Companies applying the new standard on lease accounting need to provide more information on its effects, according to a new review by the U.K. Financial Reporting Council (FRC) of interim disclosures in the first year of application.
The FRC has reviewed the interim reports of 20 companies applying International Financial Reporting Standard 16 (IFRS), “Leases,” for the first time and found a number of areas where disclosures could be improved.
IFRS 16 took effect on Jan. 1, 2019. Previously unrecognized “operating leases” are now recognized on the balance sheet as lease liabilities and right of use assets. Depreciation of right of use assets and interest expense on lease liabilities replace operating lease expenses in the income statement. While the profit before tax impact may be limited, this can have a significant effect on levels of operating profit and finance expenses, the FRC noted in its report.
Companies in sectors that typically had a high number of operating leases will see a significant increase in assets and liabilities on applying IFRS 16. High-quality disclosures will be required in order to understand these changes.
“While we are mindful that the interim disclosure requirements are less extensive than those for full-year accounts, we felt that some companies did not sufficiently explain the impact of adopting IFRS16,” the FRC said in its review. “We have highlighted in this report where we expect companies to provide more comprehensive disclosure in their upcoming annual reports.”
As required by the IFRS, companies are expected to provide more information in their annual reports and accounts to help stakeholders better understand the effect of the new standard. In its review, the FRC pointed out several areas where it expects companies to provide more comprehensive disclosure in their upcoming annual reports, including:
- Information about key accounting judgments made—for example on the identification of lease, or on assessing their length;
- Clearer explanations of the specific transition choices made;
- A detailed reconciliation between the operating lease commitment under the previous standard and the new lease liability, with clear explanations for reconciling items; and
- Where companies use alternative performance measures to help users of the accounts to understand the effect, these measures should be properly labeled, reconciled, and explained and not give more prominence than the IFRS measures.
“The best disclosures were those that were specific to the company, and that provided additional details of the impact of IFRS 16,” the FRC said. The FRC also cited in its report several examples of good disclosures.
“We encourage companies to carefully consider the findings of this review when determining the extent of disclosures included within their next annual reports,” the FRC said. “Companies should aim to ensure not only that mandatory disclosure requirements have been met, but that they have addressed the disclosure objective of the standard. Starting with this objective will go a long way to ensuring that readers understand the impact of IFRS 16 on the company. We hope companies find this thematic review useful.”