How do any of the essential pieces of equipment you lease – such as photocopiers, printers and peripheral devices – impact on your accounting practices?
In truth, such product leasing contracts have always had a significant impact on your company accounts. But from the 1st of January 2019 that impact is going to change, thanks to major amendments to financial reporting standards introduced by the International Accounting Standards Board (IASB).
Accountants Deloitte explain how International Financial Reporting Standard (IFRS) no. 16 affects the treatment of leased products and equipment reported in your company accounts.
At the end of the day, the changes are likely to result in an increase in your reported earnings, coupled with an increase in your balance sheet liabilities. Let’s see why that is.
The Current Accounting Practice
Your accounts are prepared according to one of two main accounting standards of practice:
- The International Financial Reporting Standards (IFRS) – which have broader application and which form the model towards which GAAP standards are also progressing.
Under both these standards, your lease of equipment is accounted for as either:
- A finance lease – where you assume all of the rewards and risks of the leased equipment, with payments reflected as a liability on your balance sheet• and a corresponding asset; or
- An operating lease – where significant risks and rewards are retained by the lessor and your rental or lease payments are reflected in your statement of profit and loss (with no balance sheet impact).
Changes Introduced by IFRS 16
Your leases of equipment such as printers, photocopiers and other devices were previously most likely to be recorded as operating leases (and payments deducted from your profit and loss earnings). Changes to IFRS 16 abolish the distinction between finance and operating leases and treat all product leases in the same way as finance leases were previously recorded – in other words, with lease payments recorded as a balance sheet liability and corresponding balance sheet asset.
Any accounts you prepare to submit after the 1st of January 2019 – probably the next ones you do – therefore need to treat any leased products and equipment as follows:
1. can you identify the leased item or items;
2. do you receive all the rewards and benefits of the leased item or items – which is almost certain to be the case with leases on products such as printers, photocopiers and other electronic devices;
3. do you have exclusive use of the leased items; and
4. do you have a contract containing the lease agreement?
If the answer is yes to these questions, the value of lease payments you make in a year appears as a liability in your balance sheet, together with the corresponding asset representing your Right of Use (ROC).
Your statement of profit and loss then reflects only the expenses involved in operating the lease, the interest you pay and depreciation of the leased asset or assets.
The above-referenced guidance published by accountants Deloitte helpfully includes a worked example of the impact of the switch from your previous accounting method (of recording the full cost of an operating lease in your profit and loss statement only) and the new standard which transfers such assets to your balance sheet.
The worked example shows that the new method records a significant increase in your statement of Earnings Before Interest, Tax, Depreciation, and Amortisation (EBITDA) – in other words, your operating profit before the deduction of those expenses. Your balance sheet, on the other hand, now reflects the Right of Use (ROU) of the leased assets and new liabilities reflecting the lease payments you need to make.
You might consider these changes to reflect an improvement in your recorded financial statements (especially the marked increase in EBITDA) – lending weight to your decision to enter into product leasing agreements.