If you are working in an accounting department, you should already be aware that this is one of the next major changes on the new leasing standard that will kick into effect from January 2019. While we still have more than a year to go, many companies are already preparing to shift into the new leasing standard as they start to look into their leasing activities from 2018 onwards to meet the criteria later on.
The End of the Operating Lease
Under the existing rules, lessees generally account for lease transactions either as an off-balance sheet operating lease or as on balance sheet finance leases.
The new standard requires the lessees to recognize nearly all leases on the balance sheet in their PPE and then capitalize this by depreciating the items for the remaining useful lives of the assets.
Who Will Be Affected?
Many companies uses rentals for their offices or machines as well leasing for access to some machinery or software assets so industries across will be impacted by the new standard.
Currently, many leases contracts embedded both the operating lease and non-lease (e.g maintenance) components and they do not separate them. Under the new leases standard, it is imperative and mandatory that they separate between the two because the leases will have to be recognized on the balance sheet.
For example, telco companies that are leasing network equipment or fibre optic cables need to unbundle elements that are between lease, service and maintenance. The discussion will then take place on whether the capacity it provides can outweigh the revenue that they can earn (also subject to the new revenue recognition standard in 2018).
For the real estate industries, the discussion will then take place on whether lessees are going for shorter term leases rather than longer term and the way they’d like to split between the rentals and the services (inclusive of furniture and fittings).
What Will Be Exempted?
There are 2 scenarios where the lessees may be exempted from the new IFRS requirement.
The first is a short lease term that are lower than 12 months. In this case, the lessee is able to recognize the lease payment straight in the PnL over the lease term without needing to touch the balance sheet.
The second is for lessees that leases for low value assets that are less than $5k. This usually involves components such as laptops, tablets and parts of the assets.
What This Means In Terms of Financial Impact?
If you owns a company that is impacted by these changes, you should notice a heads up on this.
The new standard will gross up balance sheets and impact pnl and cashflow.
Rent expenses will be replaced by depreciation expense in the income statement which results in a front-loaded lease expense. This should translates into lower earnings especially if the depreciation is taken at an accelerated rate. EBITDA would also be virtually higher but NOPAT lower. Operating cashflow should also be higher, since depreciation is a non-cash items but this will be offset with the payment made on the investing cashflow. Balance sheet should also swell, which means gearing may go up.
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Hi B,
Do correct me if I understand the post incorrectly.
From the original recognition off-balance sheet for operating/non operating leases, now with the IFRS16, depreciation for each leases shall be separated AND recognized in the Balance sheet.
For companies that will rely heavily on leases, with the new implementation, earnings and balance sheet has to be studied differently with effect from FY2019, taking into account of the new leases separation, which will "lower" the earnings of the companies.
Hi Sleepydevil
Your understanding and interpretation is perfectly correct 😀
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