Benefits of Leasing Under IFRS 16

This blog is written by Mr. Haseeb Zaman, Associate Taxation and Corporate Services. Please read this blog and provide your valued comments.

Benefits of Leasing Under IFRS 16

The new accounting standard for leases – IFRS 16 – requires that companies reporting under IFRS must report all leases on their balance sheets as assets and liabilities. From January 2019, all leases will be treated in a similar way to finance leases (for lessees) and will be ‘capitalized’ by recognizing the present value of the lease payments and showing them as lease assets (right-of-use assets). If lease payments are made over time, a company will also recognize a financial liability representing its obligation to make future lease payments.

Based on the above, the question remains as to the relevance of concluding operating leases going forward. Let’s consider the benefits of operating leases:

  • Flexible funding structure
  • More cost effective compared to cash or traditional funding
  • Reduced cash flow due to the residual value investment
  •  The cost and obligation of ownership, disposal and obsolescence is avoided
  • Off balance sheet financing

From the above you will note that only one benefit which relates to off balance sheet (excluding the exceptions) will not be applicable, ALL other benefits remain.

Cognizance also needs to be taken of the fact that the unguaranteed residual value portion will not be included in the right-of-use asset and corresponding liability, and will still remain off balance sheet, thus allowing partial off balance sheet recognition. Entities should therefore ensure that they deal with leasing companies that are residual risk takers to enjoy the benefit of partial recognition.

Leases remain a very attractive source of flexible financing for companies not wanting to bear the risks of ownership, and the real business benefits of leasing will not change as a result of the new standard.

The International Financial Reporting Standards body is of the opinion that it is highly unlikely that the improved visibility of lease obligations will lead to significant effects in terms of the cost of borrowing and debt covenants. The majority of credit providers and rating agencies already take lease obligations into account when evaluating a company’s ability to pay its bills, even though their calculations may be imprecise as a result of the off balance sheet nature of the reporting.

There will be costs incurred in updating systems to implement IFRS 16, the exemptions to the standard, as well as the fact that it will not apply to SMEs, will provide some reprieve. In general, the benefits of IFRS 16 should far outweigh its costs. The increased visibility of all leases will lead to better informed investment decisions by investors, and to more balanced lease-versus-buy decisions by management. In addition, IFRS 16 will lead to improved capital allocation, which should be beneficial for economic growth.

Haseeb Zaman