27 December 2018    |    Taxation

Leases and IFRS 16

IFRS 16 is a new international accounting standard for reporting lease transactions.  This will become effective for periods commencing 1 January 2019 if your business prepares its accounts under International Financial Reporting Standards (IFRS) or FRS 101.

If your accounts are prepared under FRS102 or FRS105 then you don’t have to worry about this quite yet. 

Whilst the FRC has not set a date to incorporate the changes to IFRS into FRS 102, it is widely expected to be included as part of the 2022 FRS 102 triennial review.

Every company will need to prepare for the implications of IFRS 16 well in advance of the implementation date.  As with all changes in accounting standards, the planning should begin when the opening balances of the comparative period; in case restatements are required (i.e. for a 31 Dec 2022 year end, the planning needs to start by 31 Dec 2020).

Impact of IFRS 16 on the balance sheet

All companies will require to capitalise assets held under operating leases and recognise the corresponding liability to meet the requirements of IFRS 16.  In practice, this increases your fixed assets whilst increasing future lease liabilities by the same amount.

For users of the accounts this change is supposed to provide greater transparency, as operating leases will no longer be ‘off-balance sheet’ but will be shown as a real liability in the accounts.  However, there are several implications businesses need to consider.

Implications to consider

  • What constitutes a lease? There will be a need to identify and consider the terms of the contract and the ‘right to use’ aspects of the arrangement.
  • What is the lease term? How certain is it that extension or termination options will be exercised?
  • They will be a shift in P&L expense classification so that lease costs (operating costs) become finance costs and depreciation.
  • More lease expenses will be recognised in the earlier years of a lease and less in later years (i.e. the finance costs are ‘front-loaded’ like a loan, compared to straight line treatment currently)
  • Key metrics will change given that the P&L expense will be classified and phased differently, this could affect your metrics such as operating profit, EBIT or EBITDA. This could then impact lending covenants or bonus calculations.
  • Tax implications: is the treatment of a lease for tax purposes to be based on its treatment in the accounts?  Will assets on lease be treated for tax exactly the same as those on HP?

If you would like to discuss the issues around IFRS16 is more detail please contact Angus Nicolson to discuss this in more detail.

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