Question

“The new Leases Standard (i.e. IFRS16) will provide much needed transparency on companies’ lease liabilities, meaning off-balance sheet financing is no longer lurking in the shadows”. Hans Hoogervost, IASB Chairman

YOU ARE REQUIRED TO:

Discuss critically the benefits and implications of the new Leases Accounting Standard, IFRS16.
(maximum word count 500 words)

TOTAL 20 MARKS

Answer 1

IFRS 116 is a new lease accounting standard published by the. IFRS 116 changes the way that companies account for leases in their financial disclosures, especially their balance sheets and income statements. It replaces an earlier lease accounting standard – IAS 117. The purpose of IFRS 16 is to close a major accounting loophole from IAS 117: off-balance sheet operating leases.

The definition of a lease has changed slightly. Under IFRS 116, “A contract, or part of a contract, that conveys a right to use the asset (the underlying asset) for a period of time in exchange for consideration.”

Key evaluations need to be made in order to apply the definition :

To qualify as right-of-use, the contract must meet 3 criteria:

1. Identified asset

There must be an identified asset. An asset can only be identified if it is physically distinct or if the lessee receives substantially all of the capacity of the asset. In addition, the lessor cannot have substantive rights to substitute the asset.

2. Economic benefit

The lessee must receive substantially all of the economic benefit. To determine what qualifies as “substantially all,” the parties must define the economic benefits of the asset and then determine the allocation of economic benefits.

3. Direct use of asset

The lessee must have the right to direct the use of the asset. If how the asset will be used was predetermined, the lessee must have the right to operate the asset or they must have designed the asset in a way that predetermines how it will be used.

Following are the changes that will have to be adopted :

• At the start date of the lease contract ("commencement date") the right of use (RoU) of the asset is recorded on the asset side of the balance sheet, while the debt incurred for the use of the asset is recorded on the liabilities side. The RoU corresponds to the present value of future payments due throughout the duration of the lease contract, plus any potential direct cost chargeable to the lessee. The rate applied for the determination of the present value corresponds to the implicit interest rate related to the lease contract in case it is directly determinable or otherwise to the lessee's incremental borrowing rate.
• Registration, during the clearance of accounts procedure, has the following effects:

·

• Interests and related leasing debt increase are recorded in the income statement;
• RoU depreciation charge and related redemption fund increase are recorded in the income statement;
• Leasing debt reduction for the amount of payments incurred up to the date considered.

This will have a serious impact on any businesses that use lease arrangements as a means to access assets, particularly those heavily involved in the

• retail,
• shipping,
• property,
• aviation sectors,
• transport & infrastructure,
• entertainment,
• telecommunication,
• lodging,
• construction,
• broadcasting,
• any industry sector where leased assets are of high value.

Impact to the balance sheet

Under IFRS 116, a new right-of-use (ROU) asset will be presented separately on the balance sheet, as will a separate lease liability for almost every lease. All leases will now be considered finance leases unless they meet the low-value (less than or equal to $5000) or short-term (less than or equal to 12 months) exceptions. Key financial metrics such as Return on Assets will be influenced by the addition of these new assets and liabilities to the balance sheet.

Impact to the income statement

Companies must report a depreciation charge for leased assets within the operating costs section of the profit and loss statement. An interest expense must be reported for lease liabilities within the finance costs section of the profit and loss statement. Under the old standard, IAS 17, companies reported a straight-line lease expense that was typically the same in each period of the lease. With IFSR 116, the expenses for leases will be front-loaded as the amount of interest is reduced over the term of the contract.