EVENTS

S&W Sessions: All change for lease accounting - are you ready?

  • Date: 12 Dec 2018
  • Time: 09:30 - 10:30
  • Venue: Webinar, hosted via WebEx, join from any location, use the link below

S&W Sessions are a regular series of thought provoking hot topic webinars that are relevant to your business.

This webinar will provide a summary of the newest standard IFRS 16, which came into effect on 1 January 2019. We will take a brief look at the previous standard IAS 17 before discussing the new standard’s key requirements, practical issues, possible implementation challenges as well as what preparation should already be underway to help make sure your business is ready.

The webinar will touch upon the following:

  • A reminder of the key requirements of the new standard with a focus on what’s different from current practice
  • The impact on your financial statements
  • Practical challenges
  • Tax implications / considerations of the new standard
  • Key takeaways
  • How can we help?

Who should view the webinar?

  • All in-house accounting professionals, FD’s, FC’s, Tax professionals

Overview

IFRS 16 - Introduction

  • Replaces IAS 17 but also IFRIC 4, SIC 15 and SIC 27
  • Applies for periods beginning on or after 1 January 2019
  • Lessees: fundamentally changes accounting for operating leases: Income Statement, Statement of Financial Position, Statement of Cash Flows & notes
  • Lessors: no real change but extra disclosure

IFRS 16 - Core principle

  • A single lease accounting model requiring recognition of assets and liabilities unless
    • Lease term is < 12 months
    • Underlying asset has low value
  • Need to recognise
    • Right to use the leased asset for the lease term; and
    • Lease liability reflecting the obligation to make lease payments
  • Can apply to a portfolio of leases if you reasonably believe that the result will not be materially different than applying to each individual lease
  • Does NOT apply to
    • Leases to explore for minerals, oil and gas and similar resources
    • Biological assets
    • Service concessions
    • Intellectual property
    • Rights in respect of motion picture films, patents, copyrights etc

IFRS 16 – New definition

Right to CONTROL the use of an asset for a period of time in exchange for consideration
Control is conveyed when the lessee has the right to;

  • Direct the use of the asset; and
  • Obtain substantially all the economic benefits from that use

Also consider whether the lessor has a substantive right to substitution

  • Lessor has practical ability to substitute alternative assets for period of use; and
  • Lessor would benefit economically from that substitution

IFRS 16 – Initial measurement

The lease liability

Incremental borrowing rate;
“The rate of interest that a lessee would have to pay to borrow over a similar term and with similar security the funds necessary to obtain an asset of similar value to the right-of-use asset in a similar economic environment”

The right of use asset
Depreciate over the life of the lease and test for impairment; may need to be adjusted for changes to the estimated lease payments

IFRS 16 – Example

  • 10 year lease with an option to extend for a further five years – lessee not likely to extend
  • Lease payments constant during initial period and then at a higher rate
  • Lessee makes a payment to the former tenant and an agents commission (initial costs)
  • Landlord agrees to reimburse commission and lessees improvement costs
  • Discount rate 5%
  • Right to use asset = first year lease payment paid + present value of next nine years payments discounted at 5% + initial costs – reimbursement of commission
  • Lease liability = present value of next nine years payments discounted at 5%

IFRS 16 - Modifications

Lease payments to reflect inflation (e.g. RPI linked or subject to rent reviews) Lease term changes because an option to extend now becomes reasonably certain Lease terms changed to extend scope of lease but receive discount compared to SSP Lease terms changed to extend scope of lease at SSP
  • Initially estimate based on the rate at the start date
  • Liability will need adjusting whenever cash flows change
  • Remeasure using revised lease payments and an unchanged discount rate
  • Extension would not have been included in the lease term on initial measurement of the lease asset/liability
  • Now remeasure using revised lease payments and a revised discount rate
  • Allocate consideration and determine revised lease term
  • Remeasure using revised lease payments and an unchanged discount rate
  • Treat as separate lease

Equivalent adjustment is made to right of use asset unless carrying amount is reduced to zero, in which case adjustment goes to profit or loss

IFRS 16 - Exemptions

Short-term leases

  • Lease term of 12 months or less (provided the lease doesn’t contain a purchase option)
  • Need to consider any extension options which are reasonably certain to exercise
  • Accounting policy choice (by class of underlying assets)

Leases of ‘low value’ assets

  • No monetary threshold in the standard basis of conclusions refers to assets with a value, when new, of US $5,000 or less
  • Not highly dependent on or highly interrelated with other assets
  • Accounting policy choice (lease-by-lease basis)

IFRS 16 – First time adoption

Choice

  • Full retrospective application, or
  • Modified retrospective application
    • Do not restate comparatives
    • Cumulative effect of applying the standard is taken to equity in the first year

Practical expedients

  • Do not have to apply new definition of a lease retrospectively
  • Saves gathering data which may not be available
  • If doing modified retrospective approach can apply certain practical expedients on a lease by lease basis
    • Treat leases that expire within 12 months of initial application as short term
    • Simplified calculation of right to use asset
    • Use a single discount rate to a portfolio of similar leases

IFRS 9 – Financial Instruments

Effective periods beginning 1 January 2018

FRC have looked at interim accounts of sample of firms

Assets model

  • Mostly presentational change so far, some entities found to have missed changes
  • Expected loss model for impairment change from incurred loss model

Non banking entities

  • No material changes found
  • Some disclosure issues noted
  • FRC noted extension of IFRS 9 to ‘contract assets’ (accrued income) not clear has been considered
  • Treatment of embedded derivatives likely to make entire asset fair value

IFRS 15 Revenue from contracts with customers

Effective periods beginning 1 January 2018

New model

  • New 5 step model with new and changed concepts
  • Move to control basis for recognising revenue

Findings

  • Some significant changes, both revenue being brought in earlier or brought in later
    Changes to balance sheet with new ‘contract assets’
  • 41% fully retrospective, 59% modified retrospective transition approach
  • 6% early adopted
  • New policies were fairly well disclosed, but the change in policy wasn’t always clear

IFRS 16 – Lease data required

Both transition approaches

  • Start date
  • Expected end date
  • Lease payments including variable payments
  • Option dates and payments and penalties
  • Lease incentives and dilapidation provisions

Fully retrospective approach

  • Historic discount rate
  • Historic assessment for options (reasonably certain to exercise)
  • Historic estimate of residual value guarantee
  • Historic impairment testing
  • Initial direct costs

Modified retrospective approach

  • Incremental borrowing rate at date of adoption
  • Hindsight for assessing options and residual guarantee estimates
  • Impairment testing at date of adoption or use historic onerous lease previously considered
  • Initial direct costs optional not mandatory

Lease overview

Now

  • Distinction between finance lease and operating lease
  • Operating lease - tax relief available for the P&L operating lease cost. Under a long funding lease the lessee could be entitled to capital allowances
  • Finance lease – tax relief available for P&L costs but under long funding lease the lessee could be entitled to capital allowances

Future

  • All leases now on balance sheet and treated as right to use assets – lessee tax relief available for ‘interest’ on the financial liability, and accounting depreciation on the non-financial asset, or capital allowances under the long funding lease rules

On adoption of IFRS 16

  • On adoption of IFRS 16 expected that the net assets of entities will decrease
  • This transitional adjustment usually taken through equity will be spread
  • Complex calculation requires maintenance of a separate tax basis for each lease
  • Significant deferred tax impact, depending on the profit/loss profile of the group

IFRS 16 and Corporate Interest Restriction

  • The costs incurred in relation to operating leases will continue to be excluded from the ‘qualifying finance costs’
  • However, if company accounts are being produced under IFRS, this operating lease accounting data will no longer be available
  • Hence groups will have to maintain a separate tax-only calculation in relation to their right-of-use assets so that the associated finance cost can be stripped out of the total interest expense recorded in the IFRS accounts.

IFRS 16 and Capital allowances

Good news!

  • Simplification
  • Grandfathering

Not so good news…

  • Capital allowance calculation change – long funding lease calculation based on MV but will change to present value of the minimum lease payments remaining.
  • Deferred tax change in basis – election into the long funding lease regime for new right-of-use assets will mean maintaining two different calculations for deferred tax calculation

Other recent changes - IFRS 9

Effective from periods beginning 1 January 2018

  • Classification and measurement
  • Impairment provisions are likely to be larger and recognised earlier
  • Transitional adjustments – if loan relationship / derivative then in most cases, will be spread over ten years
  • Going forwards the tax treatment will follow the IFRS 9 accounting treatment

Other recent changes - IFRS 15

Effective from periods beginning 1 January 2018

  • Over a contract the accounting profit is the same but timing of revenue recognition could have an impact on tax cash flows
  • IFRS 15 could result in either the acceleration or deceleration of revenue and if not aligned to cash flows then may need to fund tax cash flows
  • The later revenue is recognised the lower rate of CT to pay (17% in 2020)

Tax accounting final thoughts

  • Deferred tax considerations where transitional adjustments are recorded. Complexity around different spreading rules per standard e.g. 10 years or spreading calculation
  • Different methods of deferred tax calculation e.g. capital allowances
  • Deferred and current tax consolidation adjustments where subsidiary companies are not applying IFRS, these will be burdensome

 

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