The new standards on lease accounting are here. They became effective on 1 January 2019 for calendar year-end companies. However, KPMG’s survey of companies around the world reveals that some firms won’t have fully completed their implementation programs by the effective date, and will therefore be relying on interim solutions to enable compliance workarounds.
The survey conducted by KPMG gathered info from 800 companies across the world, 100 of which are in the EMEA zone (made up of Europe, the Middle East, and Africa). It presents an interesting picture of the industry at a moment just before the new standards went live.
At the time of the survey, under half of the total respondents had completed a lease inventory or selected their lease accounting software, and only a quarter had completed an accounting assessment. Regarding the latter, EMEA was nevertheless somewhat ahead of the average, at a 43% completion rate. Regarding software selection, EMEA was closer to the average, with 47% having made their selection.
Overall, just three companies per hundred had fully completed their lease accounting compliance projects! Of the rest, two thirds indicated that they were not even on track for completion, due to the challenges they were facing.
In the realm of budgets, 62% of respondents said that their projections of implementation costs had increased over the previous twelve months, partly due to having to hire external advisors. A shortage of IFRS 16 specialists in the market is likely to mean that the cost of resources will continue to be a noticeable factor.
The main challenges
The number one challenge for companies, it turns out, has been identifying all the leases they hold. It has proven hard to locate, and ensure the completeness of, the significant numbers of leases that exist. Of particular difficulty has been ensuring that all the leases that are within larger service or supply contracts (i.e. embedded leases) are covered. Our experience in Luxembourg shows that another challenge has been the judgment of whether a contract qualifies as a lease under IFRS 16 for the purpose of the lease definition or if another IFRS should be applied, e.g. IFRS 15. Similarly challenging is identifying and separating the lease and non-lease component within the contract.
Other key challenges include establishing an appropriate incremental borrowing rate (IBR); abstracting, analyzing, and entering leases into a leasing system; and integrating a lease accounting system into the existing system. The lattermost issue is the top concern in EMEA because this goes to the heart of one of the key problems: the implementation needs to be sustainable in the long-term, and not just a one-off compliance exercise.
Nevertheless, another 27% of the respondents in EMEA are planning to handle changes manually or via spreadsheets, a number that may drop as projects advance and the scale of the work required becomes clearer. Views may also change as people realize that lease information needs to be continually updated, with regular reassessments.
From our IFRS 16 projects in Luxembourg we have seen that, to implement lease accounting software, companies spend on average double the time and the effort of what they had first estimated.
Impacts across the business
Survey respondents rated the impact on the balance sheet as the most significant one, with disclosures/reporting and processes/controls not far behind.
The standards will also affect financial ratios and covenants. Many organizations and banks are still unsure whether the accounting change will be an issue, and whether or not to assess their compliance with borrowing terms against the ratios under the accounting standards in place when the loan was approved. In Luxembourg, banks are also concerned about how the change will affect risk-weighted assets and capital adequacy ratios.
There are a number of choices when it comes to transition. Over half (58%) of companies are planning to adopt the modified retrospective approach, which does not require the restatement of comparative periods, although a relatively high 31% said they are still undecided about which transition approach to take.
Furthermore, many companies (61%) plan to apply the short-term exemption to leases with less than twelve months remaining, and 57% will apply a single discount rate to a portfolio of leases.
Finally, we can confirm some of these global trends in Luxembourg: for instance, an increasing number of our clients are choosing the modified retrospective approach.
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