Leasing is a common way for a business to raise finance. In simple terms, when a company signs a lease agreement, they obtain the right to use an asset in exchange of future payments. Under current lease accounting rules (IAS 17), leases are categorised either as ‘finance leases’ or ‘operating leases’
The classification of the majority of leases as operating leases has two key issues:
1. Lack of transparency: Market analysts and credit rating agencies currently make adjustments to financial statements that often result in over or under estimation of a company’s financial position
2. Lack of comparability: On the basis of existing financial statements, investors are unable to compare between companies that borrow to buy an asset and companies that enter into a lease agreement.
The International Accounting Standards Board (“IASB” responsible for IFRS) and Financial Accounting Standards Board (“FASB” responsible for US GAAP) have undertaken a joint project to address these issues. IFRS 16 Leases was issued by the IASB in January 2016. It will replace IAS 17 Leases for reporting periods beginning on or after 1 January 2019. It can be applied before that date by entities that also apply IFRS 15 Revenue from Contracts with Customers.
There are important business considerations – including whether changes are needed to systems and processes (e.g. to track leases individually or at a portfolio level, or to accumulate the information needed for disclosures); and the impact of changes in the amounts reported on key metrics, debt covenants, and management compensation.