Do you know what IFRS 16 is? If not, you should. It went into effect January of this year and governs how businesses disclose their lease expenses. Many companies utilize rentals or leasing agreements to gain access to assets for operations. For example, a retail store leases its commercial space from a mall or other landlord for an extended period of time, while a national sales team may lease vehicles for travel.
The new IFRS 16 changes will standardize many lease considerations across industries and affect asset values for companies of all types and sizes. Each industry has its own set of considerations for lease decisions. Overall, the updated IFRS 16 leases will require more paperwork, accountability, and transparency from all private businesses.
The IFRS 16 effective date was January 1 of 2019, but the changes have been approved and public since January of 2016. That means there’s no excuse not to be up-to-date on the new protocol. The sooner you recognize the impact this new standard will have on your business, the better prepared you will be to solve potential problems, reduce implementation costs and lower compliance risk.
For your business, these changes will require more time, resources and human capital to handle the mandatory workload increase needed for compliance. But overall, the new practices and standards should improve the financial health of all companies and the health of the national economy, making its net benefits worth the collective accounting headache. This blog will give an IFRS 16 summary and offer advice on how small businesses can comply with its new guidelines.
Why The Switch?
The International Accounting Standards Board chose to replace the IAS 17 standards with increased recognition, measurement, presentation and disclosure of leases for both parties of a business lease or contract for multiple reasons. Over time, the new IFRS 16 process should help many companies recover forgotten lease agreements, auto-renewals or other areas where financial losses can be cut.
The Effects Analysis explains that one likely benefit of IFRS 16 changes includes the fact that listed companies around the world have around $3 trillion worth of future payments for leases, which were not accounted for on the balance sheet under the old accounting standards.
General wisdom says that these updated standards will ultimately empower businesses by optimizing revenue and strengthening the financial scope of every company. It will also help all organizations to ‘future-proof’ their business model ahead of the next regulatory challenge that might appear, by changing how they project future assets and liabilities.
A Clearer Reality
IFRS 16 will increase the visibility of every company’s lease agreements and better reflect our collective economic reality. The new standard will also make it easier to compare companies that lease assets with companies that borrow money to buy assets, creating a more even playing field for investment and entrepreneurship.
More Services, Fewer Assets
Experts project that the new standard may affect lessors’ business models and offerings. It could also accelerate existing market trends in leasing including the increased focus on providing services instead of physical assets.
New Data Points & Metrics
The new standard will also redefine commonly used financial metrics like EBITDA and the gearing ratio. It will also eliminate nearly all off-balance sheet accounting for lessees. This will make comparability easier, and may also affect covenants, credit ratings, borrowing costs and stakeholder perception of businesses that borrow.
Restructuring & Renegotiating
Restructuring and renegotiating may also become common as lessees and lessors will need to consider how to best adjust their negotiation strategies for new and existing leases. Joint ventures and special purpose entities could also be affected.
If you are in the Retail, Telecommunications, Transport & Logistics or Real Estate & Equipment Leasing, your business is projected to be the most impacted by IFRS 16. Retailers, for example, could take a projected 98% increase in debt following the new considerations.
An important exemption to the new IFRS 16 standards is made for leases of low-value assets like tablets and personal computers, small items like furniture and telephones and other minor assets worth under $5,000.
A similar exemption exists for leases that last 12 months or less. In such cases, a lessee acknowledges the lease payments in profit or loss on a straight-line basis over the lease term.
Steps To Make Sure Your Business Is Compliant
According to PwC, companies should “understand the impact of the new standard and develop an early communication strategy to manage its stakeholders (and their perceptions). This includes extracting, gathering and validating lease data, assessing the impact and preparing for the re-design of its IT systems and processes impacted by the new standard.”
Dig Through Your Records
The first step of the IFRS 16 compliance process is digging up all of an organization’s leases no matter where they may be collecting dust.
Get The Record Straight
In order to pull the necessary data out of these old records, you will need all leases saved in a single, searchable location in a search-readable .pdf file. Analytics systems can help you efficiently manage this important data and standardize it across categories.
Manually Confirm New Data Points & Submit
You will need to apply additional man-hours to manually check that each of your updated leases has considerations of the following data points:
“Lessor information, lease start date, full contract duration, lease incentives, frequency of rentals, index or rate-based variable payment, index or rate at the date of commencement, current rate, frequency of revaluations to latest index or rate, residual value, rate implicit in the lease, restrictions or covenants imposed, termination terms, termination breach, lease termination date, termination breach penalty payment, purchase option, purchase price, purchase option reasonably certain to be exercised, extension option, rent payable under extension, rent review fixed uplifts, rent review uplift to market rate, rent review frequency of uplifts, rent review date, contract type, contract number, contract currency, rental space, address, contract reference, signatures, among others.”
More Questions About IFRS 16?
Do you see why understanding IFRS 16 leases is such a big deal for so many businesses? By eliminating the grey area and elevating the nation’s business conscious, IFRS 16 could have a huge impact on how all businesses operate moving forward.
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