New Lease Standard IFRS 16-Free-Samples-Myassignmenthelp.com

Question: In 2016, the IASB introduced the new accounting standard IFRS16 Leases (effective from 1/2019 with early adoption permitted) which requires what were previously classified as finance and operating leases to be classified and included on the lessees balance sheet. What is the rationale behind this decision? Provide your reason with references. What are the implications that would have for the lessee and the lessor? (Note: you are expected to specify (with references) which types of companies are likely to be affected and how they are affected?) Answer: Introduction A new standard for lease accounting has been developed by IASB named as IFRS 16 Leases. It provides guidelines for lease accounting and state that the data reported must show the accurate information about the lease transactions. The standard will come into effect from January 1, 2019 and once applicable it will replace the old standard IAS 17 (Iasplus.com. 2018). The reports contains detailed information about IFRS 16, its implications on lessor and lessee and the reasons behind introducing it. In the later part, it also discussed about the companies which are likely to be affected by this. IFRS 16 Leases IASB published a new standard for lease reporting in January 2016, which will be in effect from January 2019. It was introduced by IASB as part of joint project with FASB. It deals with the new principles for disclosure and measurement of leases. A single lessee model was established which requires a lessee to take into account all the liabilities and assets for the leases that have a term period of more than 1 year (Deloitte UK. 2018). Under IFRS 16, lease is defined as a contract in which customer (lessee) get a right to use an asset for a specified period of time in exchange of some consideration (accaglobal.com. 2018). The introduction of new standard will definitely impact several industries and also the accounting requirements of lessee and lessor. The sectors which mainly get affected are retail, telecommunications, banking, metal and mining, insurance and oil and gas entities. However, entities that has applied for IFRS 15 Revenue from Contracts with Customers can apply IFRS 16 in its lease accounting before its effective date. The main motive of bringing this was to enhance the reporting of leases by eliminating their classification as financial and operating lease. This elimination will enable the lessees to show all the leases on its balance sheet so that true and fair picture can be represented (Ifrs.org. 2016). Rationale behind the standard The main reason behind introducing IFRS 16 was to amend the approach stated under IAS 17, related to the classification of leases. IAS 17 was focused on distinguishing between the two types of leases. Under it, the lease that transfers all the risk and reward of asset ownership is termed as financial lease and apart from this all other leases are known as operating leases. However, the classification set out in IAS 17 was subjective which provides a clear benefit to the people who prepare financial statements of lessee. They can argue about the fact that leases should be presented as operating in order to avoid the presentation of leased assets and liabilities on the balance sheet (accaglobal.com. 2018). It was for this reason that IASB brings new lease standard IFRS 16. Also according to the IASB Chairman, the former lease standard does not reflect the economic reality. As per him, more than 85% leases are recognized as operating and are not shown on the balance sheet. As a result of which, they contribute in creating real liabilities which may prove to be difficult for the major sectors like retail industry to cope up with the situation of financial crisis. In addition to this, under IAS 17, companies were allowed to be discrete about their operating leases. This led to the false and unfair representation of companys financial position and performance. As a result, investors find it difficult to measure and compare the economic condition of different entities due to the faulty and unreliable data provided by the balance sheet. In a nutshell, former standard does not reflect economic reality which led to the introduction of IFRS 16 (Ifrs.org. 2016). Implications Lessor The impact on the lessors will be minor as the requirement for them will remain unchanged. They are required to classify the leases in the same way as it was mentioned in IAS 17. Fundamentally, the requirements of lessor accounting has not changed under IFRS 16. However, lessors will have new disclosure requirements. The new standard contains a specific exemption for lessors related to the valuation of investment properties at fair value. Some new requirements related to sales and lease back transactions are also provided by IFRS 16. Apart from these, there is no such significant impact on the lessors (KPMG. 2016). Lessee IFRS 16 will have a great and significant impact on the lessees because of its new requirements. Till now, the companies are classifying their leases as operating and financing as per IAS 17. The off balance sheet leases are those which are not reported on the balance sheet. These are generally operating leases. The new standard will require the companies to not only convert its existing operating leases but also amends its policies and procedures. The implementation of IFRS 16 will bring changes in the companies IT and control system that are used for supporting lease accounting along with lease procurement, administration and tax. Also the financial statements of lessees will also be affected (KPMG. 2016). Source: (Ey.com. 2016). Companies most likely to be affected The changes in the lease accounting has affected many companies and also their financial metrics. However, the impact is measured as per the facts and circumstances related to each entity. The main entities or industries that get affected by IFRS 16 are: Retail and Customer: This sector is expected to be majorly impacted by the change in lease requirements. It is especially in the case where leasing the retail space is the business of the entity. Moreover, manufacturing companies also need to look at all the major contracts that includes rental of plant and equipment, distribution centre and fleet arrangements. As an effect of the changes, retailers need to check the renewal options, estimate and remeasure the variable payments that are linked to a spot rate or an index. In addition to this, they are also required to separate the service charges from the lease elements (com. 2016). Telecommunications companies: These entities lease a vast number of big ticket items that includes cell towers, network equipment, fibre optical cables and satellite transponders. According to the new requirements they need to consider the new definition of lease for identifying the arrangements that contain lease. In addition to this, these companies need to analyse the contracts where the equipment are provided to the customers. Identification of the lease and the method of lease payments is required to be done by the telecommunication entities (com. 2016). Banking and Financial institutions: Banks have many branch networks and large call centres and administration that require them to consider the lease arrangements carefully. Moreover contracts related to the ATMs and the space used by them are required to be assessed as per the requirements of the new lease standard. Financial institutions can make use of the data storage facilities and these arrangements can cover under the scope of IFRS 16. As per the changes, financial service entities need to determine the treatment of right-of-use assets for regulatory capital requirements. Metals and Mining: After the implementation of IFRS 16, companies operating in metals and mining sector needs to consider all the major arrangements they have made such as mining equipment, land and buildings as well as vehicles. Such arrangements may give rise to on balance sheet leases accounting under new standard. Likewise, construction companies also have to consider all the arrangements made related to equipment, vehicle and land and buildings leasing which may give rise to on balance sheet leases (com. 2016). Transport and logistics sector: Firms operating in this industries often lease items such as trains, ships, aircraft, real estate and also other vehicles. They also required to decide about the renewal options and identify the lease as a service or operating lease. Along with this, they need to separate the service elements from the leased equipment (com. 2016). Oil Gas entities and insurance companies: They are least affected and are may be impacted by the arrangements done in respect of vehicles, equipment and land and buildings along with those that contain a lease (com. 2016). So, all the above sectors or industries will be majorly impacted by the changes in the lease accounting standard. Once IFRS 16 become effective, the companies are required to report their leases as per the new requirements and comply with the changes made in their policies and procedures. Conclusion From the above report, it can be concluded that introduction of new lease standard IFRS 16 will change the procedure for lease accounting, specifically for operating leases. It will lay down some certain requirements that are to be followed by the companies and as a result of which their financial statements will be highly affected. IFRS 16 will eliminate the need of classifying the lease as operating and finance and will provide a single accounting model for lease reporting. The report also states that lessees will be more impacted than lessors, as they have to change their method of lease accounting in order to comply with the new requirements. Overall, it can be said that IFRS 16 will help in providing accurate information about the lease transaction of the companies. References Iasplus.com. (2018). IFRS 16 Leases. Retrieved from https://www.iasplus.com/en/standards/ifrs/ifrs-16 Deloitte UK. (2018).IFRS 16 Leases: new financial reporting standard Potential implications for lenders. Retrieved from https://www2.deloitte.com/uk/en/pages/audit/articles/ifrs-16-leases.html Ey.com. (2016). Leases a summary of IFRS 16 and its effects. Retrieved from https://www.ey.com/Publication/vwLUAssets/ey-leases-a-summary-of-ifrs-16/$FILE/ey-leases-a-summary-of-ifrs-16.pdf Pwc.com. (2016). IFRS 16: The leases standard is changing. Retrieved from https://www.pwc.com/gx/en/services/audit-assurance/assets/ifrs-16-new-leases.pdf Ifrs.org. (2016). IFRS 16 Leases. Retrieved from https://www.ifrs.org/-/media/project/leases/ifrs/published-documents/ifrs16-effects-analysis.pdf accaglobal.com. (2018). IFRS 16, Leases. Retrieved from https://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-study-resources/f7/technical-articles/ifrs16.html Ifrs.org. (2016). Introductory comments to the European Parliament. Retrieved from https://www.ifrs.org/-/media/feature/news/speeches/hans-hoogervorst-introductory-comments-to-the-european-parliament-jan-2016.pdf KPMG. (2016). IFRS 16 Leases. Retrieved from https://home.kpmg.com/content/dam/kpmg/pdf/2016/01/leases-first-impressions-2016.pdf