The year 2019 has been a busy one, implementing the IFRS 16 standard for lessees. Now, a year after the effective date of IFRS 16, is a good time to summarize the results and the lessons learned. This may be valuable for those companies, who are just starting with the new standard. Surprisingly, we see many companies who do it “last minute“, just before annual reporting. This also depends on the financial year of the company, for example, many of our Australian customers will report for the first time under AASB 16 (the Australian equivalent of IFRS 16) at end of June 2020. Our experience may be relevant to companies applying FASB topic 842 (also known as ASC 842, the US GAAP equivalent of IFRS 16), as the effective date has been moved to 1st January 2021, for non-public business entities in United States.
We completed 55 IFRS 16/ AASB 16/ ASC 842 implementation projects in 2019. With this customer portfolio, we can gain some insights. In this article I will focus on policy choices of transition options.
Under IFRS 16, there are essentially three transition options:
1. Full retrospective (“Comparative method” in US GAAP).
2a. Modified retrospective, RoU asset based on lease liability (“Effective date method” in US GAAP).
2b. Modified retrospective, RoU asset measured retrospectively.
- 1 out of 55 elected option (1), full retrospective approach.
- 49 out of 55 elected option (2a), RoU asset based on Liability (89% of our projects).
- 5 out of 55 elected option (2b), measure RoU asset retrospectively.
Obviously, the majority of companies elected option 2.a., where the RoU asset value is based on lease liability at the transition date. Before we go deeper into reasoning, let‘s take a look at project profiles, from where the statistics originate.
Our projects vary in size: The largest, in terms of RoU assets, is 1.4 billion EUR, the largest in terms of organization size has 116 legal entities. The table below gives a breakdown per region (i.e., by head-office location, where the IFRS16 implementation project was managed). There were a total of 15 implementations for international companies at group level, the majority of them in Europe. The remaining 40 are national companies.
Reasoning behind the choice of transition option
The choice of transition option is a trade-off between cost of implementation and comparability in financial statements. The majority of our customers chose not to re-state comparative periods and to go with a simpler, modified retrospective approach.
The choice of RoU asset measurement — (2a) “based on lease liability” or (2b) “measured retrospectively”— in most cases was driven by materiality. The standard enables electing this option per asset class, or even on a lease-by-lease basis. A typical decision was to measure retrospectively higher value leases, while lower-value RoU assets were based on lease liability, and to do this per asset class (e.g., land and buildings – retrospective, other assets – per liability).
As borrowing rates at transition were not high, the impact of choosing a simpler option was relatively low.
Modeling tool and visualization
The SOFT4Lessee software package (based on Microsoft Dynamics 365 ERP system) supports all three transition options, as it is even possible to model an impact, and to calculate transition balances and subsequent annual expenses for each model.
The figures below are for the purpose of illustration (real numbers from SOFT4Lessee system, with higher-than-usual discount rate, for better visualization).
Figure 1 shows the lease, as if it always was under IFRS 16—RoU asset depreciated linear, lease liability—declining balance. Half way into the lease, there is a gap between asset and liability on the balance sheet. In a full retrospective approach, a company would run the lease calculations in the system from commencement date and then take the balances needed to re-state a comparative period on financial statements.
Figure 2 is visualization of the modified retrospective transition, where the RoU asset is measured retrospectively. There is a difference between asset and liability transition balances, which goes to the equity account on the transition date (e.g. 1 Jan).
Figure 3 is modified retrospective, with the RoU asset based on lease liability (compare to Figure 2). There is no balancing with an equity account, and no need to estimate the RoU asset value separately, which makes things easier to implement. However, the RoU asset value is higher, and, consequently, has higher depreciation for years to come: We look deeper into this in Figure 4.
Figure 4 shows a comparison of total lease expense per each year. Series (1) is a straight line operating expense, if the lease was under the IAS17 standard. Series (2) is the sum of depreciation expense and interest expense, as if the lease was always under IFRS 16. Series (3) is the sum of depreciation expense and interest expense in the case of transition option 2b, ROU asset based on lease liability. In this case the expense each year is higher.
You haven’t selected experts to manage your transition yet? The SOFT4 team offers a smooth, fast transition to IFRS 16 with the lease accounting solution SOFT4Lessee. It will help you manage lease accounting in line with the IFRS 16 changes. You can’t choose to not comply, but you can choose the right tool to manage your transition. Don’t take our word for it—try SOFT4Lessee for yourself first.