After a decade of deliberation the IFRS 16 lease accounting standard is set to hit local authorities. Stephen Sheen writes the change means a substantial piece of work for finance departments. But there are benfits.
Many of the fresher-faced amongst us will be unable to remember a time when big changes to lease accounting were not just over the horizon. Almost 10 years after the International Accounting Standards Board first started its deliberations on how to shine a brighter light on lease transactions, CIPFA/LASAAC has been able to issue its detailed proposals for adopting IFRS 16 leases into the Local Authority Accounting Code.
Room151’s Annual Conference – September 20th, 2018, London Stock Exchange
Local Authority Treasurers’ Investment Forum and FDs’ Summit
A formal consultation is open until 7 September, the relevant documents being available here.
The proposals largely confirm what was trailered in early consultation last year:
- The distinction between operating leases and finance leases is to be removed for lessees. All leased property and equipment will now be brought onto the balance sheet as a right-of-use asset, reflecting the benefits the lessee has acquired for the lease term, together with a liability for the cost of that asset …
- … except for leases with a term of less than 12 months and leases for low value items.
It is only just over five years since the last significant change in lease accounting, when we shifted from UK GAAP to IFRS and the definition of a finance lease changed. A similar breadth of work will be required this time round:
- Cataloguing contracts authorities have entered into that are leases, or might need to be treated as if they were.
- Analysing what rights local authorities have secured under the contracts and how much they will pay for them.
- Detailing the accounting treatment for the right-of-use asset, the liability and the rentals that will be paid.
However, the depth of the work is likely to be more substantial. For the IFRS transition, there were a limited number of operating leases at marginal risk of having to be converted to finance leases (or vice versa). All operating leases will now need to be put through the accountants’ mangle.
The concession for low value items has proven somewhat confusing.
It is additional to the general consideration of materiality (which should in itself simplify much of the work required locally), and is an instruction to ignore leases of items of plant and equipment that have little value, even if the effect in aggregate of IFRS 16 accounting would have been material.
In the development of IFRS 16, a cut-off figure of $5,000 (£3,750) was mooted, but it does not feature in the final version of the standard, which restricts itself to a hint that tablets, PCs, small items of furniture and telephones are low value but cars are not. Photocopiers? CIPFA/LASAAC is not currently planning to provide any further specification for local government.
Benefits
The substantial benefit of the new rules will be that they require up-front analysis of lease rentals into payments for the right-of-use asset and financing costs, so that value for money (or lack of it) can be assessed clearly against alternative procurement methods, particularly buy and borrow. Accounting treatments will be able to guide decisions, rather than just document their outcomes.
The biggest technical issue will be that recognising a right-of-use asset for what would have been off-balance sheet operating leases will bring them within the scope of the Prudential Framework as capital transactions. The recent changes to the MRP Statutory Guidance have provided general future-proofing, so that the default position for all leases will be for revenue to be charged with the rentals payable each year.
However, potential problems remain with the possible effect of newly classified capital expenditure on the HRA capital financing requirement cap and the impact on expenditure from schools’ budgets.
Although CIPFA/LASAAC does not specifically ask for it in the consultation, it would presumably be helpful to feed back details of any similar risk areas that you might have identified.
The particular accounting niceties that CIPFA/LASAAC is consulting on include:
- The ability to capitalise initial direct costs of entering into a lease and the requirement to provide for dismantling, removal and renovation costs anticipated for the end of a lease.
- Determining interest rates implicit in leases or defaulting to an authority’s incremental borrowing rate as a basis for the necessary accounting mathematics.
- How to value right-of-use assets once they have been brought onto the Balance Sheet — current value or a cost model?
- Accounting for the implicit subsidy element of a lease where the rentals payable are less than market rates.
The consultation proposes leaving the accounting arrangements for lessors largely as they currently are, with the operating/finance duality.
However, it recognises that the draft International Public Sector Accounting Standard based on IFRS 16 proposes extending the right-of-use approach to lessors. CIPFA/LASAAC is asking whether there is any support for a common unitary model for lessees and lessors in local government.
The new accounting requirements are to be introduced with effect from 1 April 2019. The Balance Sheet will be restated as at that date in the 2019/20 Statement of Accounts, adjusted to what balances would have been if the new rules had always been applied.
Some practical expedients are proposed where this restatement might be problematic, such as setting up right-of-use assets for ex-operating leases valued as the lease liability outstanding at 1 April 2019.
Or, perhaps, some later date. There is a final question in the consultation that asks whether we agree with the proposed effective date for implementation. And there is also a “readiness assessment questionnaire that CIPFA/LASAAC asks authorities kindly to complete.
It would appear that CIPFA/LASAAC are more interested in a successful implementation than a prompt one, so we might yet make it into that second decade of preparations.
Stephen Sheen is the managing director of Ichabod’s Industries, a consultancy providing technical accounting support to local government.
