by Jen Lemen
Hot Topic Highlight - IFRS 16
Building a better you
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This week, we are going to look at the changes to IFRS 2016 in relation to the mandatory Accounting Principles and Practice competency. This will apply to a variety of pathways, including Building Surveying, Building Control, Quantity Surveying & Construction, Residential Property, Valuation and Commercial Property.
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What is IFRS?
IFRS stands for International Financial Reporting Standards, which are published by the IASB (International Accounting Standards Board).
In the UK, public listed companies adopt IFRS as their financial reporting standard.
Under the Companies Act 2006, SMEs can use the simplified FRS 102. This became effective from 1 January 2015 and is known as ‘new UK GAAP’.
What is IFRS 16?
IFRS 16 is part of the wider IFRS and is known as the new leases standard.
When does IFRS 16 apply from?
1 January 2019.
Who will it apply to?
All companies who rent or lease assets for business purposes.
Specifically, it applies to all leases with a term over 12 months, unless the underlying asset is of low value (which is unlikely to apply to most property transactions).
What are the objectives of IFRS 16?
- To report accurate information which reflects lease transactions
- To allow accurate analysis of cash flows (e.g. amount, timing and uncertainty) relating to leases
How were leases previously accounted for?
Until January 2019 when IFRS 16 becomes effective, a dual accounting model can continue to be used for leases, which distinguished between on-balance sheet finance leases and off-balance sheet operating leases.
What are the key changes?
- Leases must be accounted for on the balance sheet
- New definitions of financial metrics, e.g. gearing ratio and EBITDA
What are the likely impacts of the changes?
- Increased global comparability of accounts
- Credit ratings, borrowing costs and stakeholders’ perceptions of a company are likely to be affected
- Lessees will appear asset-rich but with greater debts, i.e. balance sheet will grow, gearing ratios will increase and capital ratios will decrease
- Expenses for leases will appear front-loaded, even where consistent rents are paid over the lease term
- Changes to business practices to incorporate the changes, e.g. leasehold vs. freehold decision when acquiring new assets, regearing or restructuring existing leases, increased demand for short-term leases, service elements split out of rent so they are not taken into account in balance sheet calculations
What are the key challenges likely to be?
- Collating all relevant lease documentation, e.g. from archives or solicitors, from all entities within a Group company
- Calculate the balance sheet liability, e.g. estimate the term lengths from reading each lease
- Estimating the interest/borrowing rate depending on the type of asset, location, lease length and covenant strength of separate group entities
- Cost of implementation
- Management time to implement the standard
- Establishing whether a contract is an operating lease or a contract for services
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Stay tuned for our next blog post to help build a better you
N.b. nothing in this article constitutes legal or financial advice.