Because Contracts Compliance Wasn't Complicated Enough: Introducing IFRS 16

Compliance News Contracts Management

By Mitch Hoppenworth

 

New Leasing Rules Pose Organizational, Accounting Challenges

Companies involved in leases face new and potentially complex organizational and accounting challenges in the coming calendar year.

In January 2016, the International Accounting Standards Board issued IFRS 16 to update accounting standards for the identification, accounting, and disclosure of lease agreements. The reassessment was done in cooperation with the Financial Accounting Standards Board, which issued its own similar rule, ASC 842.

The new IASB rules, effective for annual periods beginning on or after Jan. 1, 2019, require companies to account for leases that previously could be kept off books. Under the present rule, IFRS 17, any lease similar to purchasing the asset is termed a finance lease and must appear on company balance sheets. Others are classified as operating leases and can be kept off the books. IFRS 16 eliminates this distinction, dictating that all leases be reported.

 

 

Transitioning to IFRS 16 Leases

Companies should proactively examine contracts and adjust their agreements and accounting as necessary.

Lessees will want to look closely at existing leases to determine how they must be accounted for and reported under the new rules. This requires locating, analyzing, and reclassifying all of a company’s leased assets—which will create immediate challenges as leases may be scattered across departments, making identification difficult, and may be in varying formats and languages.

Such documents may have been signed prior to digital record-keeping. If in digital format, leases may be stored as PDF files, which will require manually transcribing data and reentering it into accounting systems.

UntitledThese challenges may limit the value of existing processes in collating all lease information. While some entities may have the use of extraction technology, many companies will temporarily need increased manpower and expertise. The most cost-effective solution may be an outside vendor that can bring proven expertise and the latest technology to bear in identifying contracts that contain lease arrangements.

Once leases have been identified, companies need to perform an inventory to identify lease portions of contracts, and to account for those that contain operating leases. Elements of each lease agreement, such as services, term, renewals, and maintenance must be pulled and collated. The next step is to evaluate whether a lease portion needs to be separated from any non-lease components, and if so, how to restructure or renegotiate the agreement.

A secondary issue will be finding the best accounting method for all the data once it is collected and analyzed. Developing the systems necessary for ongoing lease tracking and maintenance under the new standards is another area where outside support may be the best option.

Accounting for Existing Leases and New Contracts

IASB’s new rules will require analysis from both lessees and lessors to determine how the accounting changes will affect balance sheets and reporting needs. The contract inventory review may reveal the need to restructure contracts; for example, if a lease component is combined with a service, a company may choose to renegotiate the contract to reduce the impact of the new standard. In such cases, lease contracts may need to be amended, signed, and secured.  

For lessees, the most pressing question will be how existing off-balance sheet operating leases will affect reporting results. A thorough analysis of these leases should address whether the contract contains an operating lease and if there are non-lease components that should be separated out. That analysis may determine whether to restructure operating leases to reduce the impact of future capitalization.

Lessors will want to analyze how the new rules will change lessees’ financial reporting. They may find opportunities to reposition themselves on existing leases to garner restructuring fees or other profits.

New contracts should be drawn up with the new regulations in mind. For leases currently being negotiated, the changes may prompt a shift in the negotiations to allow lessees to reduce the amount to be capitalized and lessors to maintain favorable lease terms to secure the ongoing contract.

In examining existing agreements and drawing up new ones, implementing IASB’s new leasing rules will require legwork, careful analysis, and a flexible perspective.

 

How prepared are you for these changes and how do you plan to project manage your way through the intricacies of this new regulation?

 

 

 

 

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