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Since April 2019, due to the introduction of IFRS 16 / Ind AS 116 – Leases, there has been a significant change in the way leases are accounted for, especially by the lessees. As per the earlier leasing standard, lessees were required to account for lease transactions as operating or finance lease depending on the rules and tests of classification. As per the new leasing standard, this classification is done away with, and lessees are now required to recognise nearly all leases (except short-term and low value leases) on the Balance Sheet which will reflect their Right-to-use an asset for a period of time and the associated lease liability for rent payments.

The accounting of operating leases as per the earlier standard was relatively straightforward, which required lessees to recognise lease payments as operating lease expense on a straight-line basis over the lease term.

However, as per the new standard, Right-to-use’ an asset / Right of use asset (ROU Asset) and lease liability is recognised on lease commencement date. Subsequently, expense is recognised in the form of finance charge on lease liability and depreciation on ROU Asset.

This change requires lessees to:

• • Recognise ROU asset for the right to use the asset he obtains by virtue of a lease contract from a lessor. Lessee measures ROU asset based on calculation of lease liability. In addition to the value of lease liability, ROU asset may include pre-payments related to lease, transaction costs etc.,
  • Recognise corresponding lease liability at the present value for an amount payable to lessor over the lease term in future,
  • depreciate ROU Asset on a straight-line basis over the lease tenure/ asset useful life, whichever is lower,
  • subsequently measure the lease liability by charging finance cost and reduce it to the extent of rent payment,
  • re-measure the carrying value of lease liability due to modification in lease contract and provide the effect of such re-measurement on a prospective basis,
  • Adjust ROU Asset based on re-measurement of lease liability, and
  • Calculate impact of profit or loss in case of decrease on scope of contract or termination of lease contract.

Hence, it is imperative for lessee to maintain and update the lease calculations under IFRS 16 / Ind AS 116 to ascertain carrying values of lease liability and ROU Asset at the end of every reporting period and calculate finance charge and depreciation charge for every reporting period for the purpose of lease accounting.

These calculations generally require using a spreadsheet and if the lessee entity has more than a handful of leases, then creating, maintaining, and updating the lease calculations using spreadsheet poses significant challenges like:

1. 1. Risk of incorrect formulae
   2. Difficulty in handling complex re-measurement, modification, and termination calculations
   3. User specific spreadsheet resulting in dependency on a specific person
   4. Lack of maker – checker concept

This blog aims to discuss these challenges which all the lessee entities should be aware of and be prepared to address them whenever they arise, to ensure accuracy of lease calculations and disclosures as per IFRS 16 / Ind AS 116 – Leases.

Significant challenges posed by lease calculations using spreadsheets

1. Risk of incorrect formulae

It is a known fact that spreadsheets are prone to manual formula errors which include but are not limited to:

• • Incorrectly typed formulas, incorrect cell references, circular references.
  • Copying formulas incorrectly which includes not adjusting cell references when copying formulas to different locations.
  • Pasting values – which means pasting data without formulas and losing the dynamic nature of calculations and thereby losing the trail.
  • Mishandling date formats, leading to incorrect calculations or sorting.
  • Hidden Rows and Columns – Forgetting that hidden rows/columns affect calculations and graphs.
  • Performance Issues – Complex calculations on large data sets can slow down the spreadsheet or even cause crashes.
  • Complex Formulae are harder to understand and prone to errors.
  • Lack of Documentation – Failing to add comments to explain formulas and calculations for future reference.
  • Version Control – Managing multiple versions of a spreadsheet can lead to confusion and using outdated data.

2. Difficulty in handling complex re-measurement, modification, and termination calculations

Despite all the limitations with spreadsheet, the entity might decide to invest significant amount of time and efforts for preparation of a template to generate lease calculations required under IFRS 16 / Ind AS 116 – Leases. However, entities need to note that lease calculation is not a onetime activity.

Such spreadsheet template would only handle the calculations required at the inception of the lease contract. However, if the terms of the contract change during the lease tenure or if entity decides to foreclose the contract, it might result into re-measurement / modification / termination of the lease contract.

This requires re-measuring the existing carrying value of lease liability with corresponding adjustment in carrying value of the ROU Asset and calculating the revised finance and depreciation charge for the remaining lease tenure on a prospective basis.
Termination requires de-recognition of lease liability, ROU Asset and calculation of gain / loss on termination which is to be accounted for in Statement of Profit and Loss.

Building a template in spreadsheet to handle such complex scenarios and maintaining it perpetually may be challenging if the entity has more than handful of lease contracts which undergo modification in the contract terms.

3. User specific spreadsheet resulting in dependency on a specific person

The lease calculation template can be built in a spreadsheet with formulae, various links within worksheets and fields for entering lease details. However, such spreadsheet would always be user specific. The person who builds the template in spreadsheet would have all the knowledge about the formulae, links, etc., however, in absence of this person, it would be difficult for any other person to enter or update the lease details in spreadsheet and get accurate results from it given the complex nature of calculations.

Further, in absence of detailed handover, the new person might make inputs in the spreadsheet in a way the template is not designed to accept and get inaccurate results from spreadsheet.

Hence, such person specific dependency may result in delay in getting desired results and hamper overall productivity.

4. Lack of maker – checker concept

Spreadsheets lack the maker-checker concept which involves one person preparing the template, entering inputs, applying formulae and another person reviewing and approving it.

In absence of such review mechanism, the user inputs and formulae based calculations in the template might go unreviewed and manual errors which might exist in the spreadsheet may go unnoticed. Further, it is practically not feasible to review each cell in the spreadsheet to ensure accuracy of the formula.

Conclusion

IFRS 16 / Ind AS 116 – Leases requires complex calculations to derive the carrying values of lease liability, ROU Asset, finance charge on lease liability and the depreciation of ROU Asset and it could possibly be argued that spreadsheet is the most economical tool for these calculations.

However, before making this decision, entities must weigh in the costs and risks arising due to the above mentioned challenges in lease calculations using the spreadsheets and the legal and financial impact it could have on the entities if the lease information in the financial statements is misstated due to inherent limitations of such spreadsheets.

About LeazeOn

LeazeOn is an end-to-end lease accounting, reporting and management software for IFRS 16 and Ind AS 116 Leases compliance requirements. It provides automated solution for transition accounting, handling large volumes of leasing contracts, reporting and disclosure requirements. For more information, you can get in touch with us at [email protected] / www.leazeon.com.

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Introduction

Modern business environment is becoming increasingly complex. To succeed in these circumstances, the firms aim at growth with stability. Internal and external sources of finance are insufficient to cater the needs of expansion, diversification and modernisation. Leasing is an important and widely used financing solution. It enables entities to access and use property and equipment without incurring large cash flows at the inception. It enables lessees to address the issue of obsolescence and residual value risk.

Existing accounting standard for leases ‘IAS 17 – Leases’ provides principles resulting in all or nothing being recognised in balance sheet for economically similar lease transactions. The absence of information about leases on the balance sheet meant that investors and analysts did not have a complete picture of the financial position of an entity. It was difficult to appropriately compare entities that borrow funds to buy assets with those that lease assets. Off-balance sheet lease financing numbers were substantial.

The IASB issued ‘IFRS 16 – Leases’ in January 2016. IFRS 16 will significantly improve the transparency of information about those off-balance sheet leases. Recognition model for leases has undertaken a drastic shift as compared to the previous standard.

IFRS 16 – What do we need to know?

IFRS 16 requires lessees to recognise most leases on their balance sheets. The new standard is a significant change in approach from current standard and will affect many entities across various industries.

• • Lessees will have a single accounting model for all leases, with two exemptions (low value assets and short-term leases).
  • Lessor accounting is substantially unchanged.
  • There will be additional disclosure requirements.

Impact on financial statements of lessees is illustrated as below:

Change is balance sheet position

Change in income statement

IFRS 16 – Key impacts

The effects of IFRS 16 will need to be assessed on the facts and circumstances relevant to each entity. This will further be impacted by the different capital structures that entities have adopted, for example an entity that typically rents office premises, which is being accounted for as an operating lease, will be more significantly impacted than an entity that has purchased office premises. The financial statements of an entity shall be impacted in the following manner on an overall basis:

Along with impact on financial statements of the lessee, various other areas are likely to be impacted such as renegotiation of lease contracts, ascertainment of debt covenants, performance-based remuneration terms, dividend policy of the entity etc.

IFRS 16 – Industry-wise impact

Oil and gas industry

Upstream oil and gas companies may have significant impact of the new standard because various aspects such as transportation contracts, drilling rigs, compressors, tanks and other equipment, as well as rentals of vehicles, office space and office furniture, depending on the terms of the agreement and the nature of the assets.

Such entities enter into various contracts in respect of land, building, heavy equipment that qualify as arrangement containing a lease (previous IFRIC 4). In order to comply with the requirements of the new standard, careful consideration is required in case of such contracts.

Real estate / equipment leasing industry

The real estate and equipment lessor industry may not be significantly affected in their accounting as lessors. However, they may be impacted in their business model due to change in lessees’ behaviour. An entity may require its departments to evaluate the current portfolio of leases and prospective targets to identify tenants that may seek to alter their leasing strategies as a result of IFRS 16.

Lessees changing behaviours may result in requests for shorter lease terms and more variable lease payments which increases the risk for lessors. This puts a pressure on pricing of leasing transactions. Real estate and equipment lessor companies may find it challenging to ask for higher lease rates in the current regulatory changing environment. This could increase the cash flow volatility and risk. In turn this could impact lessors’ own ability to obtain favourable financing for their own investments.

Airline industry

Financing aircraft through off balance sheet lease models has been a well-established practice in the airlines industry for decades. In addition, airlines normally rent the essential airport facilities from respective airport owners. Entities in this industry use leases of aircrafts in their revenue generating activities. Additionally, entities often lease assets combined with other services (e.g., maintenance, insurance, etc.). Lessors provide bundled products and lessees will need unbundled lease information to account for leases separate from service elements.

Retail industry

The retail industry is likely to be one of the most affected by the new standard, given the significant use of rented premises for their stores. Most of such leases are in the form of medium-term leases (generally 3-5/9 years), whether in premium locations (flagship stores), shopping centres or ordinary outlets. Such leases typically offer renewal options, and often involve variable rentals. This variability is commonly due to inflation adjustments and contingent rentals in some locations where the property owner has a vested interest in the performance of the business (e.g. airports, and shop-in-shop arrangements). Historically such leases have been considered as operating leases, and therefore didn’t have any impact on the balance sheet.

There might be arrangements where the right of use of the asset is not so well defined and the entity might not have the full economic benefit of the asset. Careful analysis of the terms of these arrangements should be made, especially in situations where the space allocated to the entity is not clearly defined, and/or the store owner has the right to substitute the available space having a significant impact on the customer’s economic returns. Such arrangements might not meet the definition of a lease, and instead be considered as a service.

Telecommunication industry

Telecommunications entities are expected to be significantly impacted by the new lease requirements. Careful consideration would need to be given to the new definition of a lease to identify arrangements that contain a lease (previously IFRIC 4). Telecommunications will need to consider leases of network equipment, tower arrangements, signal transmission devices as well as data and fixed line agreements and fibre optic cables. Some of these entities have extensive retail outlets, which will require further consideration. The prime consideration lies in determining whether their leases provide control over a physically distinct portion of an asset or provided capacity.

In addition, telecommunication entities will need to analyse contracts where equipment is provided to their customers. In such instances, consideration would need to be given to whether the contract contains a lease and if so, how the lease payments should be allocated to products and services provided.

Banking, insurance and other financial services industry

Banking and other financial services entities that have extensive branch networks as well as large administration and call centres will need to consider any lease arrangements carefully. In addition, contracts over ATMs and the related space occupied by such machines will need to be assessed under the new lease standard’s requirements. Financial services entities may also make use of data storage facilities and these arrangements with providers could potentially fall within the scope of IFRS 16. Financial service entities will need to monitor how right-of-use assets will be treated for regulatory capital requirements.

The material and the information contained herein prepared by LeazeOn Private Limited is intended to provide general information on a subject or subjects and is not an exhaustive treatment of such subject(s). The material contains information from third party sites (external sites). LeazeOn Private Limited is not responsible for any loss whatsoever caused due to reliance placed on information sourced from such external sites. LeazeOn Private Limited is not rendering professional advice or services by means of this material. The information is not intended to be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision or taking any action that might affect your personal finances or business, you should consult a qualified professional adviser.

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