Are your finance teams prepared for new lease accounting standards?

By in Leadership

Many of those in your finance teams will be aware of AASB / NZ IFRS 16 Leases which was released by the International Accounting Standards Board (IASB) in January 2016.

However, it shouldn’t hurt to just act as a reminder it comes into effect on 1 January 2019 and to ensure your finance teams are already preparing for the deadline. Most companies are expected to be impacted by the new regulation due to the number of leasing or rental arrangements they have to have in place to access assets. The changes will impact all entities with sizable operating lease commitments.

It is a standard that should be of concern to CFOs and Boards, not just accountants and auditors. It is also a standard that needs to be considered now as the market is aware of the upcoming changes to lease accounting.

William Buck Network Technical Senior Manager, Kimberley Carney, stresses that AASB / NZ IFRS 16 Leases means that all leases will be required to be on the entity balance sheet and will reflect their true nature as a means of financing assets.

“CFOs and finance teams will need to keep in mind that leases cannot be looked at in isolation. The changes to revenue recognition (AASB / NZ IFRS 15 ) and financial instruments (AASB /NZ IFRS 9 ) will also need to be considered.”

‘One leasing model’ – So what do you need to know?

The current distinction between finance and operating leases will no longer be applicable for lessees. Rather, lessees will apply a single accounting model for all leases. This model recognises that, at the start of a lease, the lessee obtains both a right-of-use asset, an intangible asset, and a lease liability. Entities will recognise assets and liabilities arising for all leases on balance sheet, with limited exemptions.

Exclusions

There are some exclusions from AASB / NZ IFRS 16 as there are specific requirements in other accounting standards:

  • Exploration leases for minerals, oil, natural gas and similar non-regenerative resources (AASB/NZ IFRS 6 Exploration for and the Evaluation of Mineral Resources)
  • Biological assets (AASB 141 / NZ IAS 41 Agriculture)
  • Service concession arrangements (Interpretation/NZ IFRIC 12 Service Concession Arrangements)
  • Licences of intellectual property of a lessor (AASB /NZ IFRS 15 Revenue from Contracts with Customers)
  • Rights held by a lessee under a licensing agreement (AASB 138 /NZ IAS 38 Intangible Assets).

Subsequent accounting

In subsequent periods, the ‘right-of-use’ asset is accounted for in a similar manner to property, plant and equipment. The lease liability is accounted for as a financial liability.

Accordingly:

  • The ‘right-of-use’ asset is amortised over the shorter of the leased asset’s useful life and the lease term.
  • The lease liability is accounted for under the effective interest method. Lease payments are split between interest expense and a reduction of the lease obligation.

Reassessment of the lease liability

The lease liability is re-measured (with a corresponding adjustment to the ‘right-of-use’ asset) when:

  • Future lease payments based on an index or rate used to determine those payments are revised – example: a change to reflect changes in market rental rates following a market rent review.
  • The lease term is revised –the revised lease payments are determined based on the revised lease term.
  • The lease is modified – Accounting for a modification to a lease depends on the nature of the modification. The possible outcomes are to account for the change as:
    • A separate lease; or
    • A re-measurement of the lease liability using a discount rate determined at that date, and corresponding adjustment to the right-of-use asset. Any resultant decrease in the right-of-use asset would be recognised in the profit and loss.

Key Changes for Lessees

The main implications of AASB/NZ IFRS 16 include:

  • Leases (subject to the exceptions) will be capitalised by recognising a ‘right-of-use’ asset and a lease liability for the present value of the obligation.
  • The lease expense will be front-end loaded, comprising amortisation of the right-of-use asset, and interest on the lease liability.
  • When initially measuring the right-of-use asset and lease liability, non-cancellable lease payments, as well as payments for option periods which the lessee is reasonably certain to exercise must be included in the present value calculation.

What can you be doing now to prepare?

Kim advises CFOs to ensure their business is already well into its preparations for the adoption of the new standards. This will help you to better manage the implementation process and reduce any potential compliance risks.

“Most importantly, businesses need to be aware that they only have two years until the standard becomes mandatory. However, as we are already well into the 31 December 2017 financial reporting period, and the comparative period will begin on 1 January 2018 , time is of the essence and companies need to have drafted a clear plan for adopting this standard and have begun implementing it too.”

“You will need to ensure you have all of the information and processes in place to be able to capture the financial information needed on all leasing arrangements. Also be mindful of any new leases you take on over the next 6-12 months. Make sure you fully understand the terms and conditions of any new leases and what impact this may have.”

Kim says the first year of adoption of any new standard, and this is a particularly large standard, will always be labour intensive and require finance teams to be prepared for the unexpected.

“For example, ensure staff are aware there will be an impact on their financial statements. Because of the way the expense works in the early years of a lease, you will effectively have, or look to have, more expense. As a result, upfront your P&L position will be worse off, rather than the last few years, of the lease.”

You can read more about the lease accounting changes on our factsheets below or get in touch with one of our experts.

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