IFRS 16 Leases, the new international accounting standard, will come into effect from 1 January 2019. This will have a substantial impact on car rental and leasing companies.
During a presentation to SAVRALA members by accounting firm Deloitte Touche, Trevor Derwin, A & A Partner in the Johannesburg office explained that the essence of the changes lies in the accounting treatment applied by lessees. At present, the costs pertaining to leased vehicles are not reflected on the balance sheet; in the future all leases will have to be reflected on the balance sheet, with the exception of short term leases (less than 12 months) or low value leases.
“There are a number of considerations to take into account for companies who have lease agreements” said Derwin. “These include the impact on the company’s financial report, key ratios, disclosures, the cost of implementation, the ability to access desired information, the impact of covenants and debt renegotiations and leasing strategies. It is essential that these companies start discussions with their bankers, analysts and lessor companies to ensure they are ready to implement the new standards.
“However, there will be no difference to the bottom line for leasing and rental companies,” he added. “Despite the changes, there remains considerable advantages to leasing as opposed to buying vehicles.”
The main changes required by the new standards include the accounting treatment for lessees in a lease (where most leases will be brought on balance sheet as finance leases), the definition of a lease and enhanced disclosures.
Under the new standards, a contract contains a lease if it depends on the use of an identified asset and if it conveys the right to control the use of such an asset. Further, the customer must enjoy substantially all of the economic benefits from the use of the asset during the lease term. In determining whether a customer has the right to control an asset, the customer must be able to determine how and for what purpose the asset is used.
A further consideration lies in substantive substitution rights. In this instance, if the supplier has the practical ability to substitute alternative assets, and the supplier benefits economically from this right, the contract would no longer be considered a lease.
Many lease contracts today include both a lease and service component. Under the new standard these should be accounted for as separate components with the lease element capitalized to the on balance sheet lease, while the service component is expensed as incurred. Lessees may, however, elect to not separate non-lease components from lease components by class of asset.
“Identifying a lease will sometimes require a significant amount of judgment based on the elements of the definition of a lease” said Derwin. “It is also important to determine the lease term, ie whether it is reasonably certain that an extension or termination option will be exercised. In addition, identifying the appropriate rate to discount the lease payments will require significant consultation.”
“Although the new standards come into effect in January 2019, they will apply equally to existing as well to new lease arrangements,” he concluded. “For those SAVRALA members who play the role of lessor, there is a business opportunity in that they can assist their customers to find the best solution. We urge all your members, lessors and lessees alike, to discuss these changes with their auditors to ensure they are informed and ready to implement they changes as they come through”.
Download the PDF of the July 2017 presentation by Trevor Derwin:
IFRS 16 Leases – Technical Update