A new lease of life? The IFRS 16 challenge
May 20, 2019
So what did I miss?
In my experience, if you work in a business with any material leases, it’s been quite hard to avoid the news that IFRS 16 is finally here and mandatory for all reporting periods beginning on or after 1 January 2019. It’s certainly been a very long time in the making. In fact the International Accounting Standards Board (IASB) first started looking at revamping the lease accounting standards in 2006.
With a gestation period this long, and with limited impact on cash, it’s perhaps not surprising that many companies have been avoiding the issue and kicking the proverbial can down the road.
Unfortunately, once you scratch the surface it’s a little more complicated to adopt than many first thought (or at least hoped!).
Remind me what it is again….
The concept of IFRS 16 is a familiar one - bring your future obligations and assets on to your balance sheet. In essence, the concept of an operating lease, where you expense the lease payment over the lease period, has disappeared.
There are three major implications:
- Rental charge is replaced with interest on the liability and depreciation of the asset, which has different phasing over the asset’s life.
- These charges are now recognised below EBITDA.
- The option to apply one of three methods gives variability in how assets at transition date are recognised, with there being a possibility to recognise a day one reserves hit for lower future P&L charges.
This means that while over the life of the lease, there is no difference in total expense, there could be major impacts on profit, net assets, and Earnings Per Share (EPS).
Then throw in a range of complexity around how you account for breaks clauses, rental uplifts, dilapidations and onerous leases, and operational complexity in having to gather accurate historic information under certain transition methods, and it's now easy to see why companies have underestimated the impact and effort to implement.
What are my options?
From what I’ve seen, our clients take a range of different approaches. Some have tried to implement system solutions, some have developed their own spreadsheets, and some have outsourced it.
But it’s not been plain sailing. More recently, a lot of my clients are telling me that:
- They have complexities in their lease portfolio that systems and third parties can’t deal with
- They need help collecting the data efficiently and rapidly
- They don’t want a black box that can’t be easily verified and audited
- They need something fast and can’t wait for procurement or IT
One of the solutions that we’ve developed at PwC has helped our clients deal with those questions by providing a tailored, transparent tool that can be used to evaluate the day one impact as well as calculate ongoing financial journals each month. It can be implemented in a matter of days and is fully transparent. Best of all, it doesn’t require complex IT infrastructure or procurement.
We’ve delivered this to a wide ranging, global client base from FTSE 100 to mid-market businesses with multi currency and geographic operations. To date, we’ve run c. 10,000 different types of leases in the tool.
Perhaps the most important message, however, is that whatever you decide is right for your business, you need to get started right now.