Common challenges with IFRS 16 and why using Excel is NOT the answer

What does the standard say?

The objective of IFRS 16 is to report information that (a) faithfully represents lease transactions and (b) provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. To meet that objective, a lessee should recognise assets and liabilities arising from a lease.

IFRS 16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.

A lessee measures right-of-use assets similarly to other non-financial assets (such as property, plant and equipment) and lease liabilities similarly to other financial liabilities. As a consequence, a lessee recognises depreciation of the right-of-use asset and interest on the lease liability. The depreciation would usually be on a straight-line basis. In the statement of cash flows, a lessee separates the total amount of cash paid into principal (presented within financing activities) and interest (presented within either operating or financing activities) in accordance with IAS 7.

Assets and liabilities arising from a lease are initially measured on a present value basis. The measurement includes non-cancellable lease payments (including inflation-linked payments), and also includes payments to be made in optional periods if the lessee is reasonably certain to exercise an option to extend the lease, or not to exercise an option to terminate the lease. The initial lease asset equals the lease liability in most cases.

The lease asset is the right to use the underlying asset and is presented in the statement of financial position either as part of property, plant and equipment or as its own line item.

Adoption of the standard and common challenges

A considerable amount of work is required by organisations in becoming compliant, which from our considerable project experience is often underestimated.

The data collection and validation can be particularly challenging for companies with leases spread across various geographies.

The following summarises some of the key areas in which organisations face considerable challenges, in the adoption of IFRS16:

Preparation and collection of data

Lack of historical discipline

No central repository, many leases in many different places

Property, fleet, office equipment held in multiple systems

Missing data points

Calculations:

Complex nature with a large number of variables & inputs

Modelling/stress testing

Requires flexibility & subjective assessment

Audit trail required for generated journals

Multiple ERPs and COAs

New Reporting Requirements

Entity vs group reporting

Financial & operational

Multi-currency

Auditor Requirements

Frozen GAAP (IAS 17) for debt covenants

On-going data management and process

Whereas some organisations have already completed implementation projects, there are many who have left it too late or fallen behind with manual workarounds or interim solutions prevalent.

The integration of processes around IFRS16 can also be particularly challenging, in many cases IFRS16 acting a sub-ledger, the output of complex calculations needing smooth integration with organisation’s ledgers as part of a regular month close and working day timetable.

Updating leases for periodic modifications, changing of options such as renewals or terminations and capturing new leases all now form part of a periodic process, requiring a controlled and central environment for users to be able to work in.

Updating assumptions that feed into the IFRS16 calculations such as interest rates, FX rates and indexation tables can also particularly difficult to manage without a systemic solution to allow for a central repository, or administration.

In summary, implementation of a solution needs to take care of the future business as usual (BAU) state, as well as the initial transition disclosure and reporting requirements. A controlled and effective process that allows accurate management of the data required for IFRS16 compliance is mandatory to future success.

Using Excel does not solve the problem

Excel is not the correct strategic solution to the IFRS16 challenge, here are some of the key reasons why:

Calculations are incredibly complex, requiring a huge emphasis on testing for human error and robustness across a number of different scenarios.

A single, accessible and scalable repository is compulsory to data integrity. Managing in an excel spreadsheet becomes error prone and inflexible.

Managing changes to leases such as renewals or termination options above becomes incredibly difficult in terms of both calculation and audit trail.

The high volume of leases and associated attributes required for both calculation and reporting purposes is incredibly difficult, if not impossible, to manage manually.

A systemic solution is far easier to audit to ensure compliance, allowing greater transparency and automated categorisation of leases, such as exemptions.

Finance teams can avoid time consuming, manual and repetitive exercises by using a purpose built technical IFRS16 model.

Any changes to, and maintenance of, assumptions can be centrally managed and controlled using simple processes, not cumbersome and time consuming manual tasks.

Financial reporting is inflexible, difficult to provide comparatives and audit reports difficult to provide.

Excel is harder to integrate in terms of on-going process such as an automated feed to ledger systems or consolidation system adjustments.

How can VantagePoint help?

VantagePoint consultants have extensive experience in leading, managing and delivering over 25 IFRS16 system implementations, across a number of FTSE100 companies, within various industry verticals and geographies.

We understand the complex nature of the data, the common challenges of project implementations and how best to overcome these, along with the standard reporting outputs which have been required across multiple projects.

Please get in touch to speak with our team to help us understand how we can help you achieve your goal of IFRS16 compliance in terms of both data and process.