbread PLC:
- Under IFRS 16, lease liabilities and associated ‘right-of-use’ assets are recognized on the balance sheet using discounted cash flows. As many of Whitbread’s leases are long property leases, these changes have significantly increased both total assets and total liabilities, and had a material impact on key performance metrics, including earnings per share. In the income statement, rental charges for operating leases are replaced with depreciation of the newly recognized asset and interest on the newly recognized lease liability. This in turn impacts some of Whitbread’s key reporting measures, including adjusted operating profit, which has increased as a pre-interest measure, and profit before tax, which has decreased as a disproportionate amount of interest is applied at the start of a lease.
This is followed by a tabular summary of the impact on the balance sheet and (shown below) income statement:
Here’s one of various interesting observations dotted throughout the report, this one relating to presentation:
- In some cases, a clearer presentation may have been achieved through separately presenting the right of use asset and lease liabilities on the face of the balance sheet due to their size and nature. We noted:
- In 80% of the instances where lease liabilities were presented in the notes, they accounted for at least 12% of gross liabilities.
- In 85% of the companies sampled where right of use assets were presented in the notes, those assets were more than 5% of gross assets, and in one example, the right of use asset was more than 200 times audit materiality. However, each of these companies had separately presented significantly smaller line items on the face of the balance sheet.
- We expect preparers to consider the materiality of amounts in the context of the IAS 1.55 requirements and whether they should present right of use assets and lease liabilities on the face of the balance sheet.
Let’s look at some of the comments related to covid-19 in particular:
- Given the increased importance of impairment disclosures in the light of Covid-19, we encourage companies to consider the completeness of their disclosures. If other assets are subject to a significant risk of material impairment but right of use assets are not, a brief explanatory sentence may be helpful to readers.
- We expect companies to clearly explain the use of any of the reliefs permitted by the (recent amendment to IFRS 16), and to consider whether any judgements made, for example relating to scope, need to be disclosed.
- The time bands disclosed (for IFRS 7 liquidity risk disclosures) need to be consistent with the information provided internally to key management personnel. While the appropriate level of disaggregation of time bands may differ between companies, we expect companies to consider whether a greater degree of disaggregation is required in the current Covid-19 environment.
- Explanations of missed rent payments (will constitute more important disclosure) if these constitute default events impacting other financial instruments or compliance with borrowing covenants.
As I said before, regarding that first item, I’ve always thought it’s a little onerous to expect companies to anticipate all of the possible things that some readers (especially specialized ones) might conceivably expect to be material in their financial statements and then to specify for them that those things aren’t actually material. That aside, the last two items are really examples of joining the dots – between internal discussions and external ones, between financial events and contractual consequences, between financial statements and management commentary – and of establishing a reporting culture and mindset that increases the likelihood of the connections between those dots being identified and communicated.
The report notes that the FRC is “writing to a number of companies included in our sample, where we identified a substantive question relating to their disclosures and/or specific areas for improvement.” The use of the present tense might suggest it’s taking a while…
The opinions expressed are solely those of the author