Insight & Analysis

Preparing for IFRS 16

Published: Jan 2019

IFRS 16 is coming – and with the new accounting standards expected to bring trillions of dollars of assets onto balance sheets around the world, treasurers need to be prepared. What steps should treasurers be taking, and which challenges should they be aware of?

The new IFRS 16 lease accounting standards came into force on 1st January 2019. Expected to bring over US$2.8trn of assets onto balance sheets around the world, the new rules will have a significant impact on IFRS and US GAAP reporting firms, affecting everything from financial metrics to debt covenants. So what are the implications for corporate treasurers – and what should you be doing to prepare?

Implications of IFRS 16

Under the previous rules, leases which were classified as operating leases could be reported in the footnotes of financial statements. IFRS 16 closes this loophole by eliminating the difference between operating leases and finance leases, with all leases to be treated as finance leases and reported on the balance sheet.

The implications of the new rules for treasurers include the following:

  • Increased auditor scrutiny. The new rules will result in greater auditor scrutiny over companies’ leasing processes and controls, so companies will need to track their leases more closely than in the past.
  • Financial ratios. IFRS 16 is expected to impact financial ratios including the leverage ratio, return on assets, and current ratio which could impact agency ratings, existing debt covenants, and future debt arrangements. Michael Keeler, CEO of LeaseAccelerator, says that the effect on each company will vary – “so treasury should research and confirm how these metrics will change when the standard is implemented.”
  • Data management. Leases will need to be tracked more closely under the new rules, so robust data management will be essential.
  • Lessor relationships. Keeler also points out that treasury often takes on the role of managing lessor relationships, which will be important under the new standards as a source of lease data “that companies need to track but may not currently have access to.” He points out that maintaining these relationships may allow companies easier access to this data in the future – “and potentially advantages in negotiation.”

Top tips

So what should you be doing to prepare? Naturally the first step is to understand the requirements under the new leases standards. Victor Chan, International Director, Ernst & Young GS LLP, Professional Practice – IFRS Services group, says the second step should be to evaluate how the new leases standard would impact the financial statements both of the entity and of its peers, including the impact on financial ratios and credit profile. Treasurers should then evaluate how the new standard would impact the financial statement of the entity’s customers.

Keeler, meanwhile, suggests a number of actions that treasurers should take in the lead up to the implementation deadline:

  1. Help accounting develop a methodology for determining the incremental borrowing rate or discount rate to use for calculating the present value of the lease payments.
  2. Assist accounting with capturing key financial variables, including weighted average cost of capital (WACC).
  3. Share the information that treasury has on file about the lease portfolio, including which assets are leases, the lessors and the asset owners.
  4. Leverage relationships with leasing companies to get the latest copies of leases or other critical data.
  5. Advise on long-term processes, policies, and controls for the future state design of the leasing programme:
    1. Establish sourcing policies to optimise capital use in the leasing programme. One control could be requiring a lease versus buy analysis for every asset request to ensure that the best acquisition decision is made.
    2. Develop long-term lessor relationships. As the leasing process becomes more visible, relationships with a company’s vendors and landlords will become more important. Strong relationships with lessors will give the company advantages in the sourcing and negotiation processes for equipment and real estate assets.
    3. Keep financial metrics up-to-date. Treasury can establish an internal process for their organisation to ensure that they keep financial metrics relevant to the leasing programme up-to-date in the organisation’s lease administration software. These data points include the company’s incremental borrowing rate and current market rates.

Overcoming the challenges

Finally, treasurers should be aware of the potential challenges that may arise, such as capturing the necessary data from disparate systems and locations. Again, maintaining positive relationships with lessors can help in this regard: “Having a strong relationship with the lessors will allow the treasury group to reach out, should there be a question about a lease or a missing data field,” Keeler explains.

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