What is IFRS 16?
IFRS 16 is a new accounting standard that will impact International companies that report under IFRS Accounting standards. IFRS 16 requires companies to recognize the assets and liabilities associated with leases which have terms greater than 12 months. Historically, leases were reported as off-Balance sheet items, which would be found in the notes section of a company’s financial reports.
When will IFRS 16 go into effect?
IFRS 16 has been in effect since January 1st, 2019. Companies are required to adopt the new standard in their fiscal year-end 2019 reporting period. Earlier adoption of the rule is permitted in Interim periods.
How will IFRS 16 affect a company’s Financial Statements?
Balance Sheet
Operating leases are primarily going to impact a company’s Balance Sheet. The Assets that are being leased will be reflected as Fixed Assets and will be offset by an increase in Total Debt. There is no approximation of how much Debt will be Short Term or Long Term, therefore the additional Debt allocation will vary by each company.
Income Statement
Expenses that are associated with Leases have historically been reflected in the Other Operating Expenses section of the Income Statement. These expenses are not expected to increase but are expected to shift across different line items on the Income Statement. For example, since Leases are being recognized as Fixed Assets, Deprecation expenses will increase. Additionally, any Interest Expenses associated with the lease will be recorded under Interest Expense. This will cause a change in EBITDA; however, no other profit lines will be affected.
Example
Tesco PLC is a British groceries and general merchandise retailer which has multiple store locations. Generally, most retailers lease store locations rather than own, which means that the FHR for a Retail company like Tesco PLC will be impacted by IFRS 16. Tesco PLC is required to show all store leases on its Balance Sheet, which caused an increase in Debt from the Q2_2020 reporting period compared to Q2_2019. The table below shows the impact on the FHR and CHS due to the changes in the Balance Sheet and Income Statement line items mentioned above.
|
Tesco PLC |
8/25/2018 |
8/24/2019 |
Difference |
|
FHR |
42 |
38 |
-4 |
|
CHS |
38 |
41 |
3 |
|
Fixed Assets |
18.81 |
26.65 |
42% |
|
Total Debt |
7.94 |
17.25 |
117% |
|
EBITDA |
3.07 |
3.81 |
24% |
Conclusion
The changes brought upon by IFRS 16 are expected to slightly change the FHR’s for International companies that report under IFRS Accounting standards. The severity of ratings changes will depend on each company, as some companies will have large leases and others will not. We expect that the ratings for companies with large leases will be adversely impacted by this new change.