IFRS 16: what’s new in accounting for leases?
In January 2016, the International Accounting Standards Board (IASB) issued a new accounting standard, IFRS 16 Leases. This new standard supersedes the existing IAS 17 Leases and related interpretations.
A company is required to apply IFRS 16 from 1 January 2019 but it can decide to apply IFRS 16 before that date as long as IFRS 15 Revenue from Contracts with Customer is also applied.
A need for change
Leasing is widely used by many organisations, enabling them to use property, plant and equipment without incurring large initial cash outflows.
IAS 17 classified leases as either ‘finance leases’ or ‘operating leases’. Finance leases were reported on the balance sheet, whereas operating leases were reported off the balance sheet. This led to lack of transparency about lease obligations and a failure to meet the needs of the users of financial statements.
The way forward for lessee accounting
IFRS 16 eliminates the classification of leases as finance and operating leases. All leases are to be reported on a company’s balance sheet as assets and liabilities. Some exceptions exist; IFRS 16 does not require a lessee to recognise assets and liabilities for:
- short-term leases (i.e. leases of 12 months or less)
- leases of low-value assets, for example, leases of assets with a capital value up to US$5,000.
The result of applying IFRS 16 will be an increase in lease assets and financial liabilities. Hence, for companies with material off balance sheet leases, there will be a change to key financial ratios which would be derived from the company’s reported assets and liabilities, for example gearing ratio, current ratio, asset turnover, etc.
Implications for lessors
There are few implications for lessors. IFRS 16 substantially carries forward lessor accounting from IAS 17.
A lessor will continue to classify leases as either finance leases or operating leases applying IFRS 16, and account for those two types of leases differently. Compared to IAS 17, the new standard requires a lessor to disclose additional information about how it manages the risks related to its residual interest in assets subject to leases.
The IASB concluded that the benefits of IFRS 16 will outweigh the costs. Thus, IFRS 16 will result in a more faithful representation of an organisation’s assets and liabilities. As a result, it will provide greater transparency about the company’s financial leverage and capital employed to all market participants. This will improve comparability between companies that lease assets and companies that borrow funds to buy assets.