Here’s how accounting for leases is changing

Here’s how accounting for leases is changing

It has become an increasingly popular topic of conversation that accounting rules for the leasing of assets is about to change. The accounting practices currently adopted by most UK businesses are covered within an internationally agreed accounting rule called IAS17, which recognises two types of lease:

  • Finance Lease – on balance sheet
  • Lease Purchase – on balance sheet
  • Operating lease – off balance sheet

Much reference has been made in recent months to changes in the way in which leases are treated from an accountancy perspective. Such references involve the introduction of a new, internationally agreed accountancy standard (IFRS16).

Companies using IFRS16 will have to account for nearly all of their leases (including operating lease) on balance sheet from January 2019. For some industries, the sudden appearance of new assets and liabilities will make certain accounting ratios look very different, with both positive and negative implications.

This has led to questions as to whether businesses will change the way in which they acquire capital equipment.

The first point to make clear is that the only organisations which will need to adopt IFRS16 on 1st January 2019 are those that are publicly quoted. Similar changes will also apply to companies currently using USGAAP, but the vast majority of organisations in the UK will not be affected. Second, any agreements currently classified as finance leases, including hire purchase, are not affected since they are already on balance sheet.

Even for those larger companies that will need to change the way they account for leases, it is worth noting that only certain sectors will be significantly affected, and these will be businesses where leased assets (currently off balance sheet) are of disproportionate significance. Two such assets are property and aircraft – and therefore the industries which will face the biggest change in the appearance of their accounts from next January include retail, leisure and airlines.

For those businesses that currently apply IAS17 but will be changing to IFRS16 next year, there appears to be little reason to move away from operating leases as a method of acquiring use of assets. While off balance sheet funding may be appealing, there are many other powerful reasons why operating leases will remain attractive:

  • effective and easy source of funding
  • maintenance and services included within the finance package
  • improved cash flow
  • predictable monthly payments
  • removal of asset and disposal risks
  • flexibility of use

The points raised above are a very general summary of a complex subject so it is important that any organisation contacts their own Company Accountant to get clarification relating to their own specific circumstances.

Categories: Asset Refinancing and Leasing