With IFRS16 and ASC842 coming into force on 1st January 2019 lease accounting is set to change. Here I discuss the challenges, impacts, and benefits these standards are bringing, and suggest ways systems such as IFS Applications can assist the user.

Lease accounting from January 2019

Leases

For both IFRS and US GAAP, IFRS16 and ASC842 are coming into effect from January 2019 and bring operating leases onto the balance sheet similar to current finance leases. This KPMG factsheet outlines the differences in detail.

Operating leases, currently treated as an expense, will now be considered a long term right of use asset (ROU), capitalized at full and fair value with the funding being considered as a debt. This asset is then amortized over the period of the contract.

All operating leases will be considered using this treatment, except for those with a term of less than 12 months, and those of a value less than $5,000.

 

Challenges to lease accounting adoption

Operating leases are currently handled as contracted operating expenses, as such they may not undergo the accounting collation, calculation and audit their financial lease counterparts enjoy.Coins

This may present four major challenges to successful adoption:

  1. Locating, sourcing, collating and assessing current operating leases.
  2. Implementing new processes to record and maintain operating lease values in accordance with the new standard.
  3. Calculating the present value of the lease using an appropriate discount rate, as discussed in this PWC podcast
  4. Assessing the impact caused by this change in accounting methodology on the financial ratios—in particular those that use debt, asset and EBIT as numerators or denominators.

Global macro-economic impacts of lease accounting

The largest impact falls to those companies who have a large value of operating leases. Research by IFRS suggests that airlines, retailers and travel/leisure companies will be most affected, with an average of 30% of total assets as operating leases.

The same IFRS research indicates 62% of North American and 47% of European listed companies will be affected and an understatement of assets equating to 22% and 26% respectively, with a total asset uplift of circa $3Tn globally.

Company financial impacts of lease accounting

Within the financial statements there will be three major changes;

  • Higher Total Asset values – the full ROU asset value will be recognized on the balance sheet
  • Higher Liabilities – the full lease value will be recognized as being financed.
  • Higher EBITDA – as monthly operational cost is replaced by front loaded amortized values.

This will have a major impact on the financial ratios and company valuations, which is very clearly explained in this research paper from Deloitte and factsheet from KPMG.

Benefits offered by the new standard

GrowthAs with any new standard there are benefits to be had rather than just compliance costs;

For the investor who may already adjust the balance sheet to include known operating leases, the improved transparency provides for a better like for like comparison.

For the companies affected, the new focus provides a catalyst for asking questions on the ‘cost effectiveness’ of operating leases as well as tighter financial control.

System enablers

System such as IFS Applications can assist in compliance by satisfying the needs of the lessor and lessee in the following ways;

  • Provision of a dashboard to accumulate leases and highlight the salient values.
  • Provision of an integrated amortization engine to calculate the amortization values and post off into the relevant accounts.
  • Provision for multiple accounting policies to allow for local GAAP, IFRS, SoX compliance variances either at consolidation or on a dual ledger.
  • Provision for automation of financial ratios to be calculated pre and post changes to lease accounting methodology, with comparisons available using dashboards, reports and BI.

 

OK I’m interested, where do I start?

IFS Applications has a Lease accounting solution with both IFRS16 and ASC842 compliance built into its core and integrated with our financial accounting suite. Go onto the IFS website www.ifs.com to find out more, or email me on steve.treagust@ifsworld.com.