IFRS 16 Leases
IFRS 16 Leases was issued in January 2016 to better manage the lessee accounting model. Essentially, IFRS 16 retains the finance and operating lease distinction for lessors but lessees are now required to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. This came into effect in the private sector on January 1st 2019 and will have a significant impact on financial statements, especially if the entity has a large number of operating leases. There are some nuances between how IFRS 16 is treated between both the public and private sector, but the fundamentals do remain the same. For example, the Government Financial Reporting Manual (FReM) details the UK public sector uses the HM Treasury discount rate, where the entities cannot readily determine the interest rate implicit in the lease. FReM also details out the treatment of peppercorn leases. For peppercorn leases, rather than creating the asset based upon the IFRS 16 cost model, the asset value is based upon the current value of existing use or fair value.
Lesson 1: Give yourself time
For most public sector finance departments this will likely be the largest accounting project they undertake in 2020. The work involved in collecting all data points for accurate, robust and repeatable disclosures should not be underestimated. Many private sector customers recommend treating this as a project. Careful planning will quickly identify the work ahead and make for a more effective, agile transition.
There are extra complexities that need to be considered under the public sector’s transition. An example of this is the treatment of peppercorn leases, where the rent paid is considered as nil or nominal. The leased asset therefore needs to be based upon the fair value, which means that the public sector needs to value all the lease properties in the estate, where a peppercorn lease exists. Note, lease liability is still measured in accordance with IFRS 16. More information on the treatment of peppercorn leases is available here.
Lesson 2: This is wider than just a finance issue
What started as a purely finance based project in the private sector quickly became a wider remit involving process transformation for most core departments. Finance generally continue as the project sponsor, but quickly recognised that they needed to actively involve other departments who have touch points during the lease lifecycle. This is likely to include departments ranging from Real Estate, FM, IT, Procurement, legal, and Finance. Greater input from every stakeholder will create opportunities to move away from the challenges of siloed working to more collaborative working. Therefore, it is essential to establish how they interact with these leases and establish the processes and controls required to efficiently manage the new accounting standard on an ongoing basis.
Lesson 3: Build the right team for success
Organisations who got it right first time in successfully transitioning to IFRS 16 treated this as they would approach any other business critical project. Identifying a Project Team Manager who have all the tools, capacity and experience to meet all required deliverables. There are likely to be new policies, procedures, applications and governance that needs to be applied for this to happen so if the skillset is not readily available internally, specialised external project resources who can demonstrate meeting these gaps may save you a lot of additional pain and expense further down the line.
Lesson 4: Invest in technology over Excel
Many private sector companies have started trying to manage IFRS 16 via Excel only to run adrift. Challenges in terms of process, limited automation, security and double handling of spreadsheets and Finance systems leads to data integrity problems and overall lack of control.
Investing in lease management and accounting technology ensures that the business as usual treatment of leases is managed effectively whilst automatically driving the asset and liability calculations and disclosure reporting for the finance team. If implemented correctly, the technology should meet and then exceed the return of investment over time.
Lesson 5: Have a robust data management strategy
Departments interacting with leases are often siloed. The data required comes from various sources and is usually housed in multiple sources and structures. Equally leases will vary in complexity and these factors can exacerbate the challenge of building sustainable data governance and risks the integrity of meeting accounting standards. Many private sector customers have benefited from using the latest AI lease abstraction tools and integrated these with their chosen lease accounting software to streamline the end to end digital data strategy.
This not only increases the accuracy of data capture as part of the initial implementation but when used on an ongoing basis will fully automate the end to end process and avoid having to undertake follow up data capture projects year on year.
Lesson 6: Keep auditors updated and involved
The ramifications of failing a Government audit are wide ranging depending on the circumstances. Examples may extend beyond embarrassment for the individuals, their bosses and the office as jobs can be put at risk. Additionally, reputational damage may impact for the long-term, additional expense is likely to be incurred for remediating these failures and closer scrutiny by the auditor for future audits is an expected consequence.
Many of our customers in the private sector would recommend keeping auditors updated on technology you plan to use to manage IFRS 16 lease obligations, actively involving them during the procurement process. This allows their perspective on the suitability or indeed any perceived limitations of the technology and adds value to ensuring that entities make informed decisions in selecting the right solution to be IFRS 16 compliant now and for the future.
If you would like to find out more about our software for IFRS 16, please get in touch today.