MPA105 - Financial Accounting & Reporting: IFRS 16 Leases Analysis

This report provides a comprehensive analysis of IFRS 16 Leases, a new standard introduced by IASB for lease accounting, effective from January 1, 2019, replacing IAS 17. It delves into the rationale behind the standard, highlighting the shortcomings of IAS 17 in accurately representing lease transactions and the economic reality. The report discusses the implications of IFRS 16 on both lessors and lessees, noting a significant impact on lessees due to the elimination of the operating and finance lease classification. It also identifies the industries most likely to be affected, including retail, telecommunications, banking, metal and mining, transport, oil & gas and insurance companies, and concludes that IFRS 16 aims to provide more accurate and transparent information about lease transactions, enhancing the reliability of financial statements.

RUNNING HEAD: FINANCIAL ACCOUNTING AND REPORTING
IFRS 16 leases

Financial accounting and reporting 1
Contents
Introduction...........................................................................................................................................2
IFRS 16 Leases......................................................................................................................................2
Rationale behind the standard................................................................................................................3
Implications...........................................................................................................................................4
Lessor................................................................................................................................................4
Lessee................................................................................................................................................4
Companies most likely to be affected....................................................................................................5
Conclusion.............................................................................................................................................7
References.............................................................................................................................................8

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Introduction
A new standard for lease accounting has been developed by IASB named as IFRS 16 Leases.
It provides guidelines for lease accounting and state that the data reported must show the
accurate information about the lease transactions. The standard will come into effect from
January 1, 2019 and once applicable it will replace the old standard IAS 17 (Iasplus.com.
2018). The reports contains detailed information about IFRS 16, its implications on lessor
and lessee and the reasons behind introducing it. In the later part, it also discussed about the
companies which are likely to be affected by this.
IFRS 16 Leases
IASB published a new standard for lease reporting in January 2016, which will be in effect
from January 2019. It was introduced by IASB as part of joint project with FASB. It deals
with the new principles for disclosure and measurement of leases. A single lessee model was
established which requires a lessee to take into account all the liabilities and assets for the
leases that have a term period of more than 1 year (Deloitte UK. 2018). Under IFRS 16, lease
is defined as a contract in which customer (“lessee”) get a right to use an asset for a specified
period of time in exchange of some consideration (accaglobal.com. 2018). The introduction
of new standard will definitely impact several industries and also the accounting requirements
of lessee and lessor. The sectors which mainly get affected are retail, telecommunications,
banking, metal and mining, insurance and oil and gas entities.
However, entities that has applied for IFRS 15 Revenue from Contracts with Customers can
apply IFRS 16 in its lease accounting before its effective date. The main motive of bringing
this was to enhance the reporting of leases by eliminating their classification as financial and
operating lease. This elimination will enable the lessees to show all the leases on its balance
sheet so that true and fair picture can be represented (Ifrs.org. 2016).

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Rationale behind the standard
The main reason behind introducing IFRS 16 was to amend the approach stated under IAS
17, related to the classification of leases. IAS 17 was focused on distinguishing between the
two types of leases. Under it, the lease that transfers all the risk and reward of asset
ownership is termed as financial lease and apart from this all other leases are known as
operating leases. However, the classification set out in IAS 17 was subjective which provides
a clear benefit to the people who prepare financial statements of lessee. They can argue about
the fact that leases should be presented as operating in order to avoid the presentation of
leased assets and liabilities on the balance sheet (accaglobal.com. 2018). It was for this
reason that IASB brings new lease standard IFRS 16.
Also according to the IASB Chairman, the former lease standard does not reflect the
economic reality. As per him, more than 85% leases are recognized as operating and are not
shown on the balance sheet. As a result of which, they contribute in creating real liabilities
which may prove to be difficult for the major sectors like retail industry to cope up with the
situation of financial crisis. In addition to this, under IAS 17, companies were allowed to be
discrete about their operating leases. This led to the false and unfair representation of
company’s financial position and performance. As a result, investors find it difficult to
measure and compare the economic condition of different entities due to the faulty and
unreliable data provided by the balance sheet. In a nutshell, former standard does not reflect
economic reality which led to the introduction of IFRS 16 (Ifrs.org. 2016).
Implications
Lessor
The impact on the lessors will be minor as the requirement for them will remain unchanged.
They are required to classify the leases in the same way as it was mentioned in IAS 17.

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Fundamentally, the requirements of lessor accounting has not changed under IFRS 16.
However, lessors will have new disclosure requirements. The new standard contains a
specific exemption for lessors related to the valuation of investment properties at fair value.
Some new requirements related to sales and lease back transactions are also provided by
IFRS 16. Apart from these, there is no such significant impact on the lessors (KPMG. 2016).
Lessee
IFRS 16 will have a great and significant impact on the lessees because of its new
requirements. Till now, the companies are classifying their leases as operating and financing
as per IAS 17. The off balance sheet leases are those which are not reported on the balance
sheet. These are generally operating leases. The new standard will require the companies to
not only convert its existing operating leases but also amends its policies and procedures. The
implementation of IFRS 16 will bring changes in the companies’ IT and control system that
are used for supporting lease accounting along with lease procurement, administration and
tax. Also the financial statements of lessees will also be affected (KPMG. 2016).
Source: (Ey.com. 2016).
Companies most likely to be affected

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The changes in the lease accounting has affected many companies and also their financial
metrics. However, the impact is measured as per the facts and circumstances related to each
entity. The main entities or industries that get affected by IFRS 16 are:
 Retail and Customer: This sector is expected to be majorly impacted by the change
in lease requirements. It is especially in the case where leasing the retail space is the
business of the entity. Moreover, manufacturing companies also need to look at all the
major contracts that includes rental of plant and equipment, distribution centre and
fleet arrangements. As an effect of the changes, retailers need to check the renewal
options, estimate and remeasure the variable payments that are linked to a spot rate or
an index. In addition to this, they are also required to separate the service charges
from the lease elements (Pwc.com. 2016).
 Telecommunications companies: These entities lease a vast number of big ticket
items that includes cell towers, network equipment, fibre optical cables and satellite
transponders. According to the new requirements they need to consider the new
definition of lease for identifying the arrangements that contain lease. In addition to
this, these companies need to analyse the contracts where the equipment are provided
to the customers. Identification of the lease and the method of lease payments is
required to be done by the telecommunication entities (Ey.com. 2016).
 Banking and Financial institutions: Banks have many branch networks and large
call centres and administration that require them to consider the lease arrangements
carefully. Moreover contracts related to the ATMs and the space used by them are
required to be assessed as per the requirements of the new lease standard. Financial
institutions can make use of the data storage facilities and these arrangements can
cover under the scope of IFRS 16. As per the changes, financial service entities need
to determine the treatment of right-of-use assets for regulatory capital requirements.

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 Metals and Mining: After the implementation of IFRS 16, companies operating in
metals and mining sector needs to consider all the major arrangements they have
made such as mining equipment, land and buildings as well as vehicles. Such
arrangements may give rise to on balance sheet leases accounting under new standard.
Likewise, construction companies also have to consider all the arrangements made
related to equipment, vehicle and land and buildings leasing which may give rise to
on balance sheet leases (Ey.com. 2016).
 Transport and logistics sector: Firms operating in this industries often lease items
such as trains, ships, aircraft, real estate and also other vehicles. They also required to
decide about the renewal options and identify the lease as a service or operating lease.
Along with this, they need to separate the service elements from the leased equipment
(Pwc.com. 2016).
 Oil & Gas entities and insurance companies: They are least affected and are may be
impacted by the arrangements done in respect of vehicles, equipment and land and
buildings along with those that contain a lease (Ey.com. 2016).
So, all the above sectors or industries will be majorly impacted by the changes in the lease
accounting standard. Once IFRS 16 become effective, the companies are required to report
their leases as per the new requirements and comply with the changes made in their policies
and procedures.
Conclusion
From the above report, it can be concluded that introduction of new lease standard IFRS 16
will change the procedure for lease accounting, specifically for operating leases. It will lay
down some certain requirements that are to be followed by the companies and as a result of
which their financial statements will be highly affected. IFRS 16 will eliminate the need of

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classifying the lease as operating and finance and will provide a single accounting model for
lease reporting. The report also states that lessees will be more impacted than lessors, as they
have to change their method of lease accounting in order to comply with the new
requirements. Overall, it can be said that IFRS 16 will help in providing accurate information
about the lease transaction of the companies.

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References
Iasplus.com. (2018). IFRS 16 — Leases. Retrieved from
https://www.iasplus.com/en/standards/ifrs/ifrs-16
Deloitte UK. (2018). IFRS 16 Leases: new financial reporting standard Potential implications
for lenders. Retrieved from https://www2.deloitte.com/uk/en/pages/audit/articles/ifrs-
16-leases.html
Ey.com. (2016). Leases a summary of IFRS 16 and its effects. Retrieved from
http://www.ey.com/Publication/vwLUAssets/ey-leases-a-summary-of-ifrs-16/$FILE/
ey-leases-a-summary-of-ifrs-16.pdf
Pwc.com. (2016). IFRS 16: The leases standard is changing. Retrieved from
https://www.pwc.com/gx/en/services/audit-assurance/assets/ifrs-16-new-leases.pdf
Ifrs.org. (2016). IFRS 16 Leases. Retrieved from
http://www.ifrs.org/-/media/project/leases/ifrs/published-documents/ifrs16-effects-
analysis.pdf
accaglobal.com. (2018). IFRS 16, Leases. Retrieved from
http://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-
exams-study-resources/f7/technical-articles/ifrs16.html
Ifrs.org. (2016). Introductory comments to the European Parliament. Retrieved from
http://www.ifrs.org/-/media/feature/news/speeches/hans-hoogervorst-introductory-
comments-to-the-european-parliament-jan-2016.pdf
KPMG. (2016). IFRS 16 Leases. Retrieved from
https://home.kpmg.com/content/dam/kpmg/pdf/2016/01/leases-first-impressions-
2016.pdf

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