Are You Ready for IFRS 16?
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) released new accounting standards that define how organizations must account for leases. These accounting standards, addressed in the International Financial Records Standard 16 (IFRS 16), stipulate how most leases must be reported on a company’s balance sheet. For many lessees -- this change is huge.
While the new leasing standard does not go into effect until January 2019, companies can begin reporting in January 2017 and start communicating expected changes with stakeholders – now. The new standard will affect virtually all commonly-used financial ratios and performance metrics such as gearing, current ratio, asset turnover, interest cover, EBITDA, EBIT, operating profit, net income, EPS, ROCE, ROE, and operating cash flows. These changes may affect loan covenants credit ratings and borrowing costs, and could result in other behavioral changes. And, these changes may compel many organizations to reassess certain ‘lease versus buy’ decisions.
IFRS 16 changes will affect lessees in the following key areas:
- Balance Sheet: Initially recognizes lease assets and liabilities on the balance sheet at the present value of future lease payments.
- Income Statement: Recognizes amortization of lease assets and interest on the lease liabilities over the lease term. The overall effect on profit will depend on the portfolio of leases an entity holds. However, in the earlier years of a lease, it is expected that the profit will be lower as a result of higher interest accruing on the lease liability (akin to an amortizing mortgage).
- Cash Flow Statement: Separates the total amount of cash paid into a principal portion (presented within financing activities) and interest (presented within either operating or financing activities).
As you can see, the changes are dramatic. This is not just a software change or upgrade. It is a major change in business processes, how applications integrate to accommodate the rule change, and last but certainly not least -- companies will be challenged to effectively communicate IFRS 16 standards to stakeholders who will see major changes in financial results.
To successfully implement IFRS 16 requires a structured initiative that will manage:
Business Process Change
Business processes in many areas, including finance, procurement, tax, treasury, legal, operations, corporate real estate and HR will have to be changed and aligned to support a successful adoption of the accounting changes.
Software Application Integration
For those companies with real estate in one application, assets in another and separate G/L, it will be difficult. The SAP integrated platform will make this a much easier. SAP customers who are already on SAP Real Estate and have their fixed assets in SAP will have an enhancement to download in a few months that will put them into compliance.
SAP Real Estate Management application enables coordination between different departments.
The solution also provides lease accountants the ability to evaluate the financial impact of each lease and ultimately generates all valuation postings required by the new leasing standards. It even manages the postings for multiple lease accounting standards simultaneously, regardless if the general ledger account or parallel ledger methodology is utilized. This solution is part of SAP Finance and is completely integrated, helping avoid the kind of costly disruptions that can derail critical business processes, operations and costly noncompliance events.
Corporation stakeholders will need a lot assistance in understanding the changes in nearly all financial ratios and performance metrics such as: gearing, current ratio, asset turnover, interest cover, EBITDA, EBIT, operating profit, net income, EPS, ROCE, ROE and operating cash flows.
Even though the new leasing standards are not effective until December 2018 for US GAAP and January 2019 for IFRS, companies can choose to be early adopters and begin reporting January 2017. Whether you choose to be an early adopter or comply by the deadlines, there are certain things you can do today to prepare.
Current SAP Real Estate Management users should implement the new leasing enhancements as soon as they are released to begin evaluating the impact on your financial statements. Even if you do not intend to be an early adopter, the loading of the leases and analyzing the results will pay big dividends in the future.
Companies that implement the SAP IFRS 16 enhancements quickly can run it in simulation mode only and use the results to compare their financial performance before and after implementation. We believe that when key executives are knowledgeable about how IFRS 16 changes will affect performance reporting, they can effectively communicate with their stakeholders.
Recently, B4 Consulting announced its support for IFRS 16 real property leasing with SAP Real Estate Management, which includes implementation services for real estate, procurement, and financial management. Through an IFRS 16 Assessment, we examine all your business processes and areas affected by IFRS 16. Then, we develop a road map and budget for successful implementation of IFRS 16 standards – including stakeholder communications.
Get ahead of the curve and let’s talk about how you can successfully prepare for IFRS 16. Email me at firstname.lastname@example.org.
Phillip Schell is vice president of Industry Solutions at B4 Consulting, Inc.