On 1st of January 2019 the new accounting standard IFRS 16 for Leases will replace IAS 17.
Are you ready?
The IFRS body[1] estimates that there are around $3.3 trillion of lease commitments in companies around the world, and 85% of these commitments do not appear on the balance sheet of organisations.
For some organisations this change will have no impact. It is simply a reorganisation of the reporting obligations. However, many will find themselves needing to think carefully about current and future structures that may affect their relationship with investors, credit providers and others.
What is the change?
The most substantial change the new standard brings is that leases will be brought onto the balance sheet of a company increasing the visibility of their assets and liabilities. No longer is there a distinction between operating leases and finance leases. All are now equal and will need to be shown on your balance sheet.
IFRS 16 effects analysis [2]
There is also a change in how lease expenses are accounted for. The shift is outlined in the following diagram. Whilst there is a change in how the expenses are accounted for, the net effect on the bottom line is expected to be negligible, but there will be timing differences between years in the recognition of expenses over the life of a lease.
IFRS 16 effects analysis [3]
Which companies will be affected and how?
Every organisation needs to do their own work understanding the changes and implications for them. The IASB estimates around half of all listed entities globally will be affected.
The effect in some industries will no doubt be greater than others.
For many the key implications will be around their debt covenants. Whilst their cash flows will not change, how financial institutions view them may well change. Many organisations have very strict covenants in place with their banks and this change will put them on the wrong side of those arrangements.
Some organisations may also find the impact on their balance sheet will have adverse effects on investors’ willingness to part with their cash.
Now is the time to be looking carefully at how you structure any new lease agreements you are entering into and looking for alternatives.
Vendor Implications
The IASB has acknowledged that there may be an impact on vendors as companies make the decision not to lease but instead buy assets. The reality for some companies is that they will not have the capital available to make these purchases but due to other restrictions, traditional operating leasing may not be an option.
Vendors need to explore alternative methods of supporting their clients to buy the assets they still need in a way that will not impact on their balance sheets.
Conclusion
Start getting ready. The change is only around the corner and the chances are you are entering agreements now that will impact you in 2019. The IASB has concluded the benefits outweigh the cost for the market (and not doubt they do).
There are also different ways to tackle the challenges being faced by businesses. Northquest understand the implications of the new standard and are leading the way with a managed service solution that both frees up capital for organisations and supports them to meet their existing covenants with their debt providers.
Important Information: This document is not an offer for financing and is provided for general information purposes only. Northquest does not provide tax, accounting or legal advice. You should obtain independent professional advice to determine for yourself the suitability, benefits and risks of Northquest products and services to you before entering into any contract with Northquest.
[1] http://www.ifrs.org/news-and-events/2016/03/hans-hoogervorst-article-shining-the-light-on-leases
[2] http://www.ifrs.org/-/media/project/leases/ifrs/published-documents/ifrs16-effects-analysis.pdf
[3] http://www.ifrs.org/-/media/project/leases/ifrs/published-documents/ifrs16-effects-analysis.pdf