Issued in 2016 and resulting from the joint efforts of the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), IFRS 16 became effective in January 2019.
Changes were made especially to how Financial Statements and lease transactions must be recorded, thereby affecting the lessees, as the leases are no longer classified as finance leases or operating leases. Contracts in general must be recorded in the same fashion as financial leases, with few exceptions.
The changes brought forth by IFRS 16 are likely to reflect on internal procedures, as well as directly influence Balance Sheets and Income Statements:
- Leases are recognized as rights-of-use assets;
- Obligation is recognized as liabilities. As a result, the financial indicators and net working capital will be affected.
- The asset’s depreciation and the finance costs of the liability must be recognized, unlike the current practices.
According to IFRS 16, a lease is a “contract that conveys the right to use an identified asset for a period of time in exchange for consideration”. Because of its broader scope, when compared to prior rules, it is important to analyze contracts to ensure whether they comply with the new rule.
Assets must be identified in lease agreements, as well as whether the company is entitled to enjoy the economic benefits acquired from the use thereof.
In our understanding, the retail industry and airlines are most likely to be most affected by the changes, but all companies will face such effects, depending on the materiality and relevance of their lease transactions.
Considering IFRS 16 will influence the performance metrics and finance indexes, such as asset transactions, liquidity/current ratio, interest cover and other indicators, it is key for companies to adjust to such changes.
Given the complexity and the effects on performance metrics, finance indexes and liquidity, implementing IFRS 16 will require specialize work, diligence and attention to detail.