IFRS 16: The New Lease Standard
The International Accounting Standards Board (IASB) has published the new guidelines for International Financial Reporting Standards (IFRS) 16. IFRS 16 is the new standard for leasing. Virtually every international company that makes use of rentals or leasing will have to deal with these updated regulations. What are the consequences for international companies that operate from the Netherlands?
RJ-Statement 2018-3 and IFRS 16
The Council for Annual Reporting (RJ) has announced that it intends to allow the use of IFRS 16 for all legal entities that are applying the current ‘Guidelines for annual reporting’. ‘Chapter 292 Leasing’ from these guidelines, which has been used until now, will therefore be canceled. In this way, the RJ seeks to ensure that a legal entity that draws up the annual accounts for the processing of lease agreements based on the ‘Guidelines for annual reporting’ remains aligned with their parent company that adheres to IFRS.
At present, the RJ is examining the impact of IFRS 16 on ‘Chapter 292 Leasing’. Attention has been paid to the assessment of whether a contract contains a lease and if so what information should be included in the notes. In 2018, the RJ expects to come up with a ‘Statement of text proposals for amendments to the Guidelines for annual reporting’.
Redefinition of Financial ratios resulting from IFRS 16
The new requirements virtually eliminate ‘off balance sheet’ assets and liabilities for those who actively lease. Frequently used financial ratios such as gearing ratio (EBITDA) and EBITDA (income before interest, taxes, depreciations and impairments) are included in this. Although the application of IFRS 16 will increase comparability, it will also have an impact on items such as covenants, credit ratios, rental costs and stakeholder perception.
Company data and processes and IFRS 16
Changes to the lease standard have a profound impact on the business processes of those engaged in leasing, as well as their internal control environments. Leasing parties will now have to include significantly more data regarding their leasing, as almost all leased items must now be included in the balance sheet. Previously, this was often only applied in the case of operational lease contracts.
Consequences of IFRS 16 for Businesses
Under existing regulations, those actively leasing account for any lease transactions as either operational or financial leases. This depends on a set of rules and tests that show whether the lease should be accounted for on the balance sheet. The impact of these new regulations on financial statements, asset financing, IT systems and internal control of leasing is expected to be substantial. Many companies lease on a large scale, including items such as cars, offices, power plants and retail premises etc.
It is anticipated that the balance sheet total will rise. Virtually all financial ratios will change, which in turn can influence the bank covenants and credit ratios, etc. These consequences can force organizations to reconsider their decision-making as far as “leasing or buying” is concerned. Companies that lease large assets, such as buildings, machines, ships, etc. will be especially affected by the change in regulations. Companies that mainly lease small inventory items such as laptops, telephones, etc. will have less problems with the changes. The IFRS regulations give the option to not apply the rules for assets with a total value below $ 5,000. These assets therefore do not need to be declared.
The responsibilities of the party leasing out the items in question will be affected to a lesser extent. They can expect to see a change in the behavior and requirements of those customers leasing from them, however.
Changes in IFRS 16 vs Chapter 292 on Leasing
For organizations and departments that are leasing items, the distinction between operational and financial leasing will disappear. The right to use a specific asset during the agreed lease term and the liability of paying lease installments during that time must be recognized in the balance sheet for all leases with a value greater than $ 5,000.
Initially, those leasing items must therefore – in accordance with the new standard – take on an obligation based on cash payments during the lease term. The determination of the lease term will require a certain estimate of additional items that were not previously required for operational lease contracts. Initial fees and repair costs will now also be included in the first valuation.
Companies should make the necessary preparations for IFRS 16
These standards will take effect as of 1st January 2019. For the time being, it is essential that internationally operating companies are aware of the situation as it evolves. When the RJ adopts the IFRS standard it will affect almost every Dutch company.
The earlier that companies begin their preparations for these changes, (including a comprehensive understanding of the new standard) the more effectively potential problems can be anticipated and avoided in the future. In addition, this reduces initial implementation costs as well as possible non-compliance risks. You do not have to do this alone. Crowe Peak is here to help. Our accountants will provide an analysis of the current situation, after which we will estimate the possible impact on your operations. For questions or to make an appointment, contact Crowe Peak.