The new reporting standard for vehicle leases - IFRS 16 - came into effect on 1 January 2019, and replaces IAS 17, which means the new standard needs to be applied for all financial year ends starting on or after 1 January 2019.Not only is leasing becoming increasingly popular in both private and fleet capacity, but regulations are effectively being streamlined worldwide. IFRS 16 is an International Financial Reporting Standard that outlines how accounting and reporting should be done with regard to leasing.
Depending on your company structure, you will either have an internal accounting and auditing department, or this may be an operation that’s outsourced. Either way, fleet managers need to be aware of the new regulation around leasing as it could affect the overall fleet balance sheet.
No matter how many lease vehicles you have or when they were acquired, you will have to report according to IFRS 16 guidelines from all financial year ends starting from 1 January 2019. Below is an overview of what is required according to the new lease reporting standards:
1. Why IFRS 16 came into effect.
According to ACCA (Association for Chartered Certified Accountants), IFRS 16 makes significant changes to the way in which leasing transactions are reported in the financial statements of lessees (although not in the financial statements of lessors).
The approach of IAS 17 was to distinguish between two types of lease. Leases that transfer substantially all the risks and rewards of ownership of an asset were classified as finance leases. All other leases were classified as operating leases. The lease classification set out in IAS 17 was subjective and there was a clear incentive for the preparers of lessee’s financial statements to ‘argue’ that leases should be classified as operating rather than finance leases in order to enable leased assets and liabilities to be left out of the financial statements.
It was for this reason that IFRS 16 was introduced.
2. What will be the impact of IFRS 16?
According to Pricewaterhouse Coopers (PWC), the new standards will have the following implications:
- The new standard will affect virtually all commonly used financial ratios and performance metrics such as gearing, current ratio, asset turnover, interest cover, EBITDA, EBIT, operating profit, net income, EPS, ROCE, ROE and operating cash flows. These changes may affect loan covenants, credit ratings, and borrowing costs, and could result in other behavioural changes. These impacts may compel many organisations to reassess certain ‘lease versus buy’ decisions.
- Balance sheets will grow, gearing ratios will increase, and capital ratios will decrease. There will also be a change to both the expense character (rent expenses replaced with depreciation and interest expense) and recognition pattern (acceleration of lease expense relative to the recognition pattern for operating leases today).
- Entities leasing ‘big-ticket’ assets – including real estate, manufacturing equipment, aircraft, trains, ships, and technology – are expected to be greatly affected. The impact for entities with numerous small leases, such as tablets and personal computers, small items of office furniture and telephones might be less as the IASB offers an exemption for low-value assets (assets with a value of $5,000 or less when new). Low-value assets meeting this exemption do not have to be recognised on the balance sheet.
- The cost to implement and continue to comply with the new leases standard could be significant for most lessees, particularly if they do not already have an in-house lease information system.
- Lessees and lessors may need to consider renegotiating or restructuring existing and future leases.
- Business and legal structures supporting leases should also be reassessed to evaluate whether these continue to be effective (for example, joint ventures and special purpose entities).
- Lessor accounting remains largely unchanged from IAS 17 however, lessors are expected to be affected due to the changing needs and behaviours from customers which impact their business model and lease products.
3. How this affects your financial statements.
PwC offers a detailed example of how IFRS 16 will change your fleet financial statements. A few key points are:
- The overall impact on net profit is unchanged
- A right-of-use asset and lease liability will both reflect
- With the application of the right-of-use model, the lease expense recognition pattern during the lease term and presentation of lease payments in the statement of comprehensive income will change.
- Depreciation and interest expense are now recognised separately.
If you are responsible for the fleet balance sheet, it’s a good idea to consult with a professional fleet management company to find out how the new lease reporting standards will affect your fleet. In many cases, it could affect whether you opt to lease or own, and that could drastically change your fleet operations overall.
For helpful information on how to begin preparing for IFRS 16 for your fleet management, download our IFRS 16 Guide today, which also contains an IFRS 16 checklist so that you can track your progress towards compliance.