Tutor tip: new accounting standard on leases IFRS 16

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By Gillian Vaughan, Financial Reporting Subject Controller

4 March 2016

In January 2016, the International Accounting Standards Board (‘IASB’) issued the new, and long awaited, accounting standard on leases, IFRS 16, Leases.

This replaces the existing standard IAS 17 which most of you will cover at TC Financial Accounting and TPS Financial Reporting. The 2016 syllabus at TC and TPS will cover IAS 17 which distinguishes between operating and finance leases as the new standard is not applicable until 1 January 2019.

Why the need for change?

Leases provide an important and flexible source of financing. Almost everyone agrees that a lessee obtains an asset and incurs a liability when it enters into a lease.

However, IAS 17 Leases makes it difficult for investors and others to get an accurate picture of a company’s lease assets and liabilities, particularly for industries such as the airline, retail and transport sectors.

This situation has arisen because of the distinction in IAS 17 between operating and finance leases – assets and liabilities are recognised for finance leases but not for operating leases. This gives rise to ‘off balance sheet finance’ for operating leases.

Providers of lease capital (lessors) can often design leases that meet the definition in IAS 17 of an operating lease. The IASB estimated that listed companies who used IFRS or US GAAP had US$3.3trillion of lease commitments, of which 85% did not appear on the balance sheet/statement of financial position of these companies.

Does it matter?

Yes – IAS 17 makes it difficult for users of financial statements to compare companies. It also means that investors and others have to estimate the effects of a company’s off balance sheet lease obligations, which, in practice, often leads to overestimating the liabilities arising from those obligations. IFRS 16 solves this problem by requiring that all leases (with very limited exceptions) are reported on a company’s balance sheet/or statement of financial position as assets and liabilities.

A really useful podcast by Hans Hoogervorst, IASB chairman summarises how and why the new standard will improve financial reporting.

How does the new standard impact affect my studies?

Those studying TC and TPS in 2016 will be learning how to apply IAS 17, which many clients will continue to use until 2019, and, therefore, it will not impact your exams. However as you learn about the  different leases, think about why the existing operating leases give rise to ‘off balance sheet finance’ and might distort how a user would interpret a company’s financial position – these skills will be useful as you move onto TPE.

Those studying for TPE should always have an awareness of current developments and given many case studies ask you to consider and advise on how best to finance significant capital expenditure, this is a topical issue.

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