New IFRS 16 Eliminates the ‘Operating & Finance Lease’ Difference

IFRS 16 Leases was issued in January 2016 and is effective for annual reporting periods starting on or after 1 January 2019. It replaces IAS 17 Leases and related Interpretations.

IFRS 16 changes the accounting substantially for lessees. The new Standard eliminates a lessee’s classification of leases as either operating leases or finance leases. Instead, almost all leases are ‘capitalised’ by recognising a lease liability and right-of-use asset on the balance sheet. There is little change for lessors.

Highlights of New IFRS 16

• It eliminates the distinction between “operating” and “finance” leases by requiring all leases to be recorded on the balance sheet as assets and liabilities (subject to limited exemptions).
• Two exemptions are recognised (and are dealt with using a simplified approach). Firstly, you do not have to report assets and liabilities for leases where the underlying asset is of “low value”. Secondly, you do not have to report leases where the term is for 12 months or less.
• All lessors will be required to disclose additional information about their leasing activities, in particular surrounding their exposure to residual value risk (ie the possibility that a lease can only be re-leased at a price below the asset’s residual value).
• All leases reported on the balance sheet will have to be accounted for with a separate presentation of depreciation and interest.
• “Variable” and “optional” lease payments are simplified. Inflation-linked payments are included in calculating assets and liabilities, but variable payments linked to sales or usage are not. Furthermore, optional payments are only included when it is reasonably certain that the lessee will extend the lease beyond the cancellation period.

Leasing is a common form of finance. The Effects Analysis, published alongside the Standard in 2016, described the likely costs and benefits of IFRS 16. This analysis estimated that listed companies around the world have around $3 trillion worth of future payments for leases, which were not recognised on the balance sheet applying the previous accounting requirements.

IFRS 16 will increase visibility of companies’ lease commitments and better reflect economic reality. The Standard will also make it easier for users of financial statements to compare companies that lease their assets with companies that borrow money to buy their assets, creating a more level playing field.