Our Corporate Reporting lecturer Colm Foley writes on a new accounting standard which is likely to be a feature of future Corporate Reporting/Financial Accounting exams. Last week Colm discussed IFRS 15- the new accounting standard related to Revenue. Today’s blog is about changes to the IFRS 16 – Leases.
IFRS 16 – Leases
The new accounting standard, IFRS 16, Leases, is effective for accounting periods beginning on or after 1.1.2019. Early adoption is permitted, if IFRS 15, Revenue from Contracts with Customers, is also applied.
IFRS 16 will replace IAS 17 Leases. To recap, IAS 17 creates a distinction between finance leases and operating leases in the books of the lessee. Operating leases are expensed on a straight line basis to the Statement of Profit or Loss, whereas finance leases are accounted for on the Statement of Financial Position, with the finance leased asset being capitalised and a corresponding finance lease liability being recognised.
However, commentators have long argued, that operating leases can amount to a form of off-balance sheet financing, as the reporting entity may be contracted to pay operating lease rentals for a fixed term into the future, but, per IAS 17, no liability is shown for the future operating lease rentals on the Statement of Financial Position. Therefore the financial statements of entities with a high volume of operating leases would not fairly report their level of future leasing commitments. This would be particularly relevant to the airline industry, where a lot of airlines would lease airplanes on operating leases.
It is from the above that IFRS 16 was born. IFRS 16 was brought in to remedy the non-recognition of liabilities for assets held under operating leases.
For lessees, IFRS 16 removes the distinction between finance and operating leases which was a feature of IAS 17.
A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
Right to Control the use of an asset is dependent on
- D: Direction over how and for what purpose the asset is used is a right that the lessee has
- E: Economic benefits from use of the identified asset will flow to the lessee
A lessee does not control the use of an identified asset if the lessor can substitute the underlying asset for another asset during the lease term and would benefit economically from doing so.
Lessor accounting remains largely similar to the treatment set out under IAS 17, with the distinction between operating and finance leases remaining.
As a result of IFRS 16, the former chairperson of the International Accounting Standards Board, Sir David Tweedie, will finally get his wish, as the aircraft he flies in finally lands on the balance sheet of the airline that leases it.