IFRS 16 Leases - What does it mean for you?

Last week the International Accounting Standards Board (IASB) issued IFRS 16 on Leases. The changes introduced by this standard is likely to increase both assets and liabilities on your balance sheet and you will need to consider the possible impact on any bank covenants such as Debt/Equity ratios. At Moore Stephens, our expert advisors are well equipped to assist you in applying this revised standard. For more information on the change, read the article below and contact us today.

The International Accounting Standards Board (IASB) issued IFRS 16 Leases on 13 January 2016[1].  Revising the lease accounting requirements was first added to the IASB’s agenda in 2006, since then a number of exposure drafts have been issued and hotly debated. 

Why did lease requirements need to be updated?
The IASB estimates that listed companies using International Financial Reporting Standards (IFRSs) or US Generally Accepted Accounting Principles (USGAAP) currently have approximately US$3.3 trillion of lease commitments, of which 85% are operating leases and therefore have no balance sheet impact.

Key changes
Under IFRS 16 there is no longer a distinction between finance and operating leases.  Lessees will now bring to account a right-to-use asset and lease liability onto their balance sheets for all leases[2].  Effectively this means the vast majority of operating leases as defined by the current AASB 117 Leases which currently do not impact the balance sheet will be required to be capitalised on the balance sheet once IFRS 16 is adopted.

Day 1
Dr Right-to-use asset
    Cr lease liability

This will increase both assets and liabilities on the entities balance sheet and may impact bank covenants such as Debt/Equity ratios.  Entities will need to consider revising any bank covenants likely to be impacted upon in the lead up to adopting IFRS 16.

From a P&L perspective operating leases are typically expensed on a straight line basis under AASB 117.  The new IFRS 16 treatment will result in both a depreciation and interest charge impacting on the P&L.  Depreciation is likely to be on a straight basis however interest is higher in the initial years.  This will have the effect of front loading expenses in the P&L which will reduce over the life of the lease.

The impact of IFRS 16 on lessors is expected to be minimal.

Industries impacted
IFRS 16 is expected to have a wide impact across most industries in particular those industries with numerous and/or high value leases. Those industries that use extensive land and buildings and valuable equipment will be strongly impacted. The following industries are particularly likely to be impacted upon:

  • Property and construction;

  • Government and Not-for-Profit sector;

  • Retailers’ with multiple outlets;

  • Education and training;

  • Health and aged care;

  • Mining;

  • Manufacturing; and

  • Real estate.


Transition
IFRS 16 provides two options for transitioning existing operating leases into the model required:

  • Full retrospective application as if IFRS 16 always applied; or

  • Partial retrospective application as at the date of initial application (start of financial year when IFRS 16 is first adopted).  Under the partial method the liability and right-to-use asset can be recorded as the present value of remaining lease payments.

Application date
IFRS 16 is effective for reporting periods beginning on or after 1 January 2019 (early application possible if IFRS 15 Revenue from Contracts with Customers is also adopted early).

IFRS 16 Example:

Background:

  • Little people is a boutique retailer of children's clothes.  They have entered into a 5 year lease of shop premises with a Westfield on 1 July 2015.
  • The lease requires 5 yearly payments in advance of $25,000 (the first payment is 1 July 2015 and subsequent payments are 30 June).
  • The interest rate implicit in the lease is 10%

Current AASB 117 treatment
Expense annual lease payment of $25,000 through the P&L.

IFRS 16 treatment

IFRS-16-Example-(2).jpg

For more information about how these changes will impact you, contact us on +61 3 9909 7371 or fill in our contact form.

[1] Once adopted by the Australian Accounting Standards Board IFRS 16 Leases will become AASB 16 Leases.

[2] IFRS 16 contains an exemption from these requirements for short-term or low value assets.  Typically these are leases of less than 12 months or leases of items such as laptops or phones.