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The Possible Effects of IFRS 16

2018-11-06 11:03 Tuesday

The IFRS 16 standards will come into effect in January 2019, and will have broad implications for the leasing industry, resulting in companies includingvirtually all leases on their balance sheets. However, early adopters of IFRS 16 suggest that the new standards are difficult to comparatively assess, due to management discretion in accounting for lease terms and discount rates.

the IFRS 16

"The evolution in business models could encourage greater use of service contracts or other off-balance sheet alternatives, potentially resulting in less lease debt on the balance sheet. And the changes also widen differences between IFRS and US GAAP with respect to accounting for leases", Fitch Ratings acknowledged in an interview.

The rating agency claims that it has reviewed 30 companies that have already adopted the standards, among which 17 have provided interim disclosure to assess the impact of the changes in lease accounting on their financial statements.

"Accounting choices over what determines a lease, what discount rate to use, the length of lease term, and whether it is reasonably certain that a lease extension option will be exercised, will give management discretion in what numbers to present. In addition, there could be widely differing average lease terms in different geographies. As far as we observed, the new requirement is likely to affect companies' bottom line," Fitch explained.

"The longer the lease, the more front-loaded the interest cost would be, which could shift some net profits to a later lease period due to the mismatch between straight-line depreciation and interest amortization," the firm added.

"For International Accounting Standards Board, lease accounting will increase volatility in finance cost over the total lease period, and IASB is also likely to see more variation from historical results due to different borrowing costs. While the balance sheet treatment of leases is generally similar, stark differences remain in the income statement and cash flow."

Fitch's review of over 670 non- listed companies in US and UK concluded that an additional US$790 billion in operating lease commitments will be added to the balance sheet  next year.

"US GAAP retains the difference between finance and operating leases, and their traditional accounting treatment, while IFRS 16 mandates finance-lease type accounting for all leased assets. And the change has replaced minor differences between US GAAP and IFRS with major ones" the ratings agency noted.

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