For many businesses nationwide, the most important New Year’s resolution they can make looking forward to 2020 is adopting the new NZ IFRS 16 accounting standard pertaining to leases. For year-ends 31 December 2019 and onwards, many businesses will have to fundamentally change the way that they account for most material leases as a lessee, including those for commercial or residential property, vehicles, and heavy machinery.
Adopting this change is difficult enough without trying to incorporate the new accounting treatment in a ‘business as usual’ manner. Luckily, the BDO IFRS Advisory team has a few tips to help. See our answers to the most common questions we are asked about how to adopt IFRS 16.
This new accounting standard changes the way that many private sector entities will have to account for their leases, and will affect most businesses which use rentals or leasing to access and incorporate assets or property into their business operations. NZ IFRS 16 requires most leases to be accounted for on a company's balance sheet (there are exceptions for leases of less than 12 months or leases of “low value assets”).
Previously, most leases simply had their lease payments recognised as operating expenses as and when payments were made, with nothing recorded in the balance sheet.
Going forward, NZ IFRS 16 will impose “on-balance sheet” accounting to almost all leases, resulting in:
- A liability for future lease payments to be made, which is treated like a loan or mortgage, accruing interest with lease payments reducing the outstanding balance, and
- An asset that represents a business’ right to use and access the item being leased, that depreciations like any other item of plant and equipment.
This consequential change in accounting treatment will fundamentally alter the look and feel of a company’s financial statements as well as several commonly used financial metrics in businesses accounting, such as gearing ratios and Earnings Before Interest, Tax, Depreciation, and Amortisation (EBIT(DA)).
Although the new standard was anecdotally met with a significant amount of opposition from preparers and users of financial statements, NZ IFRS 16 will improve clarity around businesses true debts and available assets. By adding the value and liability of all leases onto an organisation’s balance sheet, businesses can more easily compare their performance to competitors’ and make informed decisions about new rentals they engage in.
Currently, only for-profit entities that prepare financial statements in accordance with NZ IFRS are caught by the new accounting treatment.
While the application of NZ IFRS 16 to all the leases your organisation may have, NZ IFRS 16 includes a number of practical expedients to ease the pressure by providing you the ability to scope out leases that are of a limited term and/or relate to items of “low value”.
From a cash perspective, nothing in the business is changing. Businesses will still be making the same amount of payments, to the same counterparties, on the same basis as they always have.
But what is changing is how these cash flows are represented on paper for accounting purposes, which is ultimately the story that your business’ accounting statements are attempting to tell.
So while businesses will appear more “asset-rich”, the flip side is that balances presented as “debt” will be increasing too, as well as the reported interest expense associated with these. This can affect how you manage and report on financial compliance and governance, for example compliance with banking covenants linked to financial metrics that are susceptible to change as a result of NZ IFRS 16, breaches of which may have very real-world consequences (including the recall loans or increases in future lending rates). This may require discussions with banks, and amendments to loan agreements to be undertaken as one of the first steps in adopting NZ IFRS 16.
The change may also affect employee bonuses (as well as earn-out payments, and share price calculations) where these are based on financial metrics such as EBIT(DA) – as these financial metrics improve as a consequence of NZ IFRS 16, you may be contractually required to pay employees additional amounts. Again, this is an area that should be investigated and rectified as one of the first steps in adopting NZ IFRS 16.
We can offer three pro tips on how to make the switch over to NZ IFRS 16 simpler:
- Start the transition early, and implement all changes right the first time.
As you move down the path of adopting NZ IFRS 16, twists, turns, and speed bumps can materialise. Starting the process early will allow time to identify and work through these as wells as help you thoroughly test your new processes for kinks and ensure you don’t have to go back over old ground!
- Determine the right tools for your budget and expertise.
Specialised lease accounting software products gives companies an effective way to meet financial compliance as well as providing peace of mind- but if you prefer more traditional practices (like manual spread sheets), work with what you know. It will be more time-consuming to switch how you do things midway through implementing the new standard.
- Partner with specialised accountants.
Accounting is becoming an increasingly specialised profession, so make sure you work with an accountant that has actual practical expertise in adopting and working with this new (and other) accounting standards.
The accounting world is changing constantly as businesses become more driven by compliance, and technology changes in terms of how we process information. The modern accountant is more than just a number cruncher - they are a business adviser and financial specialist rolled into one.
BDO’s IFRS Advisory team has specialised in keeping up to date with changing accounting standards so that you don’t have to. We can advise you on how to manage the transition towards NZ IFRS 16 and keep your business moving in the right direction.
- For more information and resources on NZ IFRS 16 visit BDO’s dedicated Adopting NZ IFRS 16 page
- For organisations considering the use of lease accounting software please visit our information page on BDO’s very own solution, BDO LEAD, that is available under licence or provided as an outsourced managed services
- To discuss the ways the BDO can assist with your business’ adoption of NZ IFRS 16, contact the team today.