Gearing up for change: new lease accounting
Australian Accounting Standard 16
AASB 16, Leases introduces a new lease accounting model for lessees that requires all leases to be brought to account on the balance sheet. This is expected to have a significant impact on those organisations with large or material lease portfolios due to the extensive data collection, process and system changes that may be required on implementation.
The knock-on effect
AASB 16 is not merely a financial reporting issue.
Entities need to consider:
- Impact on
long termcontract negotiation, gearing and banking covenants, forecasts, cash flow.
Leases: AASB 16 Thinking allowed
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- Educating financiers, regulators, board audit committees and other stakeholders about expected impacts.
Indicators and key metrics
- The recognition of a right-of-use asset and a lease liability for lessees will lead to the recognition of depreciation and interest expense, instead of straight-lined operating lease expenses under the current accounting standards. This change in presentation will result in an increase in total assets, financial obligations and net debt. This may impact remuneration schemes, including bonuses and share-based payments amongst other matters.
Data and systems
- Impact on IT systems, high volumes of lease data capture and reporting, business models, accounting policies, creating robust internal controls in order to maintain
integrityof lease information
- May create the need for technology solutions that provide accurate lease data and calculations. As such, some organisations will need a comprehensive technology
road mapwith considerations for modifying existing systems or implementing new solutions
- Entities need to first confirm the accuracy of existing lease databases/data sources. Commencing transition calculations without confirming the accuracy of the underlying lease information could significantly impact on the reported lease assets and liabilities.
Some key challenges that entities may face in assessing the impact of AASB 16 include:
- Determining whether contracts meet the definition of a lease. AASB 16 applies a control model to the identification of leases, distinguishing between leases and service contracts on the basis of whether there is an identified asset controlled by the customer
- Significant resource and systems implications, particularly for entities with a significant number of lease contracts, for
exampleto track leases individually or at a portfolio level and to perform calculations
- Increased requirement for management judgement particularly in respect of the definition of a lease and in the assessment of the lease term
- The impact of AASB 16 on key metrics, debt covenants and management compensation. These need to be modelled and considered at an early stage
- Opportunities to revisit leasing strategy and consider smarter contracting options
- Extensive data requirements, beyond what many entities currently have available
- Establishing an accurate and cleansed lease register to form a correct baseline of financial information. This will support lease accounting under both existing lease reporting requirements and improve the effectiveness and accuracy of the transition to new lease reporting requirements
- Availability of resources to undertake what could be a complex transition exercise.
Some key AASB 16 judgements, exemptions and policy choices requiring consideration include:
- Identifying a lease will sometimes require a significant amount of judgement based on the elements of the definition of a lease
- Determining whether it is reasonably certain that an extension or termination option will be exercised
- Identifying the appropriate rate to discount the lease payments may involve
- Exemptions may be taken for short-term leases (by class of asset) or low-value asset leases (lease-by-lease basis).
- Requirements of AASB 16 can be applied to a portfolio of similar leases provided that such aggregation is not expected to have a material effect
- Lessee may elect not to separate non-lease components from lease components by class of asset
- Lessee may, but is not required to, apply AASB 16 to leases of intangible assets
- There are a number of transition options available that require consideration, including grandfathering lease identification and selecting a full retrospective or cumulative catch-up approach on transition.
Deloitte’s lease accounting solution
We offer a comprehensive approach to implement AASB 16
- Use of a simulation tool to provide a
high levelillustration of the possible adjustments required if the operating lease commitments, as currently disclosed in an organisations financial report, were recognised on the balance sheet as a liability with a corresponding asset
- The simulation includes
illustrationof possible impacts on various financial ratios, particularly the Net Debt to Equity ratio.
Lease data readiness
- Use of proven, artificial intelligence software to automate the process of reading and extracting critical data from your lease documents and contracts.
Use of a Lease Transition Tool and your current lease portfolio to:
- Model an in-depth impact assessment on your key financial metrics if you were to adopt AASB 16 today using detailed lease contract data supported by key assumptions
- Compare the impact of the three different transition methods.
- Assistance with your assessment and identification of an appropriate
long termlease accounting software solution, including determining the required functionalities and compliance with AASB 16 requirements.
Managed lease accounting service
- The option of business partnering is offered to our clients where Deloitte performs all the lease accounting for you and we then provide you with the accounting entries, reconciliations as well as insightful analyses on a monthly basis, as well as providing audit-ready lease packs.
Published: March 2018