Flying the Standard: Taking IFRS 16 Leases to the Next Level

The new lease accounting standard, IFRS 16, is now in effect. Many companies are still getting to grips with the changes to their financial reporting, with all leases coming onto the balance sheet for the first time. But beyond initial implementation, IFRS 16 is also enabling companies to capitalise on the transparency the new standard is delivering.

Since the International Accounting Standards Board (IASB) published IFRS 16 Leases in January 2016, treasurers and CFOs have been working hard to become compliant with the new standard. It replaces IAS 17 and is applicable for accounting periods beginning on or after January 1 2019, unless previously early adopted with IFRS 15.

IFRS 16 has been a major change for lessees, since the vast majority of leases that were previously treated as operating leases are now coming onto the balance sheet. To give a sense of scale here, the IASB estimated that approximately USD$3tr. of assets and liabilities[1] will transfer onto corporate balance sheets in the coming years as a result of IFRS 16. 

Indeed, LeaseAccelerator’s own research in this space suggests that, collectively, the UK’s FTSE 350-listed companies have £180bn[2] in operating lease liabilities that must now be reflected in financial reports. The oil and gas sector holds a high proportion of leases: according to LeaseAccelerator’s research, Royal Dutch Shell has £18.3bn of operating leases and BP has 10.9bn. Sainsbury’s supermarket chain has £10bn, while Vodafone has £8.6bn, and International Airlines Group has £6.8bn.

Meeting the first hurdle

Given the resource-burden of transitioning to the new standard, most IFRS-reporters have delayed implementation of IFRS 16 for as long as possible. Nevertheless, there were a few early adopters, such as Nestlé and KLM. For most, however, 2019 is the first year that quarterly and annual reports will reflect the balance sheet changes brought about by IFRS 16.

Understandably businesses have been extremely focused on day-one compliance, dedicating vast resources to identifying their leases and determining the best way to adopt the standard – whether that be on a fully retrospective basis or through the modified retrospective approach.

Either way, the amount of work involved in ‘passing the IFRS 16 exam’ for the first time has been significant – and often exacerbated by poor visibility into leases and ownership of them, as well as a lack of technology solutions focused on lease accounting. To achieve robust compliance, companies require central visibility and control of their leases. A key requirement to sustainable compliance with IFRS 16 is a firm grasp on lifecycle events of lease-reassessments, modifications, indexes etc. The list goes on and on. What this means is that meeting the first compliance deadline is just one part of the IFRS 16 challenge. Arguably the tougher task is replicating the peak experience of the opening balance sheet on a quarterly and annual basis.

Taking the next step

Companies have hired teams of people and consultants to help them through the first IFRS 16 hurdle. And CFOs and treasurers are now starting to feel confident that they have their initial adoption of the standard completed and their leases are properly reported on the balance sheet. But going forward, core finance teams – without their initial IFRS 16 support staff – must replicate the initial rock-solid accounting they have shown in the adoption of IFRS 16 every quarter going forward.

This is made more difficult by the fact that leasing is dynamic, not static. So, whereas fixed assets can be plugged in to the balance sheet and ‘forgotten’, leases may be renewed, extended, modified or terminated. This requires a solid communication workflow with the asset user, since the accounting must consistently reflect the up-to-date activity of the lease.  

In addition, once the first IFRS 16 deadline is crossed, management are likely to start looking for returns on the investment they have made in becoming compliant. They will want to capitalise on the transparency that the new standard has brought. Questions will be asked: How can we make lease accounting more efficient and cheaper? How can we reduce the cost of our leasing activity? Are we overpaying for leases? Is leasing the most effective use of our capital?

Answering these questions requires the lessee to manage their lease portfolio in a proactive manner and have granular data on their leases, as well as the ability to consider lease-versus-buy arguments and the benefits of competitive bidding of lease contracts. It is here that specialist lease accounting software products come into their own. 

As well as helping companies to achieve day-one compliance, having the right software in place gives support on day-two automation with lease management tools that monitor the changes and fluctuations within the leasing portfolio, provides additional to support lease-versus-buy decision-making and creates an electronic audit trail.

And when it comes to what’s next and the pressure of ongoing compliance, businesses with significant leasing responsibilities and the team overseeing it need to be supported to deliver the compliance easily. This is so they can use their time, insight and analytics to focus on how to effectively use leases as a financial tool – rather than being caught up in the reporting.