IFRS 16 Leases, the new international accounting standard, will come into effect from 1 January 2019. This will have a substantial impact on fleet management companies and their clients.
The essence of the changes lies in the accounting treatment applied by lessees as most leases will come on balance sheet. Until now, the costs pertaining to leased vehicles are not reflected in the balance sheet of the lessee of a fleet management solution. In the future all leases will have to be reflected on the balance sheet, with the exception of short term leases (less than 12 months) or low value leases.
“There are a number of considerations to take into account for the lessee of a fleet” said Murray Price, managing director of Eqstra Fleet Management, who hosted a presentation by Deloitte on the new standard. “These include the impact on the company’s financial report, key ratios, disclosures, the cost of implementation, the ability to access desired information, the impact of covenants and debt renegotiations and leasing strategies. It is essential that these companies start discussions with their bankers, analysts and fleet management companies now,” he added.
The main changes required by the new standards include the accounting treatment for lessees in a lease (where most leases will be brought on balance sheet as finance leases), the definition of a lease and enhanced disclosures.
Under the new standards, a contract contains a lease if it depends on the use of an identified asset and if it conveys the right to control the use of such an asset. Further, the customer must enjoy substantially all of the economic benefits from the use of the asset during the lease term. In determining whether a customer has the right to control an asset, the customer must be able to determine how and for what purpose the asset is used.
A further consideration lies in substantive substitution rights. In this instance, if the supplier has the practical ability to substitute alternative assets, and the supplier benefits economically from this right, the contract would no longer be considered a lease.
Many fleet management contracts today include both a lease and service component. Under the new standard these should be accounted for a separate components with the lease element capitalized to the on balance sheet lease, while the service component is expensed as incurred. Lessees may, however, elect to not separate non-lease components from lease components by class of asset.
“Identifying a lease will sometimes require a significant amount of judgment based on the elements of the definition of a lease” said Trevor Derwin, A&A Partner in the Johannesburg Deloitte office. “It is also important to determine the lease term, ie whether it is reasonably certain that an extension or termination option will be exercised. In addition, identifying the appropriate rate to discount the lease payments will require significant consultation.”
“The changes will impact finance and tax, information systems, business unit leaders, strategy and procurement managers, internal audit, legal advisors, and human resources” he added. “It is essential companies start investigating their options early to ensure they are ready to comply with the new requirements and to minimise the costs relating to these changes.”