The new leases standard: IFRS 16 Leases Finally published.

After many years of waiting, IFRS 16 Leases has finally been published in January 2016.  The new leases standard will have a significant impact on those with major assets under operating lease.

Assets under operating lease will be capitalised resulting in both an asset and liability being recognised in the financial statements.  This could impact on banking covenants relating to gearing and interest cover and where an entity has such banking covenants, discussions and negotiations with the bank will be needed to manage the significant change to the statement of financial position.

Furthermore, internal measures such as EBITDA (earnings before interest, tax depreciation and amortisation) could be effected.  Currently EBITDA may include the operating rental charge but under the new standard this would be replaced with an interest and depreciation charge resulting in a potentially significant increase in the performance measure.  Where EBITDA is used as an internal performance measure, the increase could be misleading.

Communication with business analysts and other observers of an entity’s accounts will be necessary in order to prevent a misunderstanding.  It will be important to distinguish between change in performance and change in accounting treatment.

From a user’s perspective however, it will be easier to obtain a better understanding of the asset base of the entity and the liability associated with it.  The financial statements will therefore be a better tool for risk analysis than they have been in the past.

Contracts between lessors and lessees may need to be re written and an entity’s systems may have to be changed to cope with a significant increase in the number of assets being recognised.

With such significant impacts, entities will be keen to examine the potential exemptions that exist for agreements less than 12 months in duration and for small value assets (assets with a value of less than 5000 USD when new).

There is also an exemption where the entity does not have the right to direct the use of an identified asset.   Much professional judgement will be required in deciding on whether an entity is entitled to these exemptions.

The effective date for the new leases standard will be accounting periods beginning on or after the 1/1/2019.  With new standards on revenue recognition and financial instruments becoming effective in 2018, the next few years will be a busy time for entities as they manage the transitions to these new significant standards.

To find out more about IFRS – New Lease Accounting Standard and when it is running next click here 

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