A public example: what the private sector can learn about IFRS 16 from the public sector
Whilst most public sector and listed companies have now weathered the storm of IFRS 16 Lease changes, most private sector companies are still waiting to find out when UK accounting standards will follow suit. An update to FRS 102 Section 20 is expected in January 2024 to reflect IFRS 16. Considering the impact of the changes, this does not allow much time for companies to plan for the changes.
Give it time
Perhaps unusually, with IFRS 16, the private sector can follow the lead of the public sector bodies that have already implemented the standard. Having worked extensively with the NHS in England, planning and allowing enough time for the changes are essential. Despite a lengthy delay due to Covid, many Trusts were hard pressed to meet the deadlines. Finance teams across the NHS would tell you that having plenty of time to prepare for the change was critical. The more informed you are, the better because of the significant effect it can have on your accounts.
For lessees, operating leases are most affected. Under FRS 102, operating leases do not result in an asset and liability. Under the new rules, almost all leases are recognised as ‘right of use’ assets on the balance sheet, along with finance lease assets. The distinction between a finance and operating lease effectively disappears.
Another critical discussion that can take months to resolve is what discount rate you should use when calculating interest and present values for your monthly lease schedules. Again, this isn’t something that finance teams have had to consider until now.
IFRS advises that you should use the incremental borrowing rate. This is the rate of interest that a lessee would have to pay to borrow the funds required to obtain “…an asset of a similar value, over a similar term, with a similar security, in a similar economic environment”.
Using the incremental borrowing rate means that the rate will vary depending on both the lessee and the asset. Doing it this way makes it much harder to set the rate based on other organisations, as each situation will differ.
Where to start
Gathering the necessary information on all of your operating leases can be a time-consuming task. You will need information that you have probably never required before, such as how long the lease is likely to continue.
Especially with larger companies, this data will be spread across different business units, and a central register of information is unlikely. Compile a list of units and contacts early on and allow enough time for all areas of your business to gather this information.
The right tools
A spreadsheet is fine for initial information gathering. Once you start to apply the calculations and begin to forecast the accounting impact of these changes, a spreadsheet becomes complex and unmanageable very quickly.
There are several IFRS 16 compliant leasing solutions on the market. We frequently work with clients who start out using spreadsheets and invest a significant amount of time and energy in them before having to pivot and switch to a specialist solution.
From leases to fixed assets
In addition to saving time at period-end (and who wouldn’t want to do that), using an IFRS 16 compliant system will make your data much more auditable. This is particularly true if you can implement a system that covers both your lease accounting and your fixed asset register.
The two are so intertwined under the new standard. It makes sense to have an integrated solution where possible – each time a lease is added, adjusted or terminated, this will affect your fixed asset register.
With balance sheets, income statements and cash flow statements all being affected by IFRS 16, there’s a lot at stake. Debt/equity ratios will be affected, and companies with material operating leases will see much higher EBIT and EBITDA due to the changes in the way these leases are presented.
The new standard represents the biggest change to lease accounting in a very long time, so don’t be surprised if it takes longer than you expect. If we have learned anything from the public sector experience, it is to start earlier, plan thoroughly and use the right tools.
Vicky Stanley is an experienced Fixed Assets Accountant with over 20 years of experience in helping companies to manage their fixed assets more effectively.
Vicky lives in Kent in the United Kingdom with her family. After completing her ACCA qualification, Vicky started her career in accounting before moving into software and specialising in Fixed Asset Management Software.
Vicky has project-managed software deployments for organisations like the NHS and Foxtons in the UK and implementations across Europe, North America and even as far away as Japan.