Funny how times move on. I qualified in 2010 and when I was at college I distinctly remember IAS 17 being a really big deal because it was new and changed the public sector balance sheet. We probably had a whole day on what it means to have substantially the risks and rewards of ownership of an asset resulting in a generally undesirable finance lease. I remember gleefully being able to correct some of my (older and much more experienced) colleagues at the time due to being all clued up!
Roll forward a decade and for lessees the finance/operating lease distinction is being removed. The new IFRS 16 standard takes the concept of leasing as a contractual requirement to make future payments one step further: almost all leases including currently classified ‘operating leases’ will now be considered in a similar way to finance leases with a ‘right-of-use’ asset and corresponding liability being recognised.
There are other changes too. Previously only minimum contractual lease payments needed to be included for finance leases: the new standard takes the (probably more sensible) approach of requiring expected lease payments to be recognised. So, if the contract has a two-year extension that you think is likely to be exercised this needs to be accounted for at the start. Inflation-linked leases must include rising payments at the current inflation rate - a more realistic assumption than the current 0%. Changes in expectations for things like lease terms and inflation need to be accounted for on an ongoing basis throughout the life of the lease. Unlike IAS 17 where assets are initially recognised at their fair value, IFRS 16 recognises a leased asset as the present value of payments over the lease term, discounted at the interest rate implicit in the lease.
To give us hard working accountants a bit of relief there are some exemptions to the new treatment. It is mandatory to exempt any lease with a duration of less than 12 months (it is clearly illogical to capitalise a car you are leasing for a week for example) and you can choose on a case by case basis to exempt low value assets such as laptops, mobile phones and office chairs. There is also little change to the treatment by lessors where the finance/operating lease distinction remains, except the use of expected rather than minimum lease payments.
The impact – aside from more stressed accountants – will largely be on a local authority’s balance sheet where measures for debt and liabilities including prudential indicators will be affected. There will be a need to depreciate and make Minimum Revenue Provision (MRP) for the newly created lease assets. The all-important bottom line may be affected very little for simpler leases with interest and MRP charges combined being like the cash rental payment previous accounted for. However, more profound up front budgetary implications are likely for any lease where the minimum payments and actual expected payments are different. Aside from the accounting, many local authorities have told us their biggest challenge will be in locating and identifying where they have leases that will fall under the new standard – now is a good a time to improve channels of communication with your service departments!
For local authorities the new standard is recognised from 1st April 2020, so with six months to go, now is the time to start thinking about being 17 going on 16. Arlingclose will be holding a series of workshops for local authorities in the coming months and are able to offer additional assistance on the transition at year end.
For more information please contact the Arlingclose team at email@example.com or 08448 808 200.