What implications does this have for financial reporting?
The three stages to IFRS 16 financial reporting
How does it impact Company Cars & Fleets?
How does it impact Salary Sacrifice vehicles?
International Financial Reporting Standard (IFRS) 16 is an accounting standard that governs how organisations account for leases. IFRS 16 replaced International Accounting Standard (IAS) 17, but it still applies to many UK businesses that are not required to adopt IFRS.
Effective since January 2019, it impacts those reporting under IFRS, including publicly listed companies and their subsidiaries, as well as certain public sector organisations. This standard may influence how your organisation presents financial statements.
IFRS 16 employs the ‘right-of-use’ model for leases. If a company controls or has the right to use an asset it is renting, it is categorised as a lease for accounting purposes. The lease payments must be recorded as a liability on the company’s balance sheet, accompanied by a corresponding asset that represents the ‘right-of-use’ for the leased asset.
IFRS 16 eliminates the ability to keep significant financial liabilities off the balance sheet, which was allowed for certain lease types (operating leases) under UK Generally Accepted Accounting Practice (UK GAAP). The goal is to ensure that companies provide standardised information for all their leased assets, enhancing transparency and consistency.
Companies are required to prepare a set of comparative accounts for the previous year.
Under IFRS 16, lessors must classify each lease as either an 'operating lease' or a 'finance lease':
IFRS 16 operates similarly to the reporting of financial liabilities and other non-financial assets (such as property, plant, and equipment):
Lessees must present their right-of-use asset as a fixed asset and reflect their obligation to make lease payments as a liability. The portion of the liability due within the next 12 months should be classified under current liabilities.
The value of the right-of-use asset is equal to the value of the liability. This alignment ensures that the lease payments recorded at the start of the lease show the same asset and liability on the balance sheet, resulting in no immediate effect on net assets.
Lessees will depreciate the asset and acknowledge interest on the lease liability.
Depreciation is calculated on a straight-line basis, while the interest expense is front-loaded, meaning higher interest charges are accounted for in the initial years of the lease, even though the lease payments remain consistent throughout the lease term.
The service element of a lease, such as the maintenance package, does not need to be capitalised and will continue to be directly charged to the income statement, often referred to as the Profit & Loss (P&L) account.
Therefore, if a company can prove there is no financial benefit, it can consolidate similar leases into a portfolio instead of accounting for each lease separately. For instance, all car leases, that make up a company fleet could be managed within a single portfolio.
Identify All Assets Classified as Leases Under IFRS 16
Gather Comprehensive Information on these leases: This includes details such as lease terms, end-of-lease options, rental amounts, and, if available, the interest rate of the lease.
For operating leases that may be commercially sensitive, the lessee should consider their incremental borrowing cost. This reflects the rate they would pay to borrow for a similar duration, with comparable security, in a similar economic environment.
Recognise Assets and Liabilities: A net present value calculation is essential to determine the value of the liability. Establishing the right-of-use asset involves more than simply multiplying the lease rentals by the lease term.
Company Car agreements, typically leased through Contract Hire are classified as leases for several reasons:
The nature of the lease whether it is an operating lease or finance lease, is no longer pertinent for the lessee. As these agreements are classified as leases, organisations must account for contract hire agreements following the lessee accounting treatment specified in IFRS 16.
Salary sacrifice vehicles are usually leased by an employer through a Business contract hire agreement.
When an employer adheres to IFRS 16, they must capitalise the lease liability and the right-of-use asset on the balance sheet, with depreciation, interest, and maintenance costs charged to the income statement.
Salary Sacrifice Agreements
A separate agreement will be made between the employer and employee (usually referred to as an Employee Agreement), allowing the leased car to be available to the employee in exchange for the salary sacrifice.
Salary sacrifice agreements with employees can be viewed as sub-leases, as it grants the employee the right to control the use of a specific asset (the car) for a defined period. In line with the lessor accounting treatment specified in IFRS 16, they could be classified as operating leases rather than finance leases.
This indicates that the salary sacrifice is reflected solely in the Profit & Loss account, without impacting the balance sheet.
Some may sugest that the short-term employee benefit exemption under IAS 19 should apply. If this exemption is utilised, the salary sacrifice agreement would also be accounted for exclusively in the P&L account, again with no balance sheet effects.
This is Lease Electric's interpretation of IFRS 16. To navigate these complexities, Lease Electric recommends consulting your financial advisor, accountant or auditors.
