What is IFRS 16?

What is IFRS 16?

IFRS 16 is an accounting standard introduced by the International Accounting Standards Board (IASB) and which came into force on 1. January 2019. It replaced the accounting standard IAS 17. But what is IFRS 16, and why does it exist?

The accounting standard establishes principles for how companies should account for and report lease agreements in the accounts.

What is IFRS 16?

IFRS is a set of accounting standards published by The International Financial Reporting Standards Foundation. The accounting standard contains standards for different operational areas, including accounting for leasing agreements (IFRS 16).

The main rule is that according to IFRS 16 leases, companies must enter all leases on the balance sheet and present the right-of-use asset and lease liability in the balance sheet. There are a few exceptions that we will tell you more about later in the article.

IFRS 16 is a standard that establishes principles for how companies should account for and report lease agreements in the accounts. The purpose of the standard is to ensure transparent accounts across companies, so that you can see the lease agreements in the accounts to a greater extent than before.

This means that companies according to IFRS 16 must:

  • Balance the asset and liability in the balance sheet.
  • Recognize depreciation of the asset and the interest expense in the income statement.
  • Classify repayment of the lease liability under financing activities.

Lease agreements

Leasing is a common way for many businesses to gain access to assets, obtain financing and reduce the risk associated with owning the asset. Assets can be office buildings, cars, machinery and the like.

A leasing agreement is an agreement between lessor and lessee, where the right to use the asset is transferred to the lessee for a fee. This means that the leasing company owns the equipment, while the lessee pays for the right to use the asset. a lease agreement is therefore the opposite of buying the asset, where you often have loan financing, where the company pays off the loan during the period they own the equipment.

We distinguish between 2 different types of leasing agreements:

  • Financial leasing – The company pays off the entire investment over the term of the agreement, e.g. fixed assets.
  • Operational leasing – The company pays down to an agreed residual value. This is common in car leasing agreements or house rental agreements.

After the end of the leasing period, it is common for the lessee to return the equipment in its entirety, buy out the equipment or continue the lease. Whether the company should lease or buy the asset depends on various parameters – we recommend reading Danskebank’s guide here.

Who must report according to IFRS 16?

Listed companies are obliged to prepare consolidated accounts according to IFRS. In Norway, it also applies to listed companies that are not part of a group. Companies with debt securities on the Oslo Stock Exchange are also obliged to use IFRS.

Other companies also like to report according to IFRS, e.g. if the parent company is obliged to follow the standard.

Changes with IFRS 16

The previous standard for leases (IAS 17) stipulated that the lessee did not have to include the liability of the lease in the balance sheet if the agreement could be classified as operational. In this way, relatively similar leases could be classified differently in that some were entered on the balance sheet and some were not, despite the fact that they were economically similar. It is assumed today that approx. 80% of all leases under IAS 17 were classified as operational and therefore omitted from the balance in the accounts.

With the introduction of IFRS 16, the agreements must no longer be classified as operational or financial. This therefore means that most agreements must now be entered in the balance sheet, with a few exceptions. Companies with large and many lease agreements will therefore experience a big difference in the handling of lease agreements and its impact on the accounts with IFRS 16.

IAS 17

IAS 17 is an accounting standard which since September 1981 has been central for listed companies in relation to the accounting of lease agreements. The standard determined the accounting treatment of leasing agreements and distinguished between two types of agreements – financial and operational leasing.

  • The financial leasing is defined as an agreement where significant risks and benefits relating to the asset are transferred to the lessee, regardless of whether ownership is transferred back after the lease period.
  • The operational lease is defined as any leasing contract that does not fall under a financial lease.

Exemption from IFRS 16

IFRS 16 contains simple exceptions for when you can fail to balance the lease agreements. This applies if the leases are of a short-term nature or if the leased asset has a low value (purchase value). In these cases, the lease can be recognized in the profit and loss rather than recognized in the balance sheet.

It must always be stated in the notes about the exceptions used in the accounts.

Short-term rental agreement

According to IFRS 16, short-term leases are applicable to leases that have a lease period of a maximum of 12 months. There shall be no options for extending the agreement or details of the acquisition of the asset after the end of the lease period. If there are options such as extension or acquisition, the probability that companies will take advantage of the opportunities must be very low.

Low value assets

To assess the value of an asset, the starting point must always be the value for a new item and without the actual age at the time of hire. For example, a 5-year-old car must be considered the value of an equivalent new car at the time of hire. What is considered a low value in terms of amount does not appear in the standard, but is estimated at USD 5,000.

The exception according to IFRS 16 does not apply to obligations that are significant overall, typically: rental of property, cars and ships. Properties with a low value such as tablets, telephones and the like are classified as low value according to IFRS 16. The exceptions also do not apply if the asset is subleased.

Impact of lease accounting under IFRS 16

Tool for handling IFRS 16

The biggest and most difficult job with IFRS 16 can be automated and simplified. IFRS 16 requires extensive calculation and classification of data, which often takes a long time with manual processes such as using Excel. With the right IFRS 16 management software, you can ensure accurate reporting while saving time.

ShareControl IFRS 16

ShareControl IFRS 16 allows users to streamline the handling of IFRS 16 as the system makes the most difficult calculation and always ensures correct calculations. With automatic calculations and a guided process throughout the process, you ensure accurate financial reporting according to IFRS 16.

The IFRS 16 solution guides the user through the handling, so that the identification and classification of leases is easier than ever. ShareControl IFRS 16 will also calculate the value of the asset for right of use at the start of the lease. This includes the initial amount of the lease liability, in addition to any lease payments made at or before the start of the lease, less any lease incentives received.

Read more about ShareControl IFRS 16 here >>

Guide to IFRS

IFRS 16 can be a complicated and time-consuming process. With a good system for handling the regulations, you ensure accurate reporting and compliance with IFRS 16, while making your time more efficient.

To understand the legislation and how you can report according to IFRS 16, our user manual can be read – if you want to read it now, contact us. You can otherwise read more about IFRS 16 here.

There is also a lot of information about IFRS 16 from other specialist books and articles published by, among others, EY’s “IFRS in Norway, 8th edition” and “A closer look at IFRS 16 Leases (updated December 2020)”, PwC, KPMG, Deloitte and IFRS org.

Implementation of IFRS 16 software

Implementing the accounting standard can be a complicated process, but with the right method – you can streamline large parts of the processes. This also ensures a correct upload of your leases, which is crucial at the start of reporting. We at Share Control have extensive experience in helping our customers to be IFRS 16 compliant.

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