IFRS 16 - How this affects businesses and Entrepeneurs

Reading Time: 4 minutes

IFRS 16 is the latest International Financial Reporting Standard that applies to lease accounting. Hans Hoogervorst, IASB Chairman, explains: “[…] The new standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off balance sheet lease financing is no longer lurking in the shadows. It will also improve comparability between companies that lease and those that borrow to buy.”

This new standard is effective from January 2019 and replaced the previous IAS 17 lease accounting standard. For many, it may seem like an intricate standard, but on close examination, it is straight forward. The implementation thereof, however, is not so simple.

What changes were made to the standard?

The changes that occurred have to do with the way that accounting has been done for lease agreements. These lease agreements could be for property, plant or equipment (PPE). Before the implementation of IFRS 16, PPE’s were split into financial leases and operating leases. Operating leases were usually not included as assets but were simply a transaction included in the determination of operating profit.

IFRS 16 requires companies to include most leased items as an asset in their financial statements, and all payments made under lease agreements need to be reported as liabilities. Accounts are further complicated as IFRS 16 requires that costs for maintenance, cleaning etc. are separated from main lease payments, and should therefore be reported separately. Furthermore, the decline of the asset and interest on the lease liability must be indicated on profit and loss accounts.

How has IFRS 16 impacted businesses?

IFRS 16 has proven to have some significant effects on the way in which a company’s finances appear in its accounts. Here’s how:

Companies’ may appear to be more asset-rich, but with a larger debt burden. The more lease agreements your company has, the bigger the impact on your accounts.
If you manage a large leasing portfolio, IFRS 16 will affect and change your accounting and financial ratios. Unfortunately, this may lead to your company appearing less attractive to potential investors.
If your company has banking agreements in place, this new standard could also cause problems if you are obliged to maintain a certain level of profitability for banking agreements to continue.

Pick n Pay recently disclosed how IFRS 16 has impacted their numbers, and they revealed that their debt burden has gone from less than R2bn to an astounding R17bn. Why did this happen?

As a major retail group, Pick n Pay has several long-term lease agreements in place, and they will continue to have these. With the implementation of IFRS 16, these leases are now shown on their balance sheets as debt obligations.

Overall, IFRS 16 will not necessarily impact a business’ operations, but it will make accounting results seem more complicated and companies are going to have to provide in-depth disclosures to explain these results.

How will it impact you as Entrepreneur or Small Business Owner?

The implementation of IFRS 16 will directly impact you as entrepreneur or small business owner too. To comply to the new standards, you will:

Need to identify all leases as assets, while your obligations to make payments towards lease agreements will be stated as liabilities in your balance sheets.
Need to gather information on all your lease agreements – including the terms, fees payable, end-of-term options, etc., so that you can show which payments need to adhere to IFRS 16 and which are separate.

MMS Group offers to assist with your company’s IFRS needs, including IFRS 16, to ensure that you are compliant with IFRS accounting and reporting requirements. For assistance, contact us directly via phone or email, or visit our website.