What’s the best option for your business on transition to IFRS 16?
Implementation projects are costly and data requirements extensive. But a careful use of transition options and practical expedients optimize the trade-offs between cost, timing and comparability – and your company’s profit in the post-transition years.
In January 2016, the IASB issued IFRS 16 Leases – a major step towards realizing its long-standing goal of bringing most leases on-balance sheet for lessees. IFRS 16 Leases includes a single lease accounting model for lessees and does not distinguish finance and operating leases anymore. All companies that lease major assets for use in their business will see an increase in reported assets and liabilities. The larger your lease portfolio, the more changes you may have to make to your systems and processes – starting with the creation of an inventory of all leases that are on transition to the new standard. To limit costs and ease the complexity of transition, the IFRS 16 includes several approaches, individual options and practical expedients that can be used independently, and in some cases, on a lease-by-lease basis.
A variety of options to choose from
The key decisions for a company relate to the effective date, and which options and practical expedients to elect. Many different combinations and permutations are possible.
Lease definition: Option to ‘grandfather’ the assessment of which contracts are leases
Entities can choose to apply the new lease definition to all contracts or to grandfather existing contracts. Grandfathering allows the application of IFRS 16 only to those contracts in which a lease was previously identified in accordance with IAS 17 and IFRIC 4. In all sectors, grandfathering may be the favourable option to reduce the assessment cost of existing lease contracts on the new lease definition as no further documentation or data retrieval is required. However, if existing leases were (erroneously) not treated as leases under IAS 17, the error is not grandfathered and shall be treated according to IAS 8. The required disclosures in the annual financial statements will uncover such errors by explaining any difference between the operating lease commitments disclosed applying IAS 17, just before initial application of IFRS 16, and the lease liabilities recognized in the balance sheet at the date of initial application.
Retrospective vs modified retrospective
Entities may either adopt the standard retrospectively or following the modified retrospective approach. If a lessee elects to apply IFRS 16 using the modified retrospective approach, then it does not need to restate comparative figures.
Only the modified restrospective approach allows the following options and practical expedients on transition.
- The short-term leases exemption is applied – on transition and subsequently – according to the class of underlying assets. As additional relief, during the transition an entity may also apply the short-term exemption to all leases with a remaining maturity of less than 12 months on a lease-by-lease basis.
- The leases of low-value items exemption is applied on a lease-by-lease basis without additional relief on transition. The IASB had an amount of USD 5,000 or less in mind (e.g. some laptops, tablets, individual printers, mobile phones), but the final standard does not provide a fixed amount. The exemption applies without regard to materiality (individually or in aggregate) of the leases to the reporting entity.
Both short-term leases and leases of low-value items do not lead to recognition of a lease liability and ROU asset.