IFRS 16 — Beware of Ghost Assets

30 October 2019

IFRS 16 Leases is effective for periods beginning on or after 1 Jan 2019. This means finance teams will be busy working up to the end of the year to implement this new standard.

Businesses with significant lease portfolios will be affected by IFRS 16. However, the most significant impact will be felt by businesses that are currently lessees under operating leases. This is because the new standard requires companies to bring most leases on their balance sheet from 2019.

While IFRS 16 does bring more transparency to leases in companies’ financial statements, it also brings many of implementation challenges, which are further complicated when taking ghost assets into consideration.

Here is what you need to know to make sure you are not cursed by ghost assets when implementing IFRS 16.

What is new?

While the accounting for a lessor is largely unchanged, IFRS 16 fundamentally changes the accounting treatment of leases by lessees.

IFRS 16 eliminates the classification of leases as either operating leases or finance leases for a lessee. Instead, all leases are treated similarly to finance leases applying IAS 17. Exceptions are allowed for short-term leases (terms of 12 months or less) and low-value assets.

Applying IFRS 16 significantly affects the disclosures included in IFRS financial statements as it leads to an increase in capitalised assets and loans booked as liabilities. The income statement is affected as lease expenses are replaced by higher depreciation charges and an interest expense.

Implementation challenges

There are several potential implementation challenges of IFRS 16 that businesses need to address, including the following:

  • Lessees need to analyse all their existing contracts to collect lease data, a challenge for multinationals whose oversight of leases may not be centralised
  • Additionally, contracts may be in multiple languages
  • Based off of this analysis, the correct lease term needs to be determined
  • Lessees need to measure and remeasure to determine the discount rate
  • Depending on the criteria met, lessees need to identify which leases should be modified, an impact which is felt beyond the finance team
  • Lessees need to prepare for new, significantly enhanced disclosure requirements

One more item complicating the implementation of IFRS 16? Ghost assets.

The reality of ghost assets

As much as you would like to believe that companies can keep track of all their fixed assets, that is not always the case—for a variety of reasons. This leads to ghost assets, a fixed asset in the general ledger that cannot be accounted for because it is physically missing, lost or otherwise unaccounted for.

This results in your organisation paying tax on something it is no longer using and it causes incorrect reporting.

Let’s look at a practical example. A multinational organisation maintains 300,000 laptops and mobile devices with a three-year life cycle on operating leases. As operating leases were previously expensed, the low-value assets are frequently not maintained on capitalised asset ledgers. While the value of each individual laptop is relatively low, the total value of 300,000 laptops and mobile devices exceeds 10 million euros, a material amount for audit and reporting purposes.

When it comes time to refresh the lease, the device might be in one country and the lease in another. Or maybe it was lost, stolen, broken, damaged or replaced without the proper paper trail. Organisations often address this issue by replacing the asset on a like-for-like basis when the individual lease contract expires, followed by a renewal on the same basis. The status quo is maintained since the number going out is the same as the number coming in, and because the group level accounting integrity is not materially affected, it passes audit.

The accounting treatment change introduced by IFRS 16 requires adopters to perform an inventory of lease agreements and a reconciliation to the underlying asset ledgers. This is a challenge if you have not been doing that for years. Organisations in capital intensive industries, such as oil and gas and aircraft leasing, face a more material financial impact.

Ghost assets are nothing to fear

A cloud-based connected reporting and compliance solution can help eliminate the unknowns surrounding ghost assets.

Tracking fixed assets from purchase to retirement can be simplified by leveraging balance sheet reconciliation tools together with connected reporting and compliance solutions. This collaboration allows you to combine lease management with fixed asset systems in the same connected reporting environment to reduce errors across the organisation.

The power of data analytics connects industry enterprise resource planning (ERP) solutions to systems of record lease ledgers. This facilitates enhanced lease term analysis and "what-if" scenarios to audit. It also connects lease contract analysis to maximise the economic useful life of the asset.

Complex discount rate, fair market value residual analysis and discounted internal rate of return computations can also be conducted within a connected reporting and compliance solution. This reduces manual workarounds and further integrates the reconciliation of balance sheet ledger analysis to the leasing ledgers and economic benefit analysis.

It is likely that a formal technical accounting review (TAR) memorandum will be performed to illustrate that the accounting treatment carried out by the finance team and the disclosures match the requirements of IFRS 16. The TAR will be reviewed by the audit committee and auditors before final signoff of the financials.

With connected reporting and compliance solutions, you can connect all the people, data and processes involved in this review in a single cloud platform. This accelerates the review and makes the process more efficient. These same benefits can be delivered to disclosure management and audit review notes when you connect reporting and compliance. The result is more consistent accounting disclosure across large numbers of group entity accounting entries during the IFRS 16 implementation project.

Finally, connected reporting and compliance solutions can automate data gathering and preparation to minimise errors, reduce implementation risks and help maintain consistency across your financials.

Do not get spooked by IFRS 16 and ghost assets. Get in touch with Workiva to see how we can help.

About the author

Conor has over 20 years of experience as a senior finance executive for multinational corporations. He is a fellow of the Institute of Chartered Accountants in Ireland (FCA). He was also a Member of Council at the Institute of Chartered Accountants in Ireland from 2002–2005.