accounting changed
IFRS 16 Leases vs. IAS 17 Leases: How the lease accounting changed
• Posted by:Silvia M.
16
In January 2016, IASB issued another important and long-discussed standard: IFRS 16 Leases that will replace IAS 17.
Ever since then I receive lots of e-mails asking me to sum up what’s new.
OK, so here you go.
In this article, you’ll learn about the main changes that IFRS 16 introduces to the accounting for leases, illustrated on a very simple example.
Warning: this is NOT exhaustive description of the standard, and I simplify the things a lot for illustration purposes.
I will come back to it at the later stage, because I truly think that there will be lots of questions, discussions and additional guidance on how to tackle several areas of the lease accounting.
The effective date of the new IFRS 16 is 1 January 2019.
Why the new lease standard?
Short answer: To eliminate off-balance sheet financing.
Under IAS 17, lessees needed to classify the lease as either finance or operating.
If the lease was classified as operating, then the lessees did not show neither asset nor liability in their balance sheets – just the lease payments as an expense in profit or loss.
But, some operating leases were non-cancellable, and therefore, they represented a liability (and an asset) for the lessees.
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This liability was hidden from the readers of the financial statements, as it was not presented anywhere.
Oh yes, some disclosures in the notes to the financial statements were mandatory, but frankly – who, except for auditors, ever reads the notes to the financial statements?
New IFRS 16 removes this discrepancy and puts most leases on balance sheet.
I’ll show you how in the next paragraphs.
Let’s see what has changed
Is it a lease?
The new IFRS 16 introduces a new definition of a lease. However, it is very similar to the old definition in older IAS 17 (differences do exist).
It means that when you actually accounted for some contracts as for lease contracts under IAS 17 Leases, you will continue to do so also under the new standard (careful, methodology may change).
BUT!!!
You have to be extremely careful when it comes to some service contracts.
Why?
Because, the new standard IFRS 16 provides a detailed guidance to determine whether your contract is a lease contract or a service contract (non-lease contract).
Under old IAS 17, it did not matter so much whether you have an operating lease contract or a service contract, for a very simple reason: you probably accounted for both types of contracts in the same way (that is, as a simple expense in profit or loss).
However, as the accounting for some types of previously-called operating lease contracts dramatically changes, we need to distinguish whether we have a lease under IFRS 16 or some other service contract under different standard.
As a simple illustration, let me come up with a small example:
Imagine you want to rent some space in the warehouse for storing your goods. You’d like to enter into a 3-year rental contract. The owner of that warehouse offers 2 options to you:
1. You will occupy a certain area of XY cubic meters, but the specific place will be determined by the owner of the warehouse, based on actual usage of the warehouse and free storage.
2. You will occupy the unit n. 13 of XY cubic meters in the sector A of that warehouse. This place is assigned to you and no one can change it during the duration of the contract.
Both contracts look like lease contracts, and indeed, in both cases, you would book the rental payments an expense in profit or loss under older IAS 17.