These figures are in line with a previous EY survey that took place before the introduction of IFRS 16 that examined the expected impact of the standard. However, the results are averages and there is a wide range within some sectors. For example, within the shipping and transport sector, the percentage increase in assets varies from 1% to 34% (producing a 14% average).
Making more use of management commentary
The survey confirmed that the more significant the effects of IFRS 16 on the financial statements, the greater the level of disclosure and explanation in the management commentary about the first-time adoption of the standard.
Most of the companies surveyed did not restate the comparative information in their financial statements as they applied the “modified retrospective” approach on transition to IFRS 16. Instead, many of those in the sectors particularly affected by IFRS 16 tailored their disclosures in the commentary to explain the changes.
This included adding columns of financial information, either to present comparatives restated to include the impact arising from the adoption of IFRS 16 or presenting current year information both “with” and “excluding” the effects of adopting the standard.
There were also changes in the use of Alternative Performance Measures (APMs) such as EBITDA (earnings before interest, taxes, depreciation and amortization) and EBITDAR (which also excludes rent).
EBITDA is likely to rise under IFRS 16 for companies that have large-scale lease arrangements, as the majority of the former rental expenses will be reflected in depreciation and interest. The survey showed that some companies have adjusted EBITDA to include depreciation of right-of-use assets and interest expenses on lease liabilities to keep the basis of measurement consistent across the years.
IFRS 16 requires companies to reclassify cash outflows for lease payments from operating to financing activities in the statement of cash flows. The survey showed that some companies changed their definition or calculation of “free cash flow” to become, for example, “free cash flow after leases,” as they adjusted free cash flow for repayment of lease liabilities.
IFRS 16 has also had an impact on debt, as additional liabilities are recognized for leases that were previously off balance sheet. Some companies, especially those in the airline sector, previously added a multiple of operating lease expenses to net debt to present an APM called “adjusted net debt” to better reflect the level of indebtedness. Since the adoption of IFRS 16, this is no longer necessary as these companies can present net debt from the balance sheet (which includes lease liabilities).
Overall, the survey suggests that companies most affected by the implementation of IFRS 16 have communicated to investors the impact of the first-time adoption of the standard with transparency and have provided additional management commentary where necessary to explain any changes.
FAQs
Under the old standards finance lease accounting wasn't necessarily reflected on the balance sheet while operating leases were. Now, all lease activity that lasts 12 months or longer must appear on your company's balance sheet. (Leases shorter than 12 months are simply listed as operating expenses as in the past.)
How do leases impact financial statements? ›
Income Statement Impact: Expense Recognition
Under ASC 842, operating leases continue to generate a straight-line expense pattern, while finance leases result in front-loaded interest expenses and amortization of the ROU asset over time. This can lead to variations in expense recognition depending on the lease type.
What effect does leasing have on a firm's balance sheet? ›
The lessor reports the lease as a leased asset on the balance sheet and individual lease payments as income on the income and cash flow statements. The lessee reports the lease as both an asset and a liability on the balance sheet due to their stake as a potential owner of the asset and their required payment.
How does ASC 842 affect the balance sheet? ›
ASC 842 brings previously off-balance sheet operating leases onto a company's balance sheet. By reporting all leases on the balance sheet, ASC 842 can impact a company's financial metrics, such as debt-to-equity ratio and in some cases adjusted earnings metrics, like EBITDA.
What is IFRS standard the company use to present its financial statements? ›
International Financial Reporting Standards (IFRS) are a set of accounting rules for the financial statements of public companies that are intended to make them consistent, transparent, and easily comparable around the world. The IFRS is issued by the International Accounting Standards Board (IASB).
How does ASC 842 affect the current ratio? ›
Current ratio:
Potential impact of ASC 842: Current assets could remain unaffected, and current liabilities could increase, causing the current ratio to decrease.
How do leases appear on balance sheet? ›
This includes the lease being recorded on the balance sheet as a right-of-use or ROU asset and corresponding lease liabilities. The ROU asset is a new concept introduced to lease accounting with FASB Accounting Standards Update, ASC 842 and the International Accounting Standards Board version called, IFRS 16.
How do operating leases affect the three financial statements? ›
With an operating lease, the lessee does not record the leased assets on its balance sheet since there are no ownership characteristics. Instead, the rental expense associated with the lease is recognized on the income statement in the period incurred, and each payment is tracked on the cash flow statement.
Does a lease show up on the balance sheet? ›
Under the ASC 842 lease standard, almost all leases are recorded on the balance sheet. This requirement often leads to questions like: At which amount do we record the lease liability?
What effect does leasing have on the stability of a firm's reported earnings? ›
Leasing has a significant impact on the financial performance of companies. It creates opportunities for companies to use capital-intensive assets in their production activities, leading to positive effects on financial performance.
If the company chooses an operating lease, the company records only the rental expense for the equipment and does not include the asset on the balance sheet. If the company buys the equipment or building, the company records the asset (the equipment) and the liability (the purchase price).
How do accounting standards affect financial statements? ›
Accounting standards ensure the financial statements from multiple companies are comparable. Because all entities follow the same rules, accounting standards make the financial statements credible and allow for more economic decisions based on accurate and consistent information.
What is the impact of ASC 842? ›
ASC 842 requires companies to recognize all leases on their balance sheet, providing users of financial statements with a more complete picture of a company's financial position and performance. Previously, only capital leases were recognized on the balance sheet, while operating leases were not.
What are the tax impacts of the new lease accounting standard ASC 842? ›
ASC 842 does not impact how leases are treated for federal income tax purposes. Leases will either be treated as a true tax lease or a non-tax lease. Under a true tax lease, the lessor maintains ownership of the asset and the related deductions such as depreciation, while the lessee would deduct rental payments.
How will the new lease accounting standard affect the relevance of lease asset accounting? ›
Under the new lease accounting standards, all leases must be recognized as both an asset and offsetting liability for future lease payments. One key to knowing that you have a lease rather than another type of contract is whether you have the right to control or use an asset, also called the right-of-use, or ROU Asset.
How does ASC 842 affect EBITDA? ›
ASC 842's Impact on EBITDA
The net result will be a slightly lower current ratio (the value of current assets divided by current liabilities). Other ratios affected would include the debt to net worth ratio, funded debt to EBITDA, and debt service coverage.
