Changes to lease accounting standards
The new IFRS 16 – Leases accounting standard, which takes effect for accounting periods beginning on or after 1 January 2019, requires lessees to account for leases on balance sheet by recognising right-of-use assets and lease liability. This means for lessees, there will be an increase in lease assets and financial liabilities. The change will affect most financial ratios and performance metrics including EBITDA, EBIT, capital ratio, net income and operating cash flows.
If you are a lessee, IFRS 16 will impact you, especially if you lease big ticket items like aircraft, real estate, manufacturing equipment and technology. With so many competing priorities you’d be forgiven for underestimating what’s involved. Most people in your position do – and then they’re blindsided.
We know implementation can be a minefield, so we’ve put together some suggestions to help make each step along the way as straightforward as possible.
#1 Compiling your leases
Gathering all of your leases will take at least double the time you’re anticipating. It’s not just property either – yes, there’s office buildings, warehouses and stores, but there’s also land, manufacturing equipment, company car fleets, delivery trucks, laptops, computers, mobile phones, servers, office furniture, ATM machines, radars, cell towers, laboratories – even aeroplane fleets.
Finding your leases is a job in and of itself. On top of that you’ll also need to review contracts for embedded leases. A good way to ensure you don’t miss anything, is to map out the lifecycle of a lease from when it’s created until the end of its days. This will help you to locate the original documents, variations and any spreadsheets being used to track important dates and rates. It’s also the best way to identify all of your stakeholders. You might find a lease crosses the path of the procurement, legal, property, maintenance, finance, business support and IT teams – or even all of them!
#2 Engaging with your stakeholders
The changes you make as a result of the transition to IFRS 16 will impact stakeholders right across the organisation, so they should be engaged and consulted as part of the process. This alone can be very time consuming. The main stakeholders are likely to be the finance and accounting teams, but could also extend to legal, procurement, property, risk, IT and business support teams.
Some questions worth asking as part of your stakeholder assessment are: Who will load leases and variations into the system? Who will maintain the data? Who needs access to generate and review reports? Which team will be the business owner? Does the IT team need to assess and approve your choice of software provider?
The earlier you work out who should be involved and what their requirements are, the fewer problems you’ll run into down the track.
#3 Understanding IFRS 16
For most organisations, maybe even yours, IFRS 16 has taken a back seat, but now it needs to be up front and centre – especially for those operating in the banking and financial services, healthcare, telecommunications, infrastructure, retail, hospitality, education and corporate sectors. Here’s a high-level overview:
- Leases will no longer be classified as operating or finance
- With the exception of low-level and short-term leases all right-of-use assets and lease liabilities will be recognised on the balance sheet
- Depreciation on right-of-use assets and interest on lease liabilities will be included on the income statement over the lease term
- On the cash flow statement, the total amount of cash paid will be separated into principal and interest
- Financial metrics are likely to change so you’ll need to check if you still comply with your debt covenants.
This is just the beginning! You’ll need to make a number of judgments and estimations to implement the standard effectively. The sooner you understand the requirements the better prepared you’ll be.
#4 Making judgements and estimations
To apply IFRS 16 successfully you’ll need to make a range of judgments and estimations – it’s not something you can take a cookie cutter approach to. Launching into implementation without any pre-thought will almost certainly cause significant delays.
Just some of the things you’ll need to take decisions on are which transition approach to take, whether to apply any of the expedients, whether to apply exemptions, use of hindsight, whether to separate out non-lease components, which discount rate to apply and assumptions on renewals. Other challenges include new measurement criteria, practical expedients, frequent re-measurements, forecasting payments for the lifetime of your properties and assets, new depreciation schedules and accounting for renewals and changes in rent and discount rates. Unfortunately despite the best efforts of your financial spreadsheet whiz, a spreadsheet won’t cut it.
#5 Assessing impact on financial performance
The new requirements will directly impact the financial performance and value of your company so it’s essential you get it right. We expect lessees to see an increase in recognised assets and liabilities, more leases recognised in earlier periods of a lease and less in later periods, a shift in lease expense classification and amortisation, and an increase in net debt/EBITA ratios.
Given the complexity involved, we recommend you invest in a lease management and lease accounting platform that is IFRS 16 compliant so you don’t overlook anything. The changes to financial performance as a result of IFRS 16 may catch some of your stakeholders off guard so it’s worth investing time to produce a simple, well thought out, communications strategy so there are no surprises.
#6 Selecting the right software provider
We highly recommend any organisation with more than a handful of leases invest in a lease management and lease accounting platform. Make sure you set aside enough time to review a range of products, watch demos, engage with internal stakeholders and to negotiate the contract – this in itself can take months!
When selecting a provider there are a few things you can’t afford to overlook, for example, is it truly IFRS 16 compliant? Make sure the claims stack up and that the product has been tested against scenarios provided by international accounting firms. Some of the other software out there is compliant when it comes to basic leases, but not for complex ones.
Further questions worth asking: Does the company employ chartered accountants who understand the IFRS 16 requirements? Is the security top-notch? Can you create custom fields and reports? Can you give your auditor access? Are users unlimited? Is it intuitive enough that your people will actually use it? Does the provider offer training, support, onboarding? Does it provide for both lease management and lease accounting?
Nomos One has worked with chartered accountants who live and breathe IFRS 16 to design a fully integrated IFRS 16 compliant module that encompasses all criteria. It’s intuitive, flexible, customisable and generates all of the relevant outputs. We strongly believe our product is the best on the market – and auditors recommend us to their clients.
#7 Onboarding your data
How long will it take? That depends on the number and complexity of your leases and whether you choose to onboard them yourself or get the software provider to do it for you. Whichever option you choose, the onboarding process will highlight areas that have been overlooked, gaps in the data and further judgments to be made.
Be wary of software providers who suggest the whole onboarding process will only take two weeks. It takes time to gather your leases and enter them into the system. determine how you want the software set up, and set-up repayments and accounting assumptions.
Make sure your IFRS 16 transition project is resourced properly and that the subject matter expert or business lead is in the office and available to drive the project through to completion.
#8 Ownership and maintenance
As with the implementation of any new software product, testing will be required and issues may arise. Make sure you’ve allowed time to iron out any glitches and for new processes, users and systems to find their feet.
Once you’ve been through the onboarding process the data will be in relatively pristine condition – and you’ll want to keep it that way. Factor in time to get regular users trained up so they (a) get the most out of the product and, (b) have the skills to keep it up-to-date. If they don’t, this will directly affect the quality of your financial reports.
#9 Seize the business opportunity
If you have a large lease portfolio, your property or legal teams may be spending hours collating legal documents, writing reports, and reviewing documentation to ensure you’re meeting your lease management obligations. Alternatively, they might be using two or three different tools, when an end-to-end lease management and lease accounting solution could do it all – and do it well.
The implementation of IFRS 16 provides an opportunity for your whole organisation to manage leases more efficiently. This will almost certainly bolster your business case for an IFRS 16 compliant lease accounting platform.
#10 Next steps
Check out our IFRS 16 module, or read more about the Standard on our blog.