Gaining efficiency in lease accounting
Q. How does IFRS 16 offer companies an opportunity for greater efficiency?
A. Implemented by the International Accounting Standards Board, the new lease accounting standards are now taking effect. Companies are transferring an estimated $3 trillion of operating leases onto corporate balance sheets as right-of-use assets and corresponding lease liabilities. Historically, only a limited set of operating lease information has been reported in annual financial report footnotes. Under the new IFRS 16 standards, companies must add new line items to the balance sheet for leases and develop strategies for communicating these changes to their investor communities. Key financial metrics, such as return on assets, EBITDA, and the quick ratio will be impacted.
Q. What do these changes mean?
A. These new leasing standards will bring greater clarity to companies’ asset investment strategies and impact financial metrics. Companies will now describe their asset investment strategies in terms of maximising cash flows and flexibility pertaining to the duration of commitment to the use of the asset. Leasing activities are now subject to increased scrutiny by many companies by virtue of new corporate governance over the acquisition of leased assets. The adoption of the standard was challenged by compiling the contracts usually decentralized throughout a company, analysing terms and conditions of the contracts, and having an understanding of leasing activity by asset class. Now, as a result of the transparency of the new standard, the post-implementation challenges for companies are change management for procurement, IT, and operations, plus the new corporate governance over leasing activities.
Q. How can companies take advantage of this opportunity?
A. Although the implementation of these standards creates a significant administrative burden at many large firms, it also introduces new opportunities. In addition to improving external transparency into corporate leasing obligations, the standards also increase internal transparency. This added transparency will allow proactive management accountants to assess the current processes their business has in place and focus the asset acquisition process into three decisions: what asset is needed; duration of intended use; and flexibility to react to obsolescence concerns or changes in the business, plus key metrics such as EPS and target free cash flow. Other process improvements, for example, are the creation of standardised lease contracts to use in procurement efforts. A standardised contract may improve comparability among offers and competitive terms, in addition to creating an open capital market in which the firm can leverage competition among asset vendors to receive the best offer. The new accounting standards offer companies an opportunity to challenge existing processes and reinforce the economic analysis behind both lease and buy decisions. Companies should take advantage of this — designing and outsourcing processes for managing leases and incorporating efficiency by design.
John Kuett heads accounting strategy for LeaseAccelerator, the software-as-a-service (SaaS) solution for Enterprise Lease Accounting. He has 20 years’ experience directing companies’ financial reporting and compliance with IFRS 16 and ASC 842. He is an IFRS expert, specialising in topics such as IFRS 15, IAS 16, and IFRS 16 leases.
LeaseAccelerator offers the marketleading SaaS solution for Enterprise Lease Accounting, proven to be the simplest, fastest, and easiest path to compliance with the new IFRS 16 standards. The company’s ecosystem of certified, global partners delivers a variety of guaranteed turnkey solutions. On average, the firm’s Sourcing and Management applications drive savings of 17% with smarter procurement and end-of-term management. Visit explore.leaseaccelerator.com.