The International Accounting Standards Board (IASB) issued the new standard on leases – IFRS 16 – in January 2016 with an effective date of 1 January 2019. This new standard introduces a major requirement for lessees to recognise nearly all leases on the balance sheet which will reflect their right to use an asset for a period of time and the associated liability for payments. This is a major shift from the current IAS 17, which does not require entities to recognise operating leases on their balance sheet particularly for lessees. I believe it is of paramount importance for entities to perform a preliminary assessment as soon as possible to determine how their lease accounting will be affected. Entities will also need to ensure that they have the processes (including internal controls) and systems in place to collect the necessary information to implement the new standard.
Increasingly in Zimbabwe and the world over, leasing has become an important and widely used alternative for financing for assets. It enables companies to access and use property and equipment without incurring large cash outflows at the start. Companies are also able to reduce the risk of obsolescence and residual value loss especially in assets prone to rapid technological changes. I have also seen instances where sometimes leasing is the only way to obtain the use of a physical asset that is not available for purchase. Under the current standard – IAS 17 – lessees account for lease transactions either as operating or as finance leases, depending on complex rules and tests which, in practice, use ‘bright-lines’ resulting in all or nothing being recognised on balance sheet for sometimes economically similar lease transactions. The impact therefore of the new standard especially on lessee’s financial reporting, asset financing, IT, systems, processes and controls is expected to be substantial. Many companies lease a vast number of items where they were currently regarding as operating leases including cars, offices, plants, retail stores, base stations and aircraft. Therefore, lessees will be greatly affected by the new leases standard. The lessors’ accounting largely remains unchanged. However they might see an impact to their business model and lease products due to changes in needs and behaviours. In the following section, we will analyse in detail the impact of leases on both lessees and lessors.
Lessees
Arguably the most significant thing that manages cannot afford to ignore about IFRS 16 is that it will affect virtually all commonly used and reported financial and performance metrics such as gearing, current ratio, asset turnover, interest cover, EBITDA, EBIT, operating profit, net income, EPS, ROCE, ROE and operating cash flows. It is also important to note that these changes in the ratios and metrics may have a big impact on loan covenants, credit ratings and borrowing costs, and could result in other behavioural changes. I believe that these impacts will lead to many organisations and managers reassessing decisions on whether to buy or to lease.
For most entities balance sheets will grow both from the asset and liabilities side, gearing ratios will increase, and capital ratios will decrease. We will also see a significant change in the expense classification i.e. rent expenses replaced with depreciation and interest expense and the recognition pattern (acceleration of lease expense relative to the recognition pattern for operating leases today).
Entities leasing ‘big-ticket’ assets – including property, major manufacturing equipment, aircraft, trucks and technology – are expected to be greatly affected. The impact for entities with numerous small leases, such as tablets and personal computers, small items of office furniture and telephones might be less as the IASB offers an exemption for low value assets (assets with a value of $5,000 or less when new). Low value assets meeting this exemption do not have to be recognised on the balance sheet.
In my opinion, the cost to implement and continue to comply with the new leases standard could be significant for most lessees. This can be worsened if they do not already have a system to manage lease information. We believe as well the costs for transition to the new standard will be significant.
Lessors
Lessees and lessors may need to consider renegotiating or restructuring existing and future leases. Business and legal structures supporting leases should also be reassessed to evaluate whether these continue to be effective (for example, joint ventures and special purpose entities). Lessor accounting remains largely unchanged from IAS 17 however, lessors are expected to be affected due to the changed needs and behaviours from customers which impacts their business model and lease products.
As advice to companies starting to grapple with the realities of this new standard, the pervasive impact of these rules requires companies to transform their business processes in many areas, including finance and accounting, IT, procurement, tax, treasury, legal, operations, corporate real estate and HR