May 24, 2018
By: Alex Klein
Accounting and finance organizations for many multinational businesses are currently working to create plans for two separate lease accounting standards: the Financial Accounting Standards Board’s ASC 842 and the International Accounting Standards Board’s IFRS 16.
While the standards are similar in many ways, FASB and IASB failed to converge on several key points that will create changes in the accounting processes. Here’s what U.S. based companies reporting internationally need to know about that other set of standards, IFRS 16.
Classification: One of the clearest differences between the two is the difference in classification criteria for leases. While FASB chose to maintain the dual model approach for lease classification, with leases being classified as operating or finance, IASB now requires a single model. Under the single model, all non-exempt leases (discussed below) are treated as finance leases were under IAS 17.
Low-value exemption: One of the exemptions that IFRS 16 allows is that low-value assets (assets less than or equal to $5,000) are not required to be reported on the statement of financial position. The low-value exemption is in addition to the short-term (less than or equal to 12 months) exemption that is also offered under ASC 842. Disclosures are still required for both low-value and short-term leases.
Profit or loss / income statement: Under FASB’s dual classification model, operating leases will be expensed the same way they always have — as a single-line item. However, since the IASB chose to eliminate the operating lease classification, all leases will be expensed in the same way finance leases were under IAS 17. In other words, every lease over $5,000 and longer than 12 months will be recorded as a depreciation expense plus an interest expense on separate line items of the profit/loss statement. As a result, there will likely be an impact to the profit/loss statement, as well as the financial metrics that are dependent on the profit/loss statement, like EBITDA. For most companies subject to the IFRS 16 standard, the shift to finance lease treatment will remove a large portion of expense from operating to below-the-line depreciation, thus increasing EBITDA.
Index-based variable payments: Under both of the new standards, the business context for a payment change could determine whether the lease must be remeasured. However, unlike FASB, which treats an index change as a period-expense and thus does not require remeasurement, IASB chose to require remeasurements for lease liabilities when an index-based variable payment adjusts due to a change in the index.
Transition approach: IFRS 16 allows companies to choose between the full retrospective approach or the modified retrospective approach with practical expedients. Unlike FASB’s modified retrospective approach, IFRS 16 does not require companies to restate comparative information. FASB did recently vote to offer an additional transition method that would allow companies to forgo the comparative reporting requirement.
Initial right-of-use asset measurement: IFRS has outlined two alternatives for measuring the right-of-use asset under the modified retrospective approach. One measures the asset as if IFRS 16 had been applied at lease inception. The other measures the asset as the future unavoidable payments of the non-cancellable term. The former is easier to apply as it does not require historical lease information for all assets, but most companies will face a higher liability balance as well as lease payment in their reporting. The latter, while more difficult to apply, would likely result in lower liabilities and lease payments to be reported.
Practical expedients: There are several differences in the practical expedients offered between the two standards. Both allow for use of hindsight and both grant an option to not separate lease and non-lease components. However, IFRS 16 also allows companies to apply a single discount rate to a portfolio of leases with reasonably similar characteristics. Companies can rely on their IAS 37 assessment of whether leases are onerous instead of applying IAS 36 Impairment of Assets to the right-of-use assets. They can also choose to exclude the initial direct costs from the measurement of the right-of-use asset at the date of initial application. Lastly, they can choose to account for leases ending within 12 months of the date of initial application as short-term leases.
What should companies do to build their approach IFRS 16?
Major multinational companies need to take a holistic approach when creating their implementation plan for the new standards, with part of that plan focusing on the different compliance requirements of IFRS 16. Below are some steps companies should consider taking now:
Understand current processes for reporting under the current IAS 17 standard:What disclosures are being issued today and where? How is corporate reporting from headquarters in U.S. GAAP transformed into international standards? What organizations, systems and tools are involved in the process?
Consult external auditors about designing an approach to IFRS 16:External auditors can help with clarification or guidance on how to interpret the standards. Additionally, you should seek insights on what tests will be performed for balance sheet audits.
Review plans for new lease accounting policies to ensure they are inclusive of IFRS 16:Is there a policy in place to exempt low-value leases from the statement of financial position, but also complete the disclosures required for the low-value assets? Is there a policy to document whether a variable payment changes due to an index adjustment? How are policies communicated to global locations and business units?
Select the transition approach:Companies should determine which transition approach, full retrospective or modified retrospective, will be best for them, keeping in mind that many practical expedients are only available under the modified retrospective approach.
Select practical expedients:Companies will need to determine which practical expedients to elect. While initially it may be tempting to choose all practical expedients in order to reduce time to compliance, some of the expedients may impact financial statements in undesirable ways. For example, choosing not to separate lease and non-lease components will simplify the transition, but will also increase the lease liability value reported on the statement of financial position.
Include key IFRS 16 requirements in software evaluation:Businesses should ensure that their lists of software requirements include support for the unique requirements of IFRS 16 as described above. Be sure to add IFRS specific transition, and support for the practical expedients, variable payments, low-value exemption, and profit/loss statement changes.
Require software vendors to demo IFRS 16 features:Many software vendors say they can support both ASC 842 and IFRS 16. However, as many vendors are still completing their products, it is a good idea to confirm the functionality. The best practice is for companies to provide a sample of their own data and ask to see a live demo for both IFRS 16 and ASC 842.
Train local accounting teams in IFRS reporting on new standards:Local teams that provide external reporting in IFRS should understand the key differences between IAS 17 and IFRS 16. They will also need to understand key differences with U.S. GAAP to interpret data and reporting from headquarters.