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There is an imminent and significant change to the accounting treatment of leases of which many business people are not aware.

The International Accounting Standards Board (IASB) — which is an independent, private-sector body that develops and approves International Financial Reporting Standards (IFRS) — issued IFRS 16 (an accounting standard that relates to leases) on January 13th, 2016, which becomes effective for accounting periods on or after January 1st, 2019.

Jamaica uses IFRS as its financial reporting standards and therefore IFRS 16 will have an impact on how financial statements for Jamaican businesses are prepared for any financial periods on or after that date.

This article will set out the effect of IFRS 16 in broad terms from a business perspective, with the expectation that business people will be furnished with more granular details (including exceptions and nuances) of IFRS 16 by their accountants in due course, if this has not been done already.

So what is new? Well, essentially, after January 1st, 2019, there will no longer be a distinction between operating leases and finance leases. After that date, all leases will be treated as finance leases.

To be clear, for these purposes, a lease is defined as:

“A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.”

The definition is wide and applies to the lease of any asset, including, real estate, vehicles and equipment.

It is important to note that the accounting treatment with respect to leases will remain largely unchanged insofar as lessors are concerned, with IFRS 16 mainly affecting the manner in which a lessee will be required to record a lease in their financial statements.

EXAMPLE

Lease-a-lot Ltd (as lessee) currently has an operating lease for a vehicle with a financial institution (lessor) whereby:

1. the lessor owns the vehicle and the vehicle is recorded on the lessor’s balance sheet as an asset, whereas, this lease is not recorded as an asset on Lease-a-lot’s balance sheet;

2. Lease-a-lot is able to treat all lease payments made to the lessor as a lump sum expense in its profit and loss statement; and

3. at the end of the lease period, when the useful life of the vehicle has ended (for accounting purposes), the vehicle is to be sold by the lessor for its residual value.

Now, in respect of any financial periods accruing after January 1st, 2019, Lease-a-lot’s lease will be deemed to be a finance lease, with the following implications:

1. although the lessor owns the vehicle and the vehicle is recorded on the lessor’s balance sheet as an asset, Lease-a-lot will now also be required to record as an asset on its balance sheet the accounting value of its right-of-use of the vehicle with the corresponding lease liability on the balance sheet;

2. Lease-a-lot will no longer be able to record a single lease expense on its profit and loss statement, but rather, it will now be required to record two separate expense items, being: a depreciation expense and an interest expense; and

3. at the end of the lease period, when the useful life of the vehicle has ended, the vehicle may still be sold by the lessor for its residual value.

It is therefore possible that the following will happen as a result of IFRS 16 in this example:

1. Lease-a-lot’s asset values are augmented on its balance sheet, which may have a consequent effect on Lease-a-lot’s asset tax liability; and

2. The collective dollar value of the interest and depreciation expense that obtains with a finance lease is unlikely to match the lump sum lease expense that obtains under the operating lease regime, which should have a consequent effect on Lease-a-lot’s profit and loss statement — namely, its net profit figure.

IN OTHER WORDS, all business people (lessors and lessees) have about two years to prepare for the impending IFRS 16 which will affect the financial statements of lessees to a larger extent; may have asset tax implications for lessees and which may well give rise to a review of the terms and conditions of existing lease contracts and those to be executed after January 1st, 2019.

Business people who may be affected by IFRS 16, may be well advised to consult with their accountants and their attorneys to prepare for its implications, if they have not already taken such an opportunity.

Matthew Hogarth is the managing partner of MH&CO, attorneys-at-Law, a corporate law firm. He may be contacted at: legal@mhcolegal.com