Banking News

Equipment finance accounting standards readiness tested - KPMG

(22 January 2019 – Singapore) A mere three percent of corporates globally were ready for new IFRS lease accounting standards as close as three months out from the effective date of 1 January 2019 according to a recently released KPMG report “Lease accounting is here: are you ready?”

The report is based on a survey of 800 enterprises worldwide and is significant given the leasing standards change affects one in two of the world’s largest and most valuable corporates, particularly those in the airline, retail and travel and leisure sectors. The changes are set to shift more than US$2 trillion onto company balance sheets for the first time. The new standard is set to provide transparency on leased assets and liabilities, effectively improving the ability to compare between businesses that lease and those that borrow to buy, addressing off-balance sheet opaqueness. KPMG’s research revealed that 41 percent report under IFRS, 48 percent under US GAAP, and 11 percent under other reporting frameworks. The companies were surveyed in Q3 2018. Two thirds of respondents (67 percent) admitted that they were not on track with their lease accounting projects due to challenges facing them and only 16 firms outright had developed their system requirements. Just over one in ten had designed their software solution (13 percent).

The top four challenges that companies were facing, according to KPMG's research, included:

• Identifying embedded leases such as those within larger service or supply contracts
• Establishing an appropriate incremental borrowing rate (IBR)
• Abstracting and entering leases into a leasing system
• Integrating a lease accounting system into the existing system environment

The primary aim of IFRS 16 is that all leases should be reported on balance sheet, although there are exceptions for small items (for example under US$5,000) and for leases with a term of 12 months or less. Under IFRS 16, a lessee is required to recognise an asset for the right to use the leased item and a liability for the present value of its future lease payments. IFRS 16 requires lessors to classify a lease as either an "operating lease" or a "financing lease". The lessor recognises revenue under a financing lease as essentially interest payments on the amount financed. The lessor recognises income under an operating lease on a systematic basis, consistent with the benefits derived from the leased assets, which may be a straight-line basis. Some research shows that the average company will be required to absorb a 13 percent increase in EBITDA and a 22 percent increase in interest-bearing debt arising from implementation of IFRS16. For other sectors, such as retail, the expected increase is even more significant, rising by 41 percent to as high as 98 percent.

KPMG stated that 62 percent of organisations found their expected total cost has increased. For one in four companies the total cost is expected to be higher than US$500,000. Companies in Asia Pacific were generally further behind those in the Americas and EMEA. Many companies in the region will have extra time as non-calendar/financial year year ends, such as 30 June, are more common, particularly in Australia. Only 22 percent of businesses in the region said they are in the process of implementing a new lease accounting system, compared to 42 percent of businesses in the Americas and EMEA. Even in the Americas and EMEA, a surprising proportion of firms are taking a spreadsheet approach at 29 percent and 27 percent respectively.

“With systems implementation alone likely to take four to six months, it’s clear that a significant proportion of companies will not yet have completed their work and so will now be relying on temporary fixes – often manual, involving the use of spreadsheets to collate data,” stated Markus Kreher, Global Head of Accounting Advisory Services at KPMG. “It doesn’t come as a surprise given the scale and complexity of the task to comply with the new standards. To some extent, we saw a similar picture with the standards on revenue recognition and financial instruments that came into effect a year ago. The priority now is to ensure that, where workarounds are being used, they are robust and that there is a clear path to reach the end-state solution as soon as possible.”