IFRS 16 Lease aspects -3-
This is the third report on IFRS 16 Lease aspects following two recently published articles examining the effects of the introduction of IFRS 16 on European companies. For information, see the bottom of the article under ‘Background’.
In this report, we highlight the (one-off!) choices made by a company if it has opted for the modified retrospective method of transition to IFRS 16.
General principles
With the introduction of (International Financial Reporting Standard) IFRS 16 Leases, a new category of asset has been created in the financial statements: the right-of-use asset.
If the company has opted for the modified retrospective method at the transition to IFRS 16, there are still two, independent choices to determine the initial value of the new lease asset:
- comparable lease transactions are calculated ‘en bloc’ using a single discount rate, the so-called portfolio approach;
- at the start of the application of IFRS 16, there is the option – immediately preceding the start – to apply a reassessment on the basis of the ‘old’ standard IAS 17.
Both options were used extensively. This indicates that the possibilities given were quite necessary for the introduction of the standard.
Research results
Seventy-two companies were investigated, of which 87% (n=63) opted for the modified retrospective method.
Of these surveyed companies, (n=25) 40% use the portfolio approach . In other words: , with good reason, as indicated below.
Apart from that, the research also shows that in (n=38) 60% a provision for onerous contracts has been applied on the basis of the ‘old’ standard IAS 17.
Portfolio approach
The researchers are surprised at the relatively low level of application of the portfolio approach. They point to the large number of individual contracts and “… the time-consuming exercise of determining a discount rate for individual lease agreements”.
The application rate is around 40% both in the Netherlands and internationally, see graph.
Although 33% of the companies did not provide an explanation of the portfolio approach, it is likely that not many more companies used this variant; undoubtedly mentioning it, would it have happened otherwise.
The relatively low percentage can probably be explained by the fact that the reviewed ones are ‘large’ companies which have predominantly chosen central registration of lease agreements. It is known that the large accounting firms have not only insisted on this, but have also offered specific analysis tools which enable digital scanning and interpretation of the contract content of individual contracts.
Provision for onerous contracts
A surprisingly large number of companies have made use of the practical expedient to apply provisions for onerous contracts under IAS 37 immediately prior to the transition to IFRS 16 (IAS 37 is the standard that is applied in combination with IAS 17 Leases). As if there are so many contracts that turn out unfavourable (onerous) for companies.
The possibility of applying IAS 37 (Provisions, Contingent Liabilities and Contingent Assets) one last time means in practice that the value of the leased asset (calculated in accordance with IFRS 16, on the transition date) may be reduced by the provision belonging to the ‘previous’ regulation.
Here it becomes clear that the IASB has enabled abuse. The researchers report, for example, that no explanations have been provided regarding the result effects of the assessment. Only 16% indicate that they do not use a provision for onerous contracts.
The application of an impairment has the great advantage that the annual (linear) depreciation in the following years are lower, so actually increasing the result compared to a situation where no impairment was applied.
We speak about 2019 Annual Accounts, so possibly for some companies Covid-19 last minute has prompted to help substantiate an additional provision: the introduction of IFRS 16 means that in particular rental contracts for real estate and for example lease cars must be shown on the balance sheet. For both categories we know that there has been substantially less use of these assets during the Covid-19 pandemic.
Conclusion
The standard IFRS 16 Leases issued by the (International Accounting Standards Board) IASB in January 2016, which must be applied by large, listed companies from 2019, also contains a number of practical transitional provisions. These opportunities have been used to varying degrees. On balance, partly in view of the often limited explanations provided, IFRS 16 will therefore not deliver the envisaged transparency and comparability in the coming years.
Once again, a painful conclusion, because it was precisely the lack of clarity concerning financial obligations that are, or would be, hidden in operating lease transactions that prompted the large-scale adjustment of the accounting rules for leasing.
Background
A number of IFRS 16 Lease aspects are discussed in more detail in a series of articles. The information relates to non-financial companies, which are obliged to apply IFRS regulations; we are therefore expressly talking about large and listed companies.
The first report concerns leases with a residual maturity of up to 12 months and leases with assets of low value.
The second report deals with the first fundamental choice a company has to make in the transition to IFRS 16.
The topics discussed in this series are based on two recently published articles that examined the effects of the introduction of IFRS 16 on European companies. The articles in question are open source and therefore freely accessible and cover a total of 72 audited financial statements of companies, 43 of which are non-Dutch companies. The articles are in Dutch; for the record, the links to the articles are available in the first report.
