IFRS 16: There is time enough – but none to spare
New leasing standard and what CFOs and Finance Directors should know now
- The end of a battle
- IFRS 16 is more than just an accounting exercise
- What changes and how it impacts your metrics
- Why not wait
- 1 January 2019
How can Deloitte help?
Although companies have three years until they are required to present their financial statements under IFRS 16, significant preparation is required and the time to take action is now.
Our IFRS 16 team brings together experts from every Deloitte service line and can help businesses successfully implement this complex new standard. Deloitte is also uniquely positioned to support businesses in addressing the wider commercial impacts of IFRS 16 thanks to smart technology solutions and a market-leading property advisory business.
Our publication ‘Time to take action’ provides guidance on how companies should prepare for the new standard and information on how we can provide support. We have also compiled a list of 10 questions you can ask yourself to help in preparing your plan for IFRS 16 implementation.
The end of a battle
On 13 January 2016 the IASB issued the long awaited new leasing standard IFRS 16. This brought an end to a long uphill battle of turning former IASB chairman, Sir David Tweedie’s ambition – to once sit in an aircraft that actually appears on the balance sheet of the airline - into reality. Or at least almost, as the actual effective date has only been set for 1 January 2019, no less than three years from now. To many CFOs and finance leaders across the board the additional breathing time may appear as a welcome respite, since plenty of seemingly more pressing budget and forecast issues require their immediate attention. However, this may only be true for companies that currently do not have significant off-balance sheet leases.
IFRS 16 is more than just an accounting exercise
For all others, this standard has the potential to disruptively change important balance sheet and income statement metrics. Particularly the airline, retail and travel & leisure industries are expected to be significantly affected by the new leasing requirements. But it does not stop there; all other companies with significant property and car leases might experience some impact on their financial statements. It is, therefore, key to understand that IFRS 16 is not only an “accounting” or “new standards adopted disclosure” exercise that can be delegated to your most junior staff members or auditors. Instead, IFRS 16 requires the inclusion of almost all leases on the lessee’s balance sheet, with only two exceptions:
- Short-term leases
- Leases of low-value underlying assets
Both may, but are not required to be recognised as an asset. Short-term leases are leases with a term of 12 months or less. To be very precise, the lease term includes an assessment of options to extend and to terminate the lease. In effect, this results in almost all property leases to appear on the lessee’s balance sheet, regardless of the length of the non-cancellable lease term, which is typically between 3 and 6 months in Switzerland. Low value assets are only those assets that have an absolute low value when they are new, such as laptops, phones and office furniture. Cars are explicitly not considered “low value” assets.
What changes and how it impacts your metrics
For all the non-exempt leases, the lessee has to recognise a right-of-use asset and a respective lease liability, which is a financial liability. The appearance of an additional asset and an additional liability will affect important metrics like total assets, equity ratio, gearing ratio and return rates such as total return on assets and total assets turnover. And if that were not enough, the new standard will also affect important income statement metrics in subsequent periods. The “straight line” expense of the current operating lease expense is replaced by a depreciation expense for the right-to-use asset and a decreasing interest expense for the financial lease liability, resulting in an increase in EBIT and a front loaded expense pattern. The IASB itself estimated that the majority of companies will experience an EBIT increase of up to 100 basis points. But here is the real hit: As the depreciation of the right-of-use assets will be added back in EBITDA, a significant increase of over 100 basis points is expected for the industries most affected by the new leasing requirements.
Why not wait
Given the above, it is needless to say that CFOs and finance leaders should have an immediate interest in knowing what effect the first time implementation of IFRS 16 will have on their key metrics in order to:
- Steer investor communication appropriately
- Consider changes to financing arrangements (i.e. debt covenants)
- Adjust bonus schemes and more.
On top of that, your company might incur some efforts to screen and classify all lease contracts globally, implement systems to manage and track lease contracts and to gather all information necessary for the additional disclosures. Some accounting decisions require significant judgement (e.g. inclusion of extension and/or termination options) and several accounting options (e.g. bifurcation of lease and servicing payments, transition options) require advanced, high level decision making.