New lease standard to impact financial reporting

Online since 10.03.2016 • Filed under Press Release • From Issue 3 - March 2016 - August 2016 page(s) 48-49
New lease standard to impact financial reporting

The new lease standard, IFRS 16: Leases, was published on January 13, 2016. The new standard, which is the culmination of nearly a decade’s long project by the International Accounting Standards Board (IASB), will be effective for all financial periods commencing January 1, 2019, and will have a wide-reaching impact on business in South Africa.

ACCORDING to Tapiwa Njikizana, Director at W.consulting, the new lease standard, IFRS 16:

Leases, is the biggest accounting event in the last decade and will significantly affect every financial director and accountant in the country involved in financial reporting. The current standard made a distinction between so called ‘finance leases’ and ‘operating leases’ with the key difference between the two being: finance leases were deemed to be analogous with buying the underlying asset and therefore resulted in lessees recognising the leased assets and liabilities on their balance sheets, whereas in the case of operating leases, the transaction was deemed to be more a transitory right-of-use of the underlying assets, hence lessees would not recognise the underlying assets or liabilities on their balance sheets. This type of funding, related to operating leases, is often referred to as ‘off-balance sheet funding’ as the liabilities do not appear on the balance sheets of the lessees. ‘This will have a knock-on effect exacerbating the effects of an already over-indebted economy,’ says Njikizana.

He adds: ‘The gearing ratio of companies that rely significantly on off-balance sheet funding from operating leases will immediately deteriorate, possibly leading to breaches of debt covenants or further reducing the ability of affected businesses to access new funding for expansion or to weather tough periods of liquidity constraints.’

Reported cash flows will also be affected. Currently, cash outflows arising from operating leases are reflected as operating cash flows, under IFRS 16 these cash flows will now be reflected as a combination of financing cash flows (servicing of the lease liability), which will be the major portion, with a residual amount relating to the finance costs classified under operating cash flows, currently all operating lease cash flows are classified as operating. Many accountants that have criticised some of the complexities of modern IFRS have pointed to the Statement of Cash Flows as one of the places where ‘accounting still makes sense’, and they may find this change somewhat of an irritation. One of the key business consequences of this distinction between finance and operating leases is that finance leases result in a higher gearing ratio for business (being the ratio of a business’ debts to its equity) whereas operating leases do not impact gearing ratios. This advantage, of a lower perceived gearing, led many businesses to prefer entering into operating leases wherever possible suggesting there will be many companies affected by this change. Njikizana provides some background about the reason for the change: ‘With the global financial upheavals of the last decade, a number of areas of accounting came under scrutiny and chief amongst these were matters relating to the accounting for financial instruments and the matter of off-balance sheet funding related to operating leases in particular. It is estimated by the IASB that the extent of off-balance sheet funding sits, only for listed companies, at approximately US$2.86 trillion.’ Njikizama reiterated that although the implementation date is three years away, financial directors and financial departments will have to start preparing the necessary information required to on-board these off balance sheet liabilities from as early as 2017 in preparation for the 2019 effective date. ‘It’s essential that companies conduct an impact analysis as soon as possible and see which of their stakeholders will be affected and develop tailored  communication strategies for each. Our experience with the implementation of significant new  standards such as for financial instruments IFRS 9 and revenue IFRS 15, shows that businesses need to invest significant time and resources for several years before the effective date,’ he adds.

‘This is a total mind-set change – companies need to change their focus from the recognition of the leased asset and start paying more attention to the lease indebtedness. Banks won’t place much collateral value on leased assets but will penalise for the related lease liability. ‘W.consulting provides training on new and emerging accounting requirements for listed companies and large public entities that apply IFRS. Additionally, because of the far-reaching ramifications of this change, we will be publishing a video on our FRS Quickies YouTube Channel  (www.youtube.com/user/Wconsulting) to assist investors, managers and shareholders to grasp of the key aspects of the standard.’ For a more detailed explanation of the new lease standard, W.consulting is providing in-house training and advisory services that assist companies in developing a robust response to the new standard including developing sub-projects for engaging with the key stakeholders affected. W.consulting provides public training courses that will provide attendees with an opportunity to understand the new standard in detail, equipping them to go back to their organisations and champion their own implementation projects.

Issue 3 - March 2016 - August 2016

Issue 3 - March 2016 - August 2016

This article was featured on page 48-49 of SABI Magazine Issue 3 - March 2016 - August 2016 .

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