On 1 January 2019, IFRS 16 Leases replaced IAS 17 Leases and related interpretations, which is now applicable to South Africa’s annual reporting periods. The main purpose of the new reporting standards is to provide a more realistic reflection of the economy by improving financial transparency and visibility.
One of the ways this will be achieved is by eliminating a lessee’s classification of leases as either operating leases or finance leases. This will make it easier to compare the financial statements of companies that lease assets to those that borrow money to purchase assets. At the opposite end of the spectrum, huge liabilities may be introduced to companies’ balance sheets, as operating leases are changed to financial leases.
For lessors, IFRS 16 Leases will remain largely unchanged, but the opposite is true for lessees. Consequently, it is very important that South African businesses – particularly those businesses who do not employ the IFRS For SMEs accounting standard – understand how this new standard affects their financials.
There’s safety in understanding the numbers
Unfortunately, many are still unsure how to comply with these changes. Historically, South African companies relied on auditors to deal with these types of requirements, but to maintain independence, they are not involving themselves in the process. The consequence is that businesses have to implement these standards themselves, states Business Live.
“It is also important to bear in mind that not only businesses will be affected; investors also need to educate themselves,” says Benny Padachie, CA (SA), RentWorks’s CFO.
For these reasons, this article highlights the key financial facets that large corporates, such as retailers, as well as SMEs (who do not employ the IFRS for SMEs accounting standard), need to take cognisance of:
Big impact on large corporates with operating leases
For corporates not making use of operating leases, the impact of IFRS 16 on them is minimal compared to those corporates that do make use of operating leases. For example, in 2016, the International Accounting Standards Board estimated that retailers had $571bn of future payment obligations that were not recorded on their balance sheets (Source: Effects Analysis IFRS 16 Leases January 2016).
Statistics such as these clearly show that it is crucial for corporates, particularly retailers, airlines, I.T., telecommunications, transport, travel and leisure, media, energy, distribution, communications and healthcare to name a few industries with large infrastructures who made use of operating leases in the past, to understand the new standards inside-out:
- For instance, in the example of retailers named above, following the implementation of IFRS 16, EBITDA will improve due to the fact that the rent they pay is not an operating cost anymore.
- On the other hand, profit before tax is unaffected because the single expense incurred by operating leases in the past is replaced by depreciation and finance costs of the finance leases today.
- Important financial ratios of erstwhile operating lease users that will be negatively impacted by IFRS 16 are their Gearing, Return on Assets and Interest Cover ratios.
- In determining whether a contract contains a lease, previous users of operating leases need to now clearly understand which parties to the contract have the right of control of an identified asset. Working through these issues will determine whether a lease or a service contract actually exists – the fact that an identifiable asset exists does not on its own mean that a lease exists.
SMEs not employing the IFRS for SMEs standard
Fortunately, shorter leases and leases of low-value assets are exempt (read more about this in a previously published article) but SMEs and corporates who have these types of leases, need to take the following facts into consideration when the contract is up for renewal:
- Contractual terms for optional periods.
- Significant leasehold improvements.
- Costs of termination and return.
- Importance to operations (specialised, location, alternatives).
- Conditionality associated with the option.
“This is what RentWorks does all day long,” Benny Padachie, CA (SA), RentWorks’s CFO at RentWorks. “Our deal structuring team is here to help you over all of these hurdles – in an easy to understand and cost-effective way.”
Look at the bright side of the balance sheet
Although many South African auditing firms, leasing companies and businesses have voiced fairly negative opinions about the potential consequences of implementing IFRS 16 Leases, RentWorks believes that despite IFRS 16, there are still significant cash-flow and payment timing benefits for clients of RentWorks to take advantage of.
The four that stand out are:
- Unsecured residual value based lease structure – lower lease cost than any other traditional lease or instalment sale product.
- Access to additional capital without using up your existing lines of credit.
- Timing and structuring of lease payments to coincide with your project or cash flow cycle.
- Physical management of high volumes of assets across an organisation on a local-, regional-and international footprint.
Lean on RentWorks with IFRS 16
RentWorks has the depth of knowledge and experience to provide you with insight into how the other players in your industry are adapting to IFRS 16, so give us a call encourages Benny Padachie, CA (SA), RentWorks’s CFO
Give the team a call on 011 549 9000 or alternatively, visit the RentWorks website.