Lessons we’ve learned.
The new leases standard, IFRS 16, is now effective and its US GAAP equivalent, ASC 842, is effective for public business entities in 2019. However, adoption efforts are not yet behind us and many companies still face significant challenges to get to business as usual. Further, private companies that apply US GAAP were due to adopt the new leases standard next year, but the FASB has tentatively decided to defer the effective date. This deferral will create further complexities when bridging IFRS Standards to US GAAP for companies with dual reporting. KPMG discusses key lessons we have learned from implementation of the leases standard.
The new standards on lease accounting are here, but our experience with companies around the world demonstrates that many companies still have accounting questions and implementation issues in significant areas. Adoption of the standards proved more difficult than originally expected and the costs of implementation were often greater than what companies had budgeted. Here are some of the lessons learned along the way.
1. Embedded leases
Assessing whether an arrangement is, or contains, a lease has been one of the biggest practical issues for lessees when applying IFRS 16. Lease definition is the new test that determines whether an arrangement is on-or off-balance sheet.
In many cases, the assessment is straightforward, and a transaction that met the definition of a lease under previous lease accounting guidance (IAS 171 and IFRIC 42) also meets the lease definition under IFRS 16. However, many companies have identified new leases under IFRS 16, which was unexpected. Under IAS 17, not all leases, particularly embedded leases, may have been identified. This has happened because the accounting treatment for a service contract was largely consistent with that for an embedded operating lease under IAS 17, and disclosures may not have been material.
The term ‘embedded lease’ refers generally to a lease within a larger contract that is not characterized as a lease contract. The contracts may not use terms such as ‘lease’ or ‘rent’, and the lease may be a relatively minor element of the larger, overall arrangement.
Companies should establish a process to ensure that no material population of unidentified leases remains. The following are some procedures that companies have undertaken to identify leases, including embedded leases.
2. Lease information
Gaining comfort over the completeness of the lease population and accuracy of lease information has been resource intensive, time consuming and complex. The following are some of the key learnings from this data gathering.
Companies should develop or adjust their data collection and maintenance processes and controls to sustainable end-states capable of addressing the ongoing requirements of the new standard.
3. Incremental borrowing rate
IFRS 16 requires lessees to bring most4 leases onto the balance sheet. The new assets and liabilities are initially measured generally based on the present value of the lease payments. A lessee discounts the lease payments using its incremental borrowing rate (IBR) unless it can readily determine the rate implicit in the lease, which is rare.
|The IBR is the rate of interest that the lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.|
The approach to determining the discount rate for the lease is similar to that under IAS 17, but applying it in the new world of on-balance sheet lease accounting has proven challenging for lessees. Increased precision is now required for accurate balance sheet reporting, and a substantial portion of leases did not need an assigned discount rate under IAS 17 because it was clear they were operating leases. While many lease accounting tools include a discount rate field, the software itself does not calculate the discount rate for each individual lease. Identifying appropriate discount rates and documenting their basis has proven to be a major task both on transition and on an ongoing basis.
According to IFRS 16, the IBR is a lease-specific rate (estimated for each lease) and adopting a company-wide rate is not acceptable. However, many companies have adopted practical approaches, often based on similar leases and starting from a company-wide calculation adjusted to reflect different lease terms, assets, currencies, securities, etc. Inputs and judgments may differ significantly from company to company (even subsidiary to subsidiary of the same parent or group) and will likely change over time.
The following are some of the key lessons learned to date.
4. Systems challenges
Many companies5 have chosen to implement a lease accounting tool in order to avoid the operational burden of manual calculations and associated errors. There are multiple software options available. Choosing the best solution (or indeed, deciding if software is required) can be challenging because it requires a thorough understanding of business requirements and impacts before selecting a tool.
Extracting and loading all the necessary lease data, and configuring the tool for the company’s reporting purposes has caused some operational challenges and slowdowns.
The following are key lessons learned on implementing a tool.
5. Significant differences between IFRS 16 and ASC 842
While the lease definition and Day 1 lessee accounting are mostly converged under IFRS Standards and US GAAP, there are significant differences between the two with respect to transition and Day 2 lessee accounting. In particular, lessees no longer classify their leases as operating or finance under IFRS 16, but continue to do so under US GAAP. Further, the exemptions from on-balance sheet accounting (i.e. the low-value and short-term lease exemptions) differ. Under US GAAP, there is no low-value lease exemption and the definition of short-term lease differs.
Lessor accounting under IFRS 16 continues to be similar to that under US GAAP. Notable differences include: issues of collectibility, lease modifications and leases that are classified as direct financing leases under US GAAP.
These differences have complicated the adoption process for dual reporters, specifically for companies located in multiple geographies. Their cost of adoption has been relatively higher, because of the additional processes and reporting requirements, complex systems, training and duplication of auditing efforts.
The following are some of the lessons learned.
In August 2019, the FASB issued a proposed Accounting Standards Update that would defer the effective date of ASC 842 for private companies, not-for-profit organizations and employee benefit plans that do not file or furnish financial statements with or to the SEC. The proposal would defer the effective date of the new leases standard for these entities by one year, to fiscal years beginning after December 15, 2020 and interim periods within fiscal years beginning after December 15, 2021.
Companies with dual-reporting that would be subject to this one-year deferral will need to consider the implications of having different effective dates for IFRS 16 and ASC 842 and may want to consider early adopting ASC 842 to minimize the differences.
The efforts to adopt IFRS 16 have proven to be very time-intensive and challenging given the scope and breadth of its effects on the organization. We hope that the lessons above and in other KPMG articles will help you further navigate through the process of a successful transition to the new standard.
Article, Business implications of the new lease accounting standard, August 2018
Article, Leases: Top differences between IFRS 16 and ASC 842, updated August 2018
Article, Lessees: Transition differences between IFRS and US GAAP, August 2018
All resources on lease accounting under IFRS 16, Global IFRS Institute
All US GAAP resources on lease accounting under ASC 842, including amendments and the latest proposals: Financial Reporting View
Comparison between IFRS 16 and ASC 842 (before FASB amendments): IFRS compared to US GAAP
Technology consulting and selection of a lease accounting system – KPMG Lease Accounting Tool
Understanding the guidance in IFRS 16 on accounting for lease modifications by both lessees and lessors.
Companies continue to address implementation issues for revenue recognition and disclosure under IFRS 15 and ASC 606.
Differences on the capitalization of borrowing costs under IAS 23 and interest costs under US GAAP.