1st January 2019 sees the introduction of IFRS 16 - the biggest change in lease accounting in over 40 years - and many finance directors are at risk of significantly underestimating the impact and challenge the new standard will bring.
Although many FDs may think they know what is in store with IFRS 16, the level of complexity involved in addressing the standard may not be immediately clear. Implementing IFRS 16 is as much a challenge of gathering, cleansing and maintaining data as it is about a change of accounting policy and the responsibility of meeting this challenge lies firmly within the finance function.
A significant number of finance professionals have not put in place the adequate systems, processes and controls required to ensure a smooth transition. That might be because many finance functions simply haven’t yet had a chance to address the issue, while others may not be clear about what is required. Nevertheless, time is running out for the large number of companies affected by the new standard.
Finance professionals need to understand that IFRS16 is more than just additional disclosures in a company’s statutory accounts. The new rules for accounting treatments will have a significant impact on the Income Statement, Balance Sheet and Cash Flow Statement.
Expect more transparency to lease obligations by accounting for operating leases on the balance sheet. With IAS 17, these ‘off-balance sheet leases’ may have represented a significant financial obligation that investors and analysts may not have previously had full visibility on. Bringing these items onto the balance sheet will have a significant impact to the financials – for most organisations this will be at least tens of millions with many organisations reporting impacts running into the hundreds of millions and in some, even billions of pounds worth of changes.
Under the new standard, operating lease costs disappear – to be shown in the P&L through Interest Expense and Depreciation. This will have an impact on EBIT and EBITDA – a key performance metric of many companies.
IFRS 16 also brings new reporting requirements that include Initial and Ongoing disclosures for your statutory accounts. These are more onerous than currently required under the current standard (IAS17).
Consideration should be given to adverse impacts that may be seen on debt covenants – which affect the cost of borrowing and, therefore, profitability. In addition, there may also be negative effects on historic profitability based on the selection of an appropriate transition option (full retrospective, modified A or B) – and so a full understanding of the options is imperative.
IFRS 16 suggests that any leases with a value of more than $5,000 and that have more than 12 months left to run are eligible for the new treatment, which means the majority of affected assets will be cars, office equipment and property. The latter can hold enormous challenges – payment increases are often pegged against CPI and contracts can offer termination, renewal and purchase options which need to be assessed as to how likely they are to be exercised. Also, some payment types will be capitalised and some not. Properties are often sub-leased either to a third party or from one entity to a counterparty in the same organisation; all of these scenarios present technical difficulties when creating the correct entries to the accounts.
The standard offers a number of different transition options, which should in turn be assessed by organisations in order to understand which will be most effective (or least disruptive) – moreover, the standard even allows for individual leases to be isolated and subject to different transition methods. Has your business had an opportunity to model the full impact of the different options? Once that decision is taken, there is no turning back!
Finally, this is not just an accounting project but also a data project. There is an enormous amount of data that needs to be collected, normalised, validated and calculated. This is data that has historically not been captured in a structured way – and one of the biggest points of failure on compliance is likely to be incomplete or ‘dirty’ data. FDs need to be asking themselves where the lease data is currently held and how it will be captured, stored and maintained under the new standard. Once that data is centralised, how will it be maintained going forward?
Moving to full compliance will still be a considerable task even for the most organised companies, let alone those with less developed plans. Given the large amount of assets being added to the balance sheet, IFRS 16 will give many cause for concern.
But there is much to be positive about, as the standard offers the chance for organisations to gain greater control over lease obligations and really assess whether current arrangements are optimal. Indeed, many companies are using this as an opportunity to re-assess their entire approach to financial reporting, an area of corporate performance management that has seen a lot of innovation in recent years.
By establishing IFRS principles for lease recognition, measurement, presentation and disclosure, companies can put in place a best practice regime that includes:
* Capturing a full lease inventory in a centralised repository for better visibility, management and operational reporting
* Bringing leases onto the balance sheet to provide transparency of the businesses’ future payment obligations
* Incurring depreciation and interest expenses on operating leases (ROU assets) in line with best practice accounting principles.
Regardless of the industry a business operates in, it is critical your company has the right systems in place, says CCH Tagetik- experts in regulatory reporting and corporate performance management (CPM) software applications and veterans of more than 100 IFRS16 projects around the globe.
CCH Tagetik, which is a key part of the Tax & Accounting division of global information services group Wolters Kluwer, says every company affected will need to undertake a rigorous process to reach full compliance.
In technology, CCH Tagetik advises that enhancing finance systems to meet collection, calculation, reporting and disclosure requirements is vital. With regard to people it argues that finance and accounting, IT, tax, treasury, legal, operations, corporate real estate and must be joined up to be effective in delivering the changes.
When it comes to establishing a new process, CCH Tagetik suggests that the key areas to consider are the creation and management of the inventory of leases and the management of the complexities of data collection, storage, and maintenance.
CCH Tagetik has a mature platform which offers financial consolidation and planning capabilities to more than 1,100 customers across the globe. The company has taken the most relevant parts of that platform and created a pre-packaged solution to ease the IFRS 16 burden and ensure a speedy delivery. This can benefit the office of finance by:
* Automating data acquisition, formatting and loading to eliminate manual effort
* Modelling the impact of the different transition methods on the financials to better assess which option works best for the business
* Providing a user friendly, prescriptive workflow to guide end users through the process
* Validating the data at the point of entry to ensure errors are addressed and “bad data” doesn’t make it into the calculation
* Enabling central monitoring through real-time dashboards to ensure data and supplementary schedules are delivered on time
* Automatically calculating the IFRS 16 journals and posting into any number of general ledger systems and charts of accounts
* Generating reports to aid better decision making and ongoing disclosures