In fact, there isn’t just one big deal, but several little deals, and this is exactly why this standard is so complex. With each page you turn and brochure you read, another exception, complexity, or exemption is revealed.
Currently IFRS 16 is all the rage and, if you’re not talking about it, you probably feel like you’re missing something. Why? What is it about this standard that has everyone up in arms? Well, like its not-too-distant cousin IFRS 9, it promises an enormous impact on financial statements and has many a corporation scratching its head about how and to which extent they will be affected.
Hello, can you hear me…
If you’ve had your head in the sand about the practical implications of this standard, you might want to listen in for just one moment to see which types of leases will be most significantly affected:
- leases with termination and renewal options
- leases with variable payments
- sub-lease agreements
- intercompany leases
- lease payments bundled with service charges
- leases with a restoration provision on property
No need to break into a cold sweat if many of these apply to you. It simply means that you have a little bit more to think about than the rest of us, and possibly some light reading to do during the weekend.
How can I lease thee? Let me count the ways
Let’s look at just three of the above lease scenarios and I’ll highlight why each one poses its own challenge:
1. leases with termination and renewal options
Assessing the lease term is tricky due to its subjective nature—the lessee needs to decide if it is reasonably certain that a lease term will extend beyond a renewal or termination option. And, true to form, the words “reasonably certain” are not clearly defined, although some additional guidance is provided in IFRS16.B34-41.
Do take care here, as an accurate assessment of the lease term is pivotal in determining the discount rate used to calculate the present value of the future lease payments!
2. sub-lease agreements
The head lease and sublease need to be accounted for as separate contracts. Under this standard, however, you may find yourself in the situation where two different accounting models apply. Remember that the right of use (ROU) asset arising from the head lease is the determining factor in the finance vs operating lease classification (of the sublease).
3. intercompany leases
Intercompany leases usually lead to equal and opposite accounting treatment in the books of lessee and lessor, hence cancelling one another out upon consolidation as any well-behaved intercompany transaction does. However, under the new standard, you will have the lessor continuing the operating lease treatment as before on the one side, but a ROU asset and lease liability on the other! Consequently, intercompany leases will require special attention in terms of internal reporting and consolidation systems and processes.
On the road to new things
Once we can wrap our heads around the many implications of this new standard on leases, I’m sure we’ll agree that it will lead to a level of transparency that has been lacking. But until then, I refer you back to my mention of light reading…
Next up on the KPMG Blog: