Accounting Challenges in an IFRS Age
By Steve Hewison
The International Financial Reporting Standards (IFRS) are a set of globally-accepted accounting principles that companies have to follow when preparing their financial statements. The aim is that following these rules will help to ensure that companies produce easily interpreted, comparable financial documents, regardless of their industry or where they are based in the world. This makes the reporting standards particularly relevant for publicly-listed companies.
The standards are set by a group of independent experts from around the world (the IFRS Foundation and the International Accounting Standards Board, or IASB), with the guiding principles of transparency, consistency and comparability. There are 17 standards altogether, which are followed in over 100 countries, covering topics ranging from discontinued operations to fair value measurement. The latest, IFRS 17: Insurance Contracts, was issued in 2017 but was delayed at the start of 2020 to allow for better adoption globally to address concerns about the effort required when applying IFRS 17 for the first time.
IFRS 16: Leases
There are many reasons companies lease rather than buy – tax reasons, cash flow reasons, etc – but historically it has been difficult to get a clear sense of a company’s lease assets and liabilities from their balance sheets. Leases categorised as ‘finance leases’ were reported on the balance sheet whereas ‘operating leases’ were generally included in the notes to the financial statements.
The standard addressing lease accounting (IFRS 16) was issued in 2016 (on 13 January to be precise), and requires companies to now report all leases on their balance sheets; leases of less than 12 months and of low-value assets are exempt. This change was to allow for better comparisons between companies (previous guidelines were open to interpretation and were more than 30 years old), and more accurate representation of their assets and liabilities.
IFRS 16 would result in a more “faithful representation of a company’s assets and liabilities, and greater transparency about the company’s financial leverage and capital employed,” the International Accounting Standards Board (IASB) said. For example, upon its introduction, it was estimated that over 85% of lease commitments didn’t appear on company balance sheets.
Criticisms and analysis
- Naturally, the impact will vary across industries. Greatest impact is expected in the airline, retail, travel/leisure sectors – sectors with a large number of existing operational lease agreements, where numerous large assets are required, and sale and leaseback transactions are common.
- IFRS 16 will bring an increase in recorded level of debt for many reasons such as operating leases coming onto the balance sheet; and leases being measured over their expected life rather than the minimum term.
- Companies in the United States follow US GAAP standards as opposed to the IFRS. There was criticism that amendments to the GAAP leasing standards were not rolled out with IFRS 16, even though the American FASB had worked alongside the IASB to develop IFRS 16. The amendment to GAAP (ASC 842) has since been issued.
- May lead to under or overvaluation.
Luckily solutions are available to help organisations operationalise these accounting standards, to intelligently manage business challenges for ongoing lease management.
The standard has been in the news again during the COVID-19 crisis, as experts consider the accounting and reporting implications for businesses, further complicated by the first-time implementation of IFRS 16. Lessors have been offering rent concessions, such as reductions and/or holidays during the pandemic, and under IFRS 16 material changes to leases must be disclosed. The amendment issued in May 2020 (Covid-19-Related Rent Concessions) makes the requirement to assess whether certain changes to terms & conditions of a lease constitute a lease modification voluntary, as the requirement to assess could prove challenging for companies with a large number of leases, especially in the current climate.
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