What in-house lawyers need to know about IFRS 16 – the new accounting standard affecting leases

posted in Legal Risk Management

The International Accounting Standards Board (IASB) has published International Financial Reporting Standard (IFRS) 16 – the new accounting standard concerning commercial leases which comes into effect on the 1st of January 2019. Superseding the International Accounting Standard (IAS) 17, the IFRS 16 rules are set to change the way long-term leases are treated on company balance sheets.

Virtually all companies use leasing agreements as a low-risk means to gain access to property and equipment without incurring large cash outflows upfront. It also provides flexibility and is sometimes the only way to obtain the use of an asset that is not available for purchase. Therefore, the changes could affect many businesses. But don’t worry, it’s not all bad news!

This post examines how the new standard affects leases, who it concerns and how the legal department can play a strategic role in helping the company grow by advising the board of opportunities of the IFRS16 and minimising its impact.

What is the new IFRS 16 standard?

IFRS 16 is a global financial reporting standard with the objective to “report information that faithfully represents leases transactions and provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases”.

It imposes a single lessee accounting model which requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. Under the new standard, all lessee leases will need to be recorded on the balance sheet as both assets for the right to use that leased item and as a liability for the present value of its lease payment.

IFRS 16 will include all contracts that convey the right to use an asset for a period in exchange for consideration, except for licences of intellectual property granted by a lessor, rights held by a lessee under licensing agreements for intangible assets, leases of biological assets, service concession agreements and leases to explore for or use of minerals and resources.

Who will be affected?

Mainly lessees will be affected, rules for lessor are virtually unchanged because IFRS 16’s approach to Lessor accounting is remains much the same as IAS 17. That is, lessors will continue to classify leases as operating or finance.

The impact on a lessee’s financial reporting, asset financing, IT, systems, processes and controls could be significant. Many companies lease a vast number of high-value items, including cars, offices, retail, power plants, retail stores, cell towers and aircraft. Therefore, in order to put a correct value as a liability on their balance sheet, companies will need to have detailed insight into their lease agreements.

What are the specific business implications?

It could influence strategic decisions made by the business around leases. Either they might have to pay more taxes or opt for short term leases to avoid having to declare them. Or they may take a commercial decision to have long leases and wear the costs, to reduce the uncertainty of renewing leases.

After all this you might be asking yourself, is IFRS 16 a good thing and can it help my company grow?

For a start, the current standard, IAS 17, has typically provided an inaccurate account of a company’s outstanding expenses and liabilities, forcing them to estimate the off-balance sheet obligations which often results in overestimations. Similarly, it is difficult to compare businesses that lease assets with those that buy them as a clear indication of the operating leases are omitted. So, on one hand it makes reporting more accurate. On the other hand, companies may find themselves lumped with higher taxes, depending on the type of leasing strategy they adopt.

The role of Legal Counsel in assessing IFRS 16 risk

Legal Counsel in their role as risk managers and strategic advisors to the board are able to compile the necessary company insight surrounding leases. Together with the CFO and/or external parties, the legal department is instrumental in helping calculate the risk IFRS 16 might pose, to ultimately advise the board and manage risks. The final analysis can then be used to determine the company’s leasing strategy moving forward i.e. depending on the findings, the board might opt for short lease terms to mitigate financial risks identified.

A legal software like effacts can help in the risk assessment and compliance aspects of such an analysis.

How effacts can help

Being able to create and store your rental agreements centrally – giving an accurate overview of costs, liabilities and risks across different countries – allows companies to be ready for the change. Here’s how a fully comprehensive legal repository like effacts supports companies achieve the detailed insight they need:

  • Using the intuitive Real Estate dashboard, companies can distinguish which leasing agreements are targeted by IFRS16
  • Companies can store, visualize and export leasing information for auditing purposes and risk assessments to easily share with the different stakeholders such as the CFO and auditors
  • Better collaboration between the financial department, external accounting parties liaising with the legal department by authorizing access to the effacts database
  • Simple creation of reports and charts allows you to communicate relevant information to internal and external parties during the IFRS16 project and implementation phase.
  • Keep relevant information necessary for tax appraisals, including information necessary for IFRS 16.

Above image: effacts subdashboard for Rental Agreements. Create new rental agreement dossiers (1), track the status (2), stay on top of deadlines & risk (3) or create custom reports (4)

If you are curious about how this type of company insight on leases would benefit your business or if you’d like to prepare for IFRS 16, why not schedule a free demo of effacts to experience how it works first hand.

schedule free demo