‘No major dramas’ ahead of lease accounting changes

Major leasing companies are reporting that clients are prepared for the new lease accounting standard which takes effect from January 1, 2019.

The International Financial Reporting Standard (IFRS) 16, which supersedes the current lease accounting standard, International Accounting Standard (IAS) 17, will mean leased assets (including vehicles on operating leases) will be brought on to companies’ balance sheets.

Keeping vehicles off-balance sheet helps to keep the debt-to-equity ratio low.

The rules are being introduced by the International Accounting Standards Board (IASB) with the aim of giving a more complete picture of a company’s financial position.

They apply only to companies that report under IASB such as those listed on the stock exchange.

It was thought that businesses reporting under the UK's Generally Accepted Principles (GAAP) may eventually be affected too, but this is now unlikely to happen in the short to medium term, according to Julian Rose, an adviser on lease accounting to Leaseurope and founder of Asset Finance Policy.

He says: "As IFRS 16 affects companies that are publicly listed and companies that report under IASB it is fairly limited in scope.

“It was thought the IFRS 16 rules could be incorporated into the UK’s GAAP but this has widely been rejected by the market following consultation, there was an overwhelming rejection of the idea. It’s possible elements could make their way into GAAP in the future, but I would imagine that would be many years away.”

Publicly listed companies already have to make a note in their annual reports, which reflects any operating lease rentals payable.

What will the impact be?

The BVRLA has maintained that bringing leased items onto a firm’s balance sheet will not erode the commercial benefits of leasing.

Gerry Keaney, BVRLA chief executive, says: “Vehicle leasing continues to grow in popularity and this has very little to do with any balance sheet advantages.

“Its main value comes elsewhere, sheltering companies from the risk of fluctuating vehicle values, providing them with extra flexibility and purchasing power and freeing-up precious working capital that would otherwise have been spent buying an asset.”

Paul Nash, head of the asset finance and leasing group at PwC, agrees with the BVRLA’s assessment that the lease accounting changes are not going to have a detrimental impact on the popularity of contract hire.

He says: “The options for companies are that they switch to shorter contracts and it’s really not worth the additional costs you would incur by doing that. I expect the industry as a whole really to just continue as it was.”

It could be argued that if not much is changing, isn’t this all just an increase in red-tape for minimal improvements? However, Nash believes there are benefits from IFRS 16.

He says: “I would argue that having a clearer view of a company’s financial commitments is going to be beneficial.

“Accounts departments will be able to get a much clearer picture of spend on things like operating leases that will improve on what at the moment are very broad estimates on that kind of thing.”

More expensive to switch to rolling 12-month contracts

Some rental companies had predicted that the lease accounting changes would see customers looking to switch to rolling 12-month contracts to as a way for fleets to avoid new lease accounting rules.

All rentals under 12 months can be kept off-balance sheet if the treatment of the asset is uniform across all vehicles of a similar type.

However, Alphabet’s Clive Buhagiar says no customers have asked for this in the run up the changes.

He says: “Alphabet can provide rental too and none of our customers are switching to that as a result of the lease account rules.

“I think this is because contract hire benefits are still strong, particularly for the larger fleets that are outsourcing the management solution anyway. They just want their fleet to be taken care of and contract hire is just simple, easy to manage and convenient.”

Buhagiar says it would be more expensive for fleets to switch to a rolling sub-12 months rental.

Preparing fleet customers for the changes

Around 5-10% of Alphabet’s customer base will be affected by the accounting rule changes.

Buhagiar says: “There really is a mix between PLCs and international companies, but the percentage is relatively low because we also have a big proportion of SMEs and corporates that won’t be affected by this.”

Lex Autolease has a higher proportion of big fleet customers so it will see around 25% of its total fleet affected by the new lease accounting rules.

Ashley Barnett, head of consultancy at Lex Autolease, says: “We have held a number of seminars for our customers to highlight the potential impact of the new standard and the actions required to manage its implementation.

“This has involved providing an overview of the management information available to assist lessees.”

This has included developing a new web portal for Lex customers for the calculation of Right of Use (ROU) asset and lease liability.

Barnett says: “We have invested in sophisticated functionality to give lessees all the data they need via the portal, without them having to manually adjust to reflect ROU asset changes.

“Training customer-facing colleagues within Lex Autolease has also been a priority, to ensure they have a solid understanding of the new standard’s implications and can guide their customers through the transition.”

Alphabet has had a working project group working on a solutions for the lease accounting rule changes since 2016. This has been to get ahead of the changes for customers but also to make sure it has one solution it can implement internationally that is transferable between different markets.

Buhagiar says: “We’ve communicated really closely with staff on the changes and with customers consistently since 2016. It’s had to be constant though as you can’t mention it in 2016 and think people are going to remember.

He added: “We’ve worked with customers to create a reporting suite that works for those in a finance controller capacity, or for a fleet manager.”

Managers can set up lease accounting reports to notify them monthly, quarterly or at any point they need.

Buhagiar adds: “Organisations that are affected are well prepared. There’s been no major dramas about this.”