Accounting 

The Biggest Pitfalls of Adopting IFRS 16, which Addresses the Reporting of Leased Assets

Since 1 January 2019, IFRS 16 has been in effect. This standard substantially revised the accounting treatment applied by lessees to leased assets. For companies, this means more demanding work with data; the need to define which of their contracts fall under the scope of IFRS 16; and also, for instance, employee training. What are the pitfalls lessees face in connection with the new standard? And is there a way the whole accounting process can be simplified?

While earlier, payments under operating leases were directly expensed, and any extraordinary payments and rental-free periods were reported on an accrual basis, now lessees are required to report on the face of the balance sheet both the right-of-use asset and the liability arising from future lease payments, which is similar to the treatment formerly applied to finance leases. The way leases are reflected in expenses is through the amortisation of the right-of-use asset and interest on the lease liability.

What does the term “lease” under IFRS 16 incorporate? Some readers may think this only includes leases of cars or other movable assets. However, in fact, leases also include leases of buildings, office premises, land and IT infrastructure.

Three key challenges companies have to address in accounting for leases:

1. The data in place are not homogenous. To determine correctly the values of the right-of-use asset and the lease liability, companies have to, first of all, identify contracts that fall under the scope of the standard. Subsequently, the relevant data need to be extracted from the contracts. However, these primary data are unstructured. This is because frequently the contracts do not have a unified form. For instance, the lease payments are not always specified as a unique amount – conversely, primarily in respect of leases of buildings, lease amounts comprise multiple components. In such cases, a decision needs to be made on whether a particular component shall be reflected in the calculation or not. Moreover, some of the components increase on a regular basis, depending on inflation.

2. Judgements regarding the lease term. Frequently, lease contracts incorporate options for lease term extension or reduction. Here, companies have to assess whether they are reasonably certain about exercising the relevant option. Moreover, contracts for an indefinite period of time are a special issue, especially in relation to property leases. This is because IFRS 16 does not explicitly specify how the lease term should be determined in respect of such contracts, based on which subsequently the value of the right-of-use asset and the value of the lease liability are calculated. Therefore, company management is required to apply judgement, which may have a material impact on the statement of financial position. Also, most probably, the judgement will be subject to due scrutiny by auditors.

3. Frequently, Excel is not enough. After creating the register of contracts including all necessary data, the values of the right-of-use asset and the lease liability are calculated. For the primary calculation, work experience with Excel and knowledge of essential functions of financial mathematics will suffice. Many firms have decided to go this way, that is, to calculate the relevant amounts on their own using Excel spreadsheets. However, life brings about changes, and thus, new contracts are concluded, while others expire, are prolonged, extended or shortened. IFRS 16 does reflect events like this and provides guidance on their accounting treatment. However, this is the stumbling block of using the simple models in Excel – if they are to at least partially address such issues in an automated way, they may not be merely a simple Excel spreadsheet. For instance, as soon as the number of contracts increases, contracts paid in EUR are added, the Excel spreadsheet will soon reach its limits in terms of reliability and transparency of the data contained in it.

Forget about Excel – let us introduce dLease, a smart assistant in accounting for leased assets

At Deloitte, we decided to hit another way by creating an SQL database tool. We offer this instrument to our clients under the title dLease. Among other things, tens to thousands of contracts can be managed in the tool, without any impact on the system’s stability. Embedded formulas also address the changes specified above, including foreign currency translation and automated lease payment indexation (ie based on the development of inflation). With one click, dLease generates a report including all details that are necessary for the reporting of leases in line with IFRS 16 and all data required by the standard for disclosure in the notes to financial statements. This is because like every new standard, IFRS 16 not only places increased requirements on the accounting treatment, but also on the disclosure of complementary information. Would you like to know more about dLease? Go to our webpage.

The application of IFRS 16 is mandatory for reporting periods starting 1 January 2019. Even though companies were required to disclose the assessed impact of this standard already in the financial statements for 2018, many of them have postponed ongoing accounting for these items until the preparation of financial statements for 2019. If you do not have in place a tool for reporting lease contracts yet, we recommend paying attention to the selection of an appropriate instrument now so as to avoid unpleasant last-minute surprises.

The article is part of dReport – September 2019, Accounting news.

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