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IFRS 16 leases – a matter of fair presentation?

A person using a calculator

Waiting for Godot

Almost since the issue of IAS 17 in 1982, we have been waiting for the next step in dealing with the reporting of leases. Indeed, I had begun to feel that Vladimir and Estragon in Samuel Beckett’s famous play had more chance of seeing Godot finally turn up than we had of seeing a revised leasing standard requiring lessees to recognise all significant lease assets and obligations on balance sheet.

It was almost a shock when, more than 33 years later, the IASB finally issued IFRS 16. Ultimately the standard was very much as expected, with lessees required to recognise all significant leases on balance sheet via a lease liability and a right-of-use asset.

I will not bore you with the mechanics here, as that has already been done many, many times. Rather, my aim is to question whether the exercise has any point to it.

Does anybody care?

I would be a very rich man if I had £100 for every time someone has said to me "there is no point in putting all leases on balance sheet - analysts make their own adjustments anyway. All it will do is create unnecessary effort and cost". Quite apart from the fact that such comments most regularly come from entities whose balance sheets will be most affected by the recognition of all lease assets and liabilities, this raises two key questions:

  • Will recognition really affect the view given to readers of financial statements?
  • Do we really want financial statements to show a fair presentation?

Impact on readers

It is certainly true that sophisticated readers currently seek out the disclosure of operating lease obligations and make their own adjustments. However, does this apply to everyone? There is an old adage - "If you want to hide a tree: put it in a forest", and often I can’t help thinking that this motto is applied with respect to lease obligations. For example, Vodafone’s 31st March 2015 Statement of Financial Position includes £25.9 bn of non-current liabilities - 61 pages later, note 29 discloses non-cancellable operating lease commitments of £6.58 bn.

There is also the point that a substantial number of entities are making efforts to restructure their financing arrangements for assets to avoid the impacts of IFRS 16. It is fair to question why this effort is being made.

Fair presentation - the IKEA problem

The real problem to me in respect of lease accounting comes when we consider fair presentation in financial statements. The assets and liabilities which arise for lessees under IFRS 16 plainly meet the definitions of assets and liabilities, and few can argue that a fair presentation is not substantially enhanced by their recognition.

"But you do not need to recognise them: disclosure is enough. Readers can make their own adjustments anyway" comes the cry. The problem here is that if you merely disclosure lease obligations you are effectively giving readers flat packed financial statements - they do not actually give a fair presentation until you have put them together.

This is just like a wardrobe purchased from IKEA - it is not actually a wardrobe until you have put it together! The problem is compounded as many disclosures will actually result in the equivalent of a wardrobe bought from other, less reliable suppliers - there is a crucial part missing, they do not fit, there are no assembly instructions or most alarmingly there are 6 screws to spare!

In summary

The merit of IFRS 16 depends on what we want from our financial statements.

If we really believe in fair presentation, then IFRS 16 represents a massive step forward in corporate financial reporting as long as it is applied properly. For this to be the case, it is not enough just to recognise the asset and liability on balance sheet. Proper disclosures and a clear statement of the relevant accounting policy is needed if the wardrobe is not to wobble alarmingly or to collapse when actually used.

If on the other hand, fair presentation is something to be tossed aside in the quest for simplification and cost-cutting, then IFRS 16 represents one of the biggest follies ever perpetrated by the IASB.

You decide! However, if you hold the latter point of view, then that brings into question the entire existence of IFRS and the IASB, not to mention the main plank of the audit opinion.

For more information regarding IFRS 16, please visit our Leadership and Professional Development page.

Bruce Cowie, Head of Financial Reporting, Kaplan Leadership and Professional Development