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January 13, 2016

Industry reaction to the release of IFRS 16

By Franchesca Hashemi

The International Accounting Standards Board (IASB) has issued a new accounting standard which requires all leases to be reported on a company’s balance sheet as assets and liabilities in an effort to provide greater transparency to investors.

The new accounting standard, entitled IFRS 16 Leases, will come into force on January 2019.

Presently companies using IFRS and US GAAP are estimated to have leases commitments worth $3.3trn, however over 85% of these do not appear on the balance sheets, suggesting net debt for global companies will surge once the new leasing standard takes effect.

It will not converge with US GAAP standards, despite the US Financial Accounting Standard Board (FASB) and IASB working together to develop IFRS 16. However, FASB is expected to release its own version of the new leasing standard in early 2016.

"These new accounting requirements bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligations," Hans Hoogervorst, IASB chairman, said. "The new Standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off balance sheet lease financing is no longer lurking in the shadows. It will also improve comparability between companies that lease and those that borrow to buy."

Industry Reaction

Andrew Collier, director of quality and professional standards, Kreston International:

"The release of the new Leases standard IFRS 16 is welcome as it now brings clarity for preparers and will enable them to plan for the transition. The standard should improve comparability and transparency between the financial statements. It is positive that FASB are introducing a similar standard in the US although there are a number of differences that will hamper comparability. Auditors will also have an important role to play in ensuring any restatements are dealt with appropriately and that leases are correctly identified. However, the removal of the distinction between operating and finance lease should ease one area of complexity."

Leo van der Tas, EY Global IFRS services leader and a partner at Ernst & Young Accountants LLP (Netherlands):

"The IASB has addressed some of the concerns raised by respondents about the cost and complexity of implementing the new standard. However, because most leases will be recognised on the balance sheet under the new standard, lessees will put more focus on whether an arrangement is or is not a lease. For contracts that include significant services, this assessment may be challenging.

The separate IASB and FASB standards will bring more leases onto lessees’ balance sheets. However, the differences between the standards are likely to reduce comparability between IFRS and US GAAP in respect of lease transactions compared to current standards."

Brian O’Donovan, UK partner in KPMG’s international standards group:

"The new requirements are less complex and less costly to apply than the IASB’s earlier proposals. However, there will still be a compliance cost. For some companies, a key challenge will be gathering the required data. For others, more judgemental issues will dominate – for example, identifying which transactions contain leases.

Companies won’t have the full picture until other accounting and regulatory bodies have responded. For example, the new accounting could prompt changes in the tax treatment of leases.

It’s ironic that the outcome of this long-running convergence project will be divergence in accounting for common lease types. The new IFRS and US GAAP standards will introduce differences in the profile and presentation of annual lease expense where none currently exist, reducing comparability between the two major accounting frameworks."

Matthew Stallabrass, partner at Crowe Clark Whitehill LLP:

"It is disappointing, however, that after a project lasting 10 years the new standard is not fully converged with USGAAP. Whilst both standards bring operating leases on balance sheet USGAAP will retain the distinction in the Income Statement, continuing to recognise a rental expense. In my opinion this treatment better aligns financial reporting with the underlying cash flows and hence gives a fairer presentation than the approach taken in IFRS 16.

The new standard, which is applicable for periods commencing on or after 1 January 2019, will require leases to be reassessed and adjustments made on transition. This will impose costs on companies which many will not welcome given that they will have incurred costs, and processed restatements, in applying IFRS 15 Revenue in the previous year. Having two significant changes in such quick succession may impose a particular burden on smaller listed companies with fewer resources and the IASB should give this problem greater consideration when deciding effective dates for future standards."

James Chalmers, PwC’s UK assurance leader:

"All leases going ‘on-balance sheet’ should not be a surprise.

Despite some challenges, it should be a relief that the IASB has put an end to years of uncertainty by finally issuing its new standard. The IASB has taken on board the considerable amount of feedback it has received over the years in order to publish a standard that is more workable than some earlier versions. However, adopting it in time for the 2019 effective date will still be a challenge for some companies."

Nigel Sleigh-Johnson, Head of Financial Reporting Faculty at ICAEW:

"The publication of this standard is one of the most significant developments to date in the world of international financial reporting.

There is much work for companies to do to understand and implement the changes, not least in the area of data collection, and this work should be started sooner rather than later. The potential implications also go way beyond a mere change in accounting.

The standard will have a significant effect on financial ratios and debt covenants because of the leased assets and liabilities newly recognised on lessee balance sheets. Employee compensation arrangements, dividend planning and taxation may also be affected.

"One concern is the need for the EU to formally endorse the standard before it can be used by European companies. I would urge the European Commission to get the complex process of endorsement underway as soon as possible, especially considering that some businesses may wish to adopt the new standard early."

UK FRC executive director for codes and standards, Melanie McLaren:

"The FRC is pleased that this standard has now been issued and will be fully involved in considering its endorsement in Europe."

Veronica Poole, global IFRS leader and UK head of accounting at Deloitte:

"It has been a long haul with many twists and turns along the way. But the real challenges start now and the volume of work in the lead up to a 2019 implementation must not be underestimated. Identifying all the relevant transactions is challenging enough, not least the boundary between what is now considered a ‘lease’ and a ‘service’. What is in and what is out will result in a series of difficult judgements".

The new standard means that companies will be viewed and compared by their investors differently.

The final result should be clearer for both preparers and investors, since a very obvious part of financing will become explicit rather than remain implicit. Ultimately, today’s standard will ensure a more accurate outcome that investors will welcome."

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