Don’t Get Caught Off Balance with IFRS 16 Lease Standards.
2019 is drawing to an end, and so too is the first year of the International Accounting Standards Board’s IFRS 16. On 1 January 2019, the new leases standard for lease accounting came into effect. Whether this is news to you or if you think you’ve got it under control, read on to find out how to comply without it being a benefit buzz-kill.
It’s no big secret that loads of companies use rentals or leasing to finance their assets. As a widely used financing solution, leasing gives companies access to property and equipment like vehicles and machinery, without forking out large sums of cash upfront. But let’s park cashflow considerations for a moment. Leasing also provides flexibility and allows companies or individuals to address the issue of obsolescence and take the edge off the risk of declining value.
However, this year, that all changed.
Enter the IFRS 16: the new leases standard published by the International Accounting Standards Board. After more than a decade in development, this new accounting standard all but did away with the accounting difference between finance and operating leases. It requires assets usually held off-balance sheet, to now be recorded on it.
Under the new IFRS 16 standard, lessees need to note nearly all leases on the balance sheet as a right-of-use (ROU) lease asset for a period. They also need to recognise the associated liability for payments.
As a result of the changes to operating leases this year, balance sheets grew, gearing ratios increased, and capital ratios decreased. While bringing leases onto the balance sheet will have a material effect on the bottom line, there are ways businesses can reduce the ongoing impact through rethinking their company-provided perk vehicles.
Here’s how the new standard would have made waves on your financial statements this year:
- Out with the traditional ‘risks and rewards’ model; in with the ‘right-of-use’ model. Lessees need to recognise an asset and liability at the beginning of a lease.
- For lessees, the lease becomes an on-balance sheet liability as well as a new asset on the other side of the balance sheet. Put simply, lessees will become more asset-rich on paper, but also more heavily indebted.
- All new lease liabilities need to be measured with reference to an estimate of the lease term. This includes optional lease periods when an entity extends a lease.
- All companies that lease assets, such as vehicles, will see an increase in assets and liabilities.
Impact on Vehicle Operating Leases
To understand how to move forward, let’s first take a quick look in the rearview mirror.
Historically, companies entered into fixed-term operating leases with either Fleet Managers or financiers. Under these agreements, the organisation would commit to leasing a vehicle over a set period, usually 3-5 years.
Regardless of taking on a financial commitment throughout a 3-5 year period, it wasn’t mandatory to site the future liability on the balance sheet. Instead, businesses could list it as an expense. This was one of the main perks of financing vehicles under a lease as opposed to purchasing the vehicles outright or via a chattel mortgage.
Under the new IFRS 16 accounting standards, any company that holds operating or finance leases needs to bring the future liability of the total payments onto the balance sheet.
Many operating and finance leases are taken out as a value-add for vehicles used mainly by employees for personal use. That means the cost of these vehicles suddenly looks a lot less attractive to the company.
While employee vehicles have always had a Fringe Benefits Tax liability, adding the future liability of lease payments onto the balance sheet may stifle company growth and impact borrowing power. Not to mention the additional workload the finance and accounting team will have to verify accurate records.
Put simply, the leases standard has changed, and the question you need to ask yourself is – ‘what should we do about it?’
If you provide employee perk vehicles or manage a large fleet, IFRS 16 has impacted your business and bottom line. Don’t let the new leases standard get in the way of a good benefit – talk to us about what you can do to make the most of the changing landscape.