Have you checked your leases?

By in Accounting and Finance, Business Trends

Your finance teams most likely remember that the new Lease Accounting Standard (AASB/NZ IFRS 16), released by the International Accounting Standards Board (IASB) applies for the first financial year beginning on, or after, 1 January 2019. But it’s timely to make sure they’re reminded, as you’re either in or about to begin the financial year that it will be first applied.

The new standard can have a significant impact on an entity’s overall financial position, and should be of concern to CFOs and Boards – not just accountants and auditors – and it needs to be considered now.

Companies with a number of leasing or rental arrangements for accessing assets, (which accounts for the majority of companies), could be significantly impacted by the new requirements. William Buck’s Network Risk Senior Manager, Cate Pozzi, stresses that applying AASB/NZ IFRS 16 Leases means all leases will need to be recorded on the entity’s balance sheet to reflect their true nature as a means of financing assets (though there is an exclusion for short-term (less than 12 months) and low value assets).

“CFOs and finance teams will need to keep in mind that the changes to lease accounting cannot be looked at in isolation, and will come just after the changes to revenue recognition (AASB/NZ IFRS 15) and financial instruments (AASB/NZ IFRS 9) are being first applied.”

Further to this, Cate says entities will need to look at all their systems and processes including any performance measures based on profit or EBITDA, or banking or loan covenants.

“Given that there will be changes to the EBITDA, the following may need to be amended; total assets, net assets, working capital or gearing rations, performance measures, options and bank or loan covenants.”

“The main implication is that while cash flows for leases won’t change, how they will be classified in the statement of cash flows will. For the balance sheet, net assets will be affected and for the statement of profit and loss interest and amortisation expenses will now be included rather than a lease/rental expense and the depreciation and interest expense will be higher at the beginning of the lease as opposed to the lease expense being straight-lined,” Cate says.

Cate says these changes will also affect sale and leaseback accounting and the transfer of assets in a sale.

“There are transition options, the main thing for entities to remember during the transition is to apply the same accounting rule consistently to all leases in which they are a lessee,” Cate Pozzi says.

One leasing model – 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.

Initial accounting

At the start of a lease, the lessee obtains both a right-of-use asset, an asset and a lease liability. Entities will recognise assets and liabilities arising for all leases on their balance sheet, with limited exemptions.

Exclusions from the new lease standards

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)

Also, there are exclusions for agreements of less than twelve months, or for low value assets.

Subsequent accounting procedures

In subsequent periods, the right-of-use asset is accounted for similar to property, plant and equipment, while the lease liability is accounted for as a financial liability. Accordingly:

  • The right-of-use asset is depreciated 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 (e.g. 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. Possible outcomes to account for the change are:
    • 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:

  • 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 of depreciation 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 that the lessee is reasonably certain to exercise, must be included in the present value calculation.

What can you be doing now to prepare?

Cate says “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 – make sure you fully understand the terms and conditions of any new leases and what impact this may have.”

Remember, the first year of adoption of any new standard (and this is a particularly large standard) will always be labour-intensive and requires 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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