How Will IFRS 16 Affect Small Business Accounting Practices?
Back in 2016, the International Accounting Standards Board (IASB) announced changes to International Financial Report Standards (IFRS). Dubbed IFRS 16, the updated set of rules will come into effect in January 2019. When it does, it will transform the way organisations handle and account for their leases.
In this article, we will examine how IFRS 16 will affect small businesses and their accounting practices.
What Is Different in IFRS 16?
Many organisations, particularly small businesses, run their operations from leased office spaces and use leased vehicles, printers, and other equipment to increase their efficiency. Until now, all these items were considered operating leases and as such weren’t included in balance sheets. Instead, businesses only had to add them to their profit and loss accounts. Under the new rules, however, both operating and finance leases will now be recognised as liabilities and therefore included in the balance sheet.
All these leased items will also have to be listed as assets in the company books. This is according to paragraph 9 of the document, which defines any property or piece of equipment that a business has the right to use exclusively for a predetermined period of time as an asset.
In addition, all maintenance costs will have to be reported separately from the main lease payments. Finally, the depreciation and interest on leased items must be included in the profit and loss account.
Why Were These Changes Made?
Simply put, these changes aim to ensure that all businesses report their leased items in the same way.
Previously, organisations could take some of their large financial liabilities and report them as operating leases rather than financial leases. These items wouldn’t be shown on their balance sheets, thus giving an inaccurate idea of the organisation’s finances and leaving room for a lot of guesswork in accounting.
With IFRS 16 in place, businesses now have to report all leased property and equipment as assets, which will add transparency to a previously often ambiguous area. According to the IASB official responsible for this document, the new standard aims to eliminate off-balance sheet financing. Furthermore, it also aims to even the playing field between organisations that borrow to buy assets and those that lease them.
What Does This Mean for Your Small Business?
Certain countries have their own accounting standards that aren’t always in full accordance with IFRS. Unless your company is already reporting to IFRS, these changes likely won’t affect you. However, if your organisation is reporting to IFRS, your accounting practices are bound to change as of January 2019.
For one, you will obviously have to report all your leased assets in your balance sheet.
However, you will also have to reassess all your existing contracts to determine whether they contain a lease. The previously mentioned paragraph 9 clearly states that every asset for which you have right of use will be treated as a leased item and accounted for accordingly. So if, say, you have a contract to rent storage space for a set period of time, it will be treated as a lease since it contains an identifiable asset.
This only applies if you’re the exclusive user of the storage space for the duration of the contract. If, for example, you’re just renting part of a large warehouse where there is at least one more user other than you who shares the same facilities, you don’t have the right of use and the contract doesn’t include a lease.
If you’re leasing real estate for business purposes, you may also need to consider making changes to your regular lease terms. With IFRS 16 requiring you to list even your office space as an asset, agreeing to a long-term lease might not be the most financially viable option, so you may opt to shorten your standard lease term. Alternatively, you can choose to rent flexible co-working office space. Since you’re sharing your workspace and don’t have right of use, you won’t have to include it in your balance sheet.
Are There Any Exceptions to the New Rules?
There are only two types of lease that don’t have to be included in your balance sheet.
If you are leasing an item for a term shorter than 12 months and you don’t have an option to buy it at the end of your lease contract, that item isn’t subject to the new IFRS 16 rules. This also means that any related depreciation and maintenance costs won’t have to be reported separately on your account.
IFRS 16 also doesn’t apply to leased items whose value is less than US$ 5,000 (AU$6975) when new. Since computers, copier machines, and other pieces of leased office equipment usually cost considerably less, this means that you won’t have to include them in your balance sheet either.
IFRS 16 is not without its downsides. For one, companies that lease numerous items may appear asset-rich when, in fact, they’re not. With every leased item reported separately, your accounting and financial ratios will be affected, too. This, in turn, could make your business less attractive to investors.
Still, with IFRS 16 about to come into effect, you need to prepare your business for the impending changes. If you need any help understanding some aspects of IFRS 16, schedule a meeting with your accountant.