27 Mar 17

IFRS16 is getting closer – what do you need to know?

IFRS16 is getting closer. The new accounting standard, which was published by the IASB in January of last year, will replace the current standard IAS17 from January 1st, 2019. That is less than two years. It will have an impact on leasing. What do you need to know?

For the change to become official, the European Union still has to officially approve the new accounting standard. If we take that as a given, then new accounting rules will apply for leasing contracts concluded from the start of January 2019.

Under current rules, lease customers book their lease payments directly in their Profit & Loss. Under IFRS16, lease engagements are considered to give a right of use on leased properties, in exchange for future payments (a.k.a. the lease liability). 

Both the right of use and the future payments (a.k.a. the lease liability) will have to be booked in the balance sheet of the lease customers, in accordance with the International Financial Reporting Standards (IFRS). Excluded from this are leases of properties which are low-value, or leased for a period of maximum 12 months.

Why the change? Current rules do not recognise the assets and liabilities in the balance sheet of the lease customer resulting from operating leases. The lease instalments are considered 'expenses', and not a debt obligation. The IASB (and other standard setters such as the FASB and SEC) consequently saw operating lease as a way to hide assets, especially expensive ones. 

Or, as explains Fabrice Bertolle, Head of Corporate Accounting and Consolidation at Arval: “The standards settlers were concerned that financial analysts didn’t have enough visibility on leased assets, notably the important properties such as airplanes and buildings”.

That is why the new standard integrates the idea of controlled use for the leased property by the lessee and shows up in the accounts the leased property rights of use (Assets), and the obligations of lease payments (Liabilities). 

Even under the new rules, lease customers will retain key benefits of the operational leasing principle, including benefits to financing and cash flow, predictability of monthly payments, reduction of risk, flexibility of use and outsourcing of non-core processes. 

However, the change does have a number of important consequences for lease customers:

→ Firstly, rights of use and lease liabilities will now show up on their balance sheets – as will the amortisation of those rights and the interest on the corresponding liabilities. This means that instead of a lease payment (as per IAS17), the cost of lease agreements will now be recognised through a stable amortisation and a digressive interest over time (as per IFRS16)

→ Also, IFRS16 will improve EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation). Says Mr. Bertolle: “In the end, over the duration of contracts, the costs will be exactly the same, while their appearance will be different over time because of the digression of debt interest. Aside from this accounting 'unpleasantness', it must be understood that all long-term leasing operations benefits still remain”.

→ Generally speaking, only companies that are either listed or have chosen IFRS for their consolidated accounts will be affected. Exceptionally, certain countries have also opted for the application of the IFRS reference for their local accounting. However, for these countries, all companies are not systematically obliged to apply this standard either.

→ IFRS16 will become mandatory from January 1st, 2019. But lease customers who use the IFRS15 standards will be able to anticipate and apply IFRS16 from January 1st, 2018.

→ The new accounting standards require advance preparation for the consequences of this new leasing contract management. In particular as this includes a census obligation for the companies on the total of their leasing contracts and the subsequent impacts.

For more information on IFRS16, check out Arval's White Paper on the subject (registration required).

Authored by: Frank Jacobs