We take a look at how entities have managed through the 2020 reporting seasons with respect to the adoption of the new lease accounting standard (NZ IFRS 16).
2020 was always going to be a busy year for entities who were adopting NZ IFRS 16, and now with COVID-19 adding operational and financial reporting pressures, entities must surely be feeling the “pinch”. What is happening out there in practice?
2020 was always going to be a busy reporting year for those entities who decided to address the adoption of NZ IFRS 16 at the end of the year.
Now with the disruption of COVID-19, there is added pressure on entities to not only make sure that they get the adoption of NZ IFRS 16 done, but that it is done right, in the face of all the other unforeseen operational and financial reporting pressures that are at the table.
We have seen many entities reach out to external experts and specialists (such as BDO’s IFRS Advisory department) to assist with not only the adoption of NZ IFRS 16, but also other areas of financial reporting that are impacted by COVID-19.
Equally, we have seen management that have not reached out for assistance, or have done so late in the piece, resulting in some rather difficult conversations with Boards, Shareholders, and senior management as to why deadlines need to be pushed, and/or why Auditors are raising issues with certain areas on management’s accounting treatments.
If we look specifically at the adoption of NZ IFRS 16, where have entities been making things difficult for themselves?
What can those entities currently undertaking (or about to undertake) the adoption of NZ IFRS 16 learn from those that have gone before them?
No two entities NZ IFRS 16 adoptions are ever exactly the same. However, there are five common themes that continue to resurface in the adoption projects which can be challenging:
Leave enough time to do the adoption
The adoption of NZ IFRS 16 has a number of discrete steps that must be worked through consecutively, in the same way as any other project.
Hold-ups or roadblocks at various steps along the way will either hamper or straight-out prevent further steps being able to be executed (if you think back to a standard project GANTT chart, NZ IFRS has a lot of steps – even for “simple” adoptions).
This “waterfall” element that is present in the adoption of NZ IFRS 16 is something that management often don’t initially appreciate.
Accordingly, management might end up establishing and communicating timelines around having NZ IFRS 16 numbers ready for the inclusion in the year end accounts that are overly optimistic (or in the more extreme cases, not at achievable at all).
RECOMMENDATION FOR MANAGEMENT:
Invest time in the upfront planning your adoption of NZ IFRS 16 – i.e. know what the path ahead looks like, and how you are going to navigate it.This is the number one comment entities that have been through the process already tell us they would do differently if they had their time again.
Consider using a Lease Accounting Software Solution (LASS) rather than spreadsheets
Spreadsheets are great when the data they are managing is…“manageable”. In a spreadsheet context, “manageable” would usually mean:
- The volume of core data is not significant
- The core data is relatively “static” (i.e. it does not change over time if and when core estimates and judgements change), and/or
- The reliance of embedded, complicated, linked formulas is minimal.
At some point, an entity’s lease population will push these three considerations towards the “unmanageable” end of the spectrum. Where this point is exactly, is the million-dollar question.
In practice the answer usually comes down to how many property leases an entity has, and of those, how many have core data that is not “static” (i.e. those subject to regular CPI increases and/or Market rent reviews). We have seen many entities push ahead with a spreadsheet approach, only to either:
- Give up part way through, and revert to an LASS
- Persevere with a spreadsheet approach for the current year, only to be told by the entity’s Board and/or Auditor that an LASS will be required going forward.
Both of these situations represent a missed opportunity to do it early, do it once, and do it right, as well resulting in sunk costs that have been invested into a spreadsheet approach that will not be continued with. Because NZ IFRS 16 is not a one-off issue only for the current 2020 year… entities need to deal with the management and accounting of leases under NZ IFRS 16 on a continuous and ongoing basis. Therefore, the decision whether or not to invest in the use of an LASS needs to be a long-term consideration.
RECOMMENDATION FOR MANAGEMENT:
Invest time in understanding the nature and extent of the leases your entity has, and have an open and honest conversation with all interested stakeholders (i.e. Boards, Auditors, staff at the coal face).At the end of the day, what ultimately needs to be put in place is a process and solution that both (i) gets your entity through the current year’s reporting, and (ii) is workable and usable in the long-term.
Understanding what auditors will need
Often entities assume that all the Auditor needs at the end of the NZ IFRS 16 adoption process are the spreadsheets that crunch the numbers.
Often this is not the case as NZ IFRS 16 can result in complicated and nuanced accounting that incorporates various estimates and judgements that management need to make along the way.
Because these management estimates and judgements directly drive the crunching of the numbers… Auditors are obviously very interested in understanding these in terms of their nature, and management’s thought process in how they have come to a determination on these.
It is unlikely that many of these would simply be able to be extracted from a review of the number crunching spreadsheets/LASS on their own.
RECOMMENDATION FOR MANAGEMENT:
Entities should be looking to compile an internal memo/report that explains how the entity has adopted NZ IFRS 16, including addressing management’s estimates and judgements.This will provide both useful (and complementary) audit evidence to an entity’s auditors in addition to the number crunching spreadsheets, but also serve as a critical internal document to keep on hand to explain how the entity adopted NZ IFRS 16 (i.e. to provide comfort to those in future years that it adopted completely and accurately, e.g. lenders, purchasers, new investors etc.).
Understanding key areas of NZ IFRS 16
Whether or not an entity has engaged external experts (see below) or uses an LASS (see above), management still need to ensure they have a baseline understanding of NZ IFRS 16 so that management can:
Ensure with confidence that NZ IFRS 16 is adopted completely, and accurately, and/or
- Talk to, and explain how, NZ IFRS 16 impacts their entity’s financial reporting - especially how this differs from internal Management Reporting (i.e. be able to explain the numbers).
As noted above, NZ IFRS 16 can result in complicated and nuanced accounting for many different reasons. Accordingly, below are some of the recurring areas that management can upskill on as easy wins:
- High-level overview of all the various fish hooks that may eventuate (BDO Cheat Sheet)
- Ensuring that all of an entity’s leases (as defined by NZ IFRS 16) have been identified (BDO Cheat Sheet)
- Understanding the three different ways that NZ IFRS 16 can be adopted, and various other adoption simplifications that are available (BDO Cheat Sheet)
- Understanding what the discount rate to be used is, in particular (i) what it is (and is not), (ii) what it is meant to incorporate, and (iii) the fact that an entity will likely have more than one discount rate to be determined (BDO Cheat Sheet)
- The complexities that can arise with Property leases, in particular changing lease payments, assessing renewal options, addressing make-good provisions (BDO Cheat Sheet)
- If an entity acquires a business during the period, how to apply NZ IFRS 16 to the leases that come across as part of the acquisition (BDO Cheat Sheet)
- Changes to how sub-leases now need to be assessed under NZ IFRS 16 (BDO Cheat Sheet)
- How to deal with changes to lease payments as a result of COVID-19 (BDO IFR Bulletin for Lessees and (Sub)Lessors).
RECOMMENDATION FOR MANAGEMENT:
Get studying (think of the CPD hours you can tick off).
There is a plethora of general and specific guidance that has been released by both the accounting standard setting bodies, as well as accounting firms like BDO (click here, and open the “Where to get the latest BDO publications and training content” box).
Also, consider engaging an external expert to assist with the end-to-end adoption of NZ IFRS 16, or discrete and specific components of the entity’s overall adoption plan (see below).Knowledge is power, and power is key to succeeding in the adoption of NZ IFRS 16.
Have an appropriate level of expertise involved in the adoption process
Because NZ IFRS 16 relates to accounting, many entities believe that the adoption of NZ IFRS 16 is something that can (and should) simply be addressed internally by the entity’s internal accounting function.
However, as accounting standards have evolved over time, the analysis and application of accounting standards (including NZ IFRS, and in particular, complicated and nuanced accounting standards such as NZ IFRS 16), have become a specialised area of accounting - in the same way as, for example, tax accounting, valuation, and financial risk management and treasury.
So, when you have a complicated area of accounting standard application, an entity should engage an accounting standards expert (in the same way an entity would engage a tax expert for a complicated tax matter).
Depending on the nature and extent of an entity’s lease population, the need to have access to timely expertise may be a necessity, rather than a nice to have.
RECOMMENDATION FOR MANAGEMENT:Like the assessment of whether an LASS is needed, management sit back and have an open and honest conversation with all interested stakeholders (i.e. Boards, Auditors, staff at the coal face) about where external expertise is needed.
Is it too late to start the adoption process?
No, not at all - but obviously the sooner your entity’s financial reporting deadlines the quicker management will need to move. The best thing management can do now is to step back, and
- Assess where you’re at and how you are tracking
- Identify what still needs to be done, and
- If things are looking challenging don’t panic - reach out and engage a trusted expert adviser.
BDO’s IFRS Advisory department has assisted (and is currently assisting) many entities, in varying degrees and scope, through their adoption of NZ IFRS 16.
For those entities that want to find out more, we have details on our “Adopting NZ IFRS 16” webpage. So please feel free to drop us a line or email to discuss your entity’s specific challenges and how we can loop in to assist.
Final take away points for entities to consider
- Step back and assess.
- Plan, plan, plan… and then plan some more, and
- Reach out for assistance where needed.
Don’t be the frog that sits in the warm bath that eventually succumbs to environment it now finds itself in, and instead adopt our mantra of:
“Do it early… do it once… and, do it right”