International Accounting Standards Board (IASB) has issued a new standard (as mentioned below) which is effective from annual period of 1 January 2019.
- IFRS 16 – Leases – effective from 1 January 2019
Companies are looking at significant changes not only to their accounting policies, but also their operation models to ensure that there are no unexpected surprises. Changes introduced by this standard will entail enterprise-wide changes to how companies operate.
Let’s see below discussion on key items under this standard which will impact most of the companies:
A. IFRS 16 – Leases
In January 2016 the IASB issued IFRS 16 Leases which replaces IAS 17 Leases.
The new standard will apply for reporting periods on or after 1 January 2019. IFRS 16 sets out a comprehensive model for the identification of lease arrangements and their treatment in the financial statements.
Impact on Lessee
IFRS 16 removes the distinction between operating (“off balance sheet”) and finance (“on balance sheet”) leases for lessees. This will result in significant changes for lessees’ financial statements, including:
- All leases being recorded on balance sheet (except, as an option, for low value and short-term leases)
- Increased disclosure about the entity’s leasing activities including tables for the types of assets leased
Impact on Lessor
For lessors, the recognition and measurement principles of IAS 17 have been brought forward mostly unchanged. However, lessors will be subject to significantly increased disclosure requirements relating to assets under operating leases and residual value risks.
- New requirement will affect lessee’s financial statement as all leases are required to be brought on-balance sheet.
- The new standard will affect balance sheet and balance sheet-related ratios such as the debt/equity ratio.
- Impact on the income statement as the entity now has to recognize interest expense on the lease liability and depreciation on the ‘right-of-use’ asset.
- Changes in presentation as EBIT and EBITDA will be higher for companies that have material operating leases.
- Cash flow disclosures will change as cash payments for the principal portion of the lease liability will be classified within financing activities and interest on the lease liability can be presented as operating cash flow (depending on the entity’s accounting policy regarding interest payments).
Let’s understand the impact with an illustration:
Lessee Limited enters into a property lease with Lessor Limited. The following table summarises information about the leased asset:
- Lease term: 5 years
- Economic life: 15 years
- Annual lease payment: AED 10,000
- Discount rate: 8% (Incremental borrowing rate)
- Other: Title to asset remains with the lessee
The below table shows the schedule of lease payments:
A (final) call to action
As of 1 January 2019, the new standard on leases (IFRS 16 – Leases or ‘IFRS 16’) had become effective. This means that the biggest change in IFRS in terms of recording the leasing transactions has started and every company will need to assess the impact on their financial position and income statement for all potential lease contracts.
Implementation road map and involvement of the external consultant
Contact us to know more.
Last Updated: 15th February 2019
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Tag: IFRS 16, Leases