What is IFRS 16?
IFRS 16 Summary: What is IFRS 16?
The International Accounting Standards Board (IASB) published the new IFRS 16 lease accounting standard, which replaces IAS 17. For the global community, IASB is responsible for developing and promoting the International Financial Reporting Standards (IFRS) for accounting.
What changed under IFRS 16?
IFRS 16 changes the way companies account for leases in their financial disclosures, including balance sheets and income statements. Under IFRS 16, a lessee applies a single lease accounting model where leases are considered finance leases. A lessor classifies a lease as either a finance lease or an operating lease.
Here’s what Ernst & Young (EY) says about the changes: “Whether you report under International Financial Reporting Standards (IFRS) or U.S. GAAP, you are likely to be facing significant changes in reporting requirements as you assess the impact of new standards for revenue recognition, financial instruments, and lease accounting. And these changes are not just impacting organizations reporting under IFRS and US GAAP — many national accounting standard setters are also aligning local standards to IFRS.” Read more here: IFRS Compliance Software & New IFRS Lease Accounting Changes
What is considered a lease under IFRS 16?
Under IFRS 16, a lease is defined as a contract that enables international businesses to use another entity’s identified asset for a specified period of time in exchange for consideration. Common leased assets include:
- Real estate property, buildings, offices and warehouses
- Office equipment
- Medical equipment
- IT equipment
- Vehicles (automobiles, trucks, vans)
These contracts must specify a timeline in which the right-of-use of the asset is established (or an identified amount of use). It should also include all the potential economic benefits from using said asset. Simply put, some contracts that may not have been considered a lease with the original IAS 17 compliance standard, may now be a lease under IFRS 16 – and must be added to the balance sheet.
Exceptions to the IFRS 16 Lease Accounting Standard
Under the International Financial Reporting Standards (IFRS) 16, the lease accounting standard, there are a few exceptions or specific scenarios where certain leases may be excluded or treated differently. Here are some exceptions to IFRS 16:
- Short-term leases: Leases with a lease term of 12 months or less and that do not contain a purchase option are considered short-term leases. Entities can choose to exclude short-term leases from recognizing lease assets and liabilities on the balance sheet. Instead, they can expense the lease payments on a straight-line basis over the lease term.
- Low-value leases: Leases of assets with a low value (i.e. under $5,000) when new, such as small office equipment or computer peripherals, can be excluded from the balance sheet. While there is no specific threshold defined in IFRS 16, it suggests that a materiality-based approach can be adopted for such leases.
- Leases of biological assets: Leases of biological assets within the scope of IAS 41, Agriculture, are exempted from the requirements of IFRS 16. These leases are accounted for under the applicable provisions of IAS 41.
- Leases of minerals, oil, natural gas, and similar assets: Exploration and evaluation assets, as defined in IFRS 6, Exploration for and Evaluation of Mineral Resources, are excluded from the scope of IFRS 16. Therefore, leases of minerals, oil, natural gas, and similar assets are not subject to the requirements of IFRS 16.
- It’s important to note that the specific application of these exceptions may vary depending on the circumstances and professional judgment exercised by the reporting entity. It is recommended to consult the full text of IFRS 16 and seek guidance from accounting professionals or standard-setting bodies for specific situations.
IFRS 16 Impact on Financial Reporting
IFRS 16 has a significant impact on financial reporting, affecting the balance sheets, profit and loss statements, and cash flow statements of companies. It’s important to note that the impact of IFRS 16 on financial reporting can vary depending on the specific lease arrangements and the nature of the business. Companies should carefully assess the implications and ensure accurate and transparent reporting in accordance with the standard.
IFRS 16 Impact on the Balance Sheet
Recognition of lease assets: Under IFRS 16, lessees are required to recognize lease assets, representing the right to use the leased asset, on the balance sheet. This increases the total assets of the company.
Recognition of lease liabilities: In addition to lease assets, lessees must recognize lease liabilities, representing their obligation to make lease payments, on the balance sheet. This increases the total liabilities of the company.
Change in presentation: The classification of leases as operating leases or finance leases, which was previously used under IAS 17, is eliminated. Instead, the balance sheet shows a single category of lease assets and lease liabilities.
However, if a lease’s terms happen to be under 12 months or low value under $5,000, they will typically be exempt from this new rule (assuming the asset itself isn’t recognized as high value or has purchase options).
IFRS 16 Impact on Profits and Loss Statement
Changes in expense recognition: Under IFRS 16, lessees are required to recognize both interest expense on the lease liability and depreciation of the right-of-use asset. This replaces the straight-line operating lease expense recognition under IAS 17. As a result, the profit and loss statement shows higher expenses in the earlier years of the lease and lower expenses in the later years.
Impact on EBITDA and operating profit: The changes in lease expense recognition affect EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and operating profit. EBITDA increases as lease expenses previously classified as operating expenses are replaced by depreciation and interest expenses. Operating profit may also be affected due to changes in lease-related costs.
IFRS 16 Impact on Cashflow Statement
Changes in cash flow presentation: Under IFRS 16, lease payments are classified differently in the cash flow statement compared to IAS 17. The operating lease payments, previously presented as operating cash outflows, are now divided into a principal portion classified as financing activities and an interest portion classified as operating or financing activities.
Impact on operating cash flow: The classification of lease payments and the inclusion of interest and principal portions affect the operating cash flow. In the earlier years of the lease, operating cash outflows decrease as a portion of lease payments is classified as financing activities. Conversely, financing cash flows increase as the principal portion is classified as such.
Who Does IFRS 16 Impact?
Lessees who follow the International Financial Reporting Standards are affected by the new lease accounting standard. Over 160 countries all over the world will need to adhere to IFRS 16, including Spain, Ukraine, United Kingdom, Russia, Norway, Brazil, Japan, France and more.
History of IFRS 16
The International Accounting Standards Board introduced IFRS 16 in 2016. It is one of the most significant changes to their lease accounting policies in over 25 years. The goal of the new standard was to create transparency in representing leases on the balance sheet for all international businesses. IFRS 16 replaces IAS 17 as the new standard that all companies who operate under IFRS must adhere by and went into effect on January 1st, 2019.
Transition with IFRS 16 Software
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