Lease accounting

What is IFRS 16 and how will it affect leasing?

The new accounting standard came into effect on 1 January 2019. What is it and what is the impact for leasing businesses?

International Financial Reporting Standard (IFRS) 16 was introduced by the International Accounting Standards Board in 2016, and became effective from 1 January in 2019.

Its effect on lessors, who adopt the international accounting treatment record their business, is to bring nearly all leases onto the balance sheet, making them more visible for shareholders.

The vast majority of leases now are treated similarly to a finance lease is, as an asset (the “right-to-use” leased item for the lease term) and as a liability, which is the obligation to pay future rentals.

“In making this change, IFRS 16 impacts a number of accounting metrics such as EBITDA, the weighting of finance costs and depreciation and the assets and liabilities which are contained on lessee balance sheets,” DLA Piper lawyers Rebecca Williams and Anna Middlebrook tell Leasing Life.

“UK GAAP companies can still continue to apply UK GAAP to the accounting treatment of leases, but IFRS 16 will filter through to UK GAAP companies adopting IFRS/FRS 101 (Reduced Disclosure Framework) rather than FRS 102.”

Lease accounting is likely to be substantially unchanged, say Williams and Littlebrook. Lessors continue to classify leases as finance and operating leases. There are however new requirements relating to sale and leaseback transactions.

“For lessees, there is a single accounting model for all leases (bringing operating leases on balance sheet) but with two exemptions (low value assets and short term leases, 12 months or less) and additional guidance has been provided around sublease arrangements,” the DLA Piper lawyers write.

“IFRS 16 may mean lessees have to change policies and processes regarding lease accounting, administration and tax. Lessees may also reassess their needs when negotiating lease terms and payments.”

Any tax implications for lessors of plant and machinery are curtailed by the Finance Act 2019, which maintains the current tax regime after the introduction of IFRS 16. The effect is, tax-wise, that corporates are not materially impacted by the introduction of IFRS 16.

“Lessees are and will be affected by IFRS 16 (in terms of accounting but also in terms of adapting their systems and processes to ensure compliance with IFRS 16),” write Williams and Littlebrook.

“It is likely that the impact of IFRS 16 on lessors will be more related to changing behaviours and requirements from lessees when considering lease terms.”

A full version of the legal insight provided by DLA Piper in more detail can be read in April’s edition of the Leasing Life subscriber magazine which you can read here: