The new leasing standard will see a company's own assessment of lease liabilities presented as a single number on the balance sheet, increase transparency and comparability. Arriving at this figure will however be challenging for many organisations. We look at some of the key questions.
‘What’s the number?!' This is the most frequent question I receive from clients when we start discussing how they might approach the adoption of IFRS 16, the new leasing standard. For the first time, analysts and other stakeholders will be able to see a company’s own assessment of its lease liabilities encapsulated as a single number on the balance sheet, increasing transparency and comparability – so no pressure!
The implementation project will ultimately answer this question but it will be a challenging journey for many organisations to get to the right answer. Let’s look at some of the interim questions along this journey …
'What’s my best transition option?'
The standard provides a host of different transition options and practical expedients that involve a trade-off between cost and comparability. That is, the options and practical expedients that simplify and reduce the cost of implementation will reduce the comparability of your financial information - not only on transition but until all leases that are in place in 2019 have expired.
At first, clients have it clear - ‘let’s go for the easiest option’ - but after further analysis many realise that it is crucial to explore other alternatives, which may be more challenging and costly to implement. Why? Well, for instance, fully retrospective application will be more time consuming to achieve than the other options but the extra effort may be considered worthwhile given the benefit of a lower P&L charge in the post-implementation period. Choosing the best option for your company requires serious thought and analysis.
'What are the challenges?'
The clients I talk to get the basic accounting – they understand that lessees have to bring most leases on balance sheet by 2019, at the latest. What's proving to be more challenging is actually obtaining and assessing all of the relevant data necessary to implement the standard.
For example, the fully retrospective approach to transition requires companies to apply IFRS 16 as if the standard had always been applied, which increases comparability and, as noted above, has the benefit of a lower P&L charge in the post-implementation period. It also has the advantage that companies do not have to explain any differences between previously reported operating lease commitments under IAS 17 and the opening lease liability under IFRS 16 (which is not the case for the other transition options). However, it requires companies to gather and assess extensive information about their leases – not only at lease commencement, but also when there has been a change to the lease.
Ensuring that the appropriate processes are in place to gather and assess all the data necessary to implement the standard requires tremendous effort and will become many companies’ primary focus in the years leading up to implementation.
'How to succeed?'
A well-structured project will start with an impact assessment to identify the population of leases. As part of this you will need to decide whether to take advantage of the practical expedients to scope out short-term and low value leases. A sensible next step is to model the impact of the various transition options for a sample of leases to inform your transition choice. This is key, as the transition approach will determine the data that you need to collect for each lease – do you need to go back to the start of the lease or is just ‘current’ data required? This data gathering will be a big exercise, even if you decide not to apply the standard fully retrospectively. It will need careful planning and sufficient resource engaged in your various business units or geographies. And make sure you have clarity on exactly which data is needed – this can only come from a deep understanding of the standard; you only want to do this exercise once!
Whilst 2019 seems a long way away, there is a lot to do to comply with IFRS 16; you should start planning for the challenge now. View our latest guidance on leases via the link below or register here for our upcoming IFRS 16 webinar.
Senior Manager, Accounting Advisory Services, KPMG