Introduction to Accounting for Lease (IFRS 16): Nigeria and The UK

INTRODUCTION TO ACCOUNTING FOR LEASE (IFRS 16): NIGERIA AND THE UK

IFRS 16 was issued in January 2016 by the IASB (International Accounting Standards Board) with an effective date of 1 January 2019. IFRS 16 relates to accounting for leases. IFRS 16 changes the accounting significantly for lesses. International Accounting Standard (IAS) 17 was replaced by IFRS 16. IAS 17 took the approach of identifying two different types of leases. Leases that transmit essentially all the risks and rewards of ownership of an asset were categorized as finance leases. Operating leases were assigned to all other leases. There was a clear incentive for those who prepared the lessee's financial statements to "argue" that leases should be classified as operating leases rather than finance leases in order to remove leased assets and liabilities from the statement of financial position because the lease classification outlined in IAS 17 was subjective.

The International Financial Reporting Standard (IFRS) 16 addresses lease accounting. The new standard, which replaces the previous one, IAS 17, offers a single accounting model for all leases, including operating leases, which weren't previously shown on the balance sheet. This standard makes sure that all leases are recorded on the balance sheet in an effort to increase transparency in financial reporting. A thorough review of IFRS 16 will be giving in this article, covering its main provisions, implementation issues, and effects on financial reporting.

The new standard eliminates the distinction between operating and finance leases and recognizes a right-of-use asset and lease liability for all leases. Lessees should initially recognize a right-of-use asset and lease liability based on the discounted payments required under the lease, taking into account the lease term as determined under the new standard. Lessor accounting does not change and lessors continue to reflect the underlying asset subject to the lease arrangement on the balance sheet. The key elements of the new standard and the effect on financial statements are as follows: a ‘right-of-use’ model replaces the ‘risks and rewards’ model, lessees are required to recognize an asset and liability at the inception of a lease, all lease liabilities are to be measured with reference to an estimate of the lease term, contingent rentals or variable lease payments will need to be included in the measurement of lease assets and liabilities, and lessees should reassess variable lease payments that depend on an index or a rate when the lessee remeasures the lease liability.

Except for leases with a period of 12 months or less and leases of low-value assets, lessees are required by IFRS 16 to recognize all leases in their balance sheet. Except for those limitations, lessees are required to record a right-of-use asset and a lease liability for all leases. The lease liability represents the lessee's duty to make lease payments, while the right-of-use asset represents the lessee's ability to utilize the leased asset.

The Nigerian Federal Executive Council on 28 July 2010 approved 1 January 2012 as the effective date for convergence of accounting standards in Nigeria with IFRS. After IFRS was accepted in 2012, IFRS 16 became effective on January 1st, 2019. Therefore, IFRS 16 requirements were required to be followed by Nigerian businesses who generate their financial statements in line with IFRS when accounting for leases. Similarly, the Financial Reporting Council (FRC) is in charge of establishing accounting standards in the UK. In line with the EU's acceptance of the standard, the UK adopted IFRS in 2005, and IFRS 16 went into effect on January 1 of 2019. Because of this, UK businesses who compile their financial statements in accordance with IFRS are required to account for leases in accordance with IFRS 16's requirements.

For many businesses, especially those with sizable lease portfolios, the implementation of IFRS 16 has presented substantial hurdles. The biggest difficulty is figuring out the lease term, which is needed to figure out the asset for right-of-use and lease obligation. The non-cancellable portion of the lease as well as any time frames covered by an option to renew or terminate the lease are included in the lease term, providing the lessee is reasonably certain to exercise the option.

Determining the discount rate that will be used to compute the present value of lease payments presents another difficulty. The implicit interest rate contained in the lease, if it can be easily established, or the lessee's additional borrowing rate, should be reflected in the discount rate. The incremental borrowing rate is the cost the lessee would incur if they had to borrow money to buy an asset with a comparable market value to the one they are leasing.

Financial reporting, especially the balance sheet and the income statement, is significantly impacted by IFRS 16. Lessees will perceive a rise in their total assets and liabilities by accounting for right-of-use assets and lease liabilities. Important financial measures like the debt-to-equity ratio and return on assets may be impacted by this shift in reporting.

The recording of depreciation and interest expenditures will take the place of leasing expenses on the income statement. EBITDA (earnings before interest, taxes, depreciation, and amortization) and net income may be impacted by this move.

The way businesses account for leases has changed significantly as a result of IFRS 16. It offers a single accounting model for all leases, enhancing financial reporting transparency. The benefits of greater transparency and comparability in financial reporting outweigh the difficulties that many businesses faced in implementing IFRS 16. Businesses need to make sure they have reliable systems and procedures in place in order to adhere to the standard and offer accurate financial reporting.

Even though IFRS 16 is widely acknowledged, there could be variations in how the standard is applied in various countries. Because of this, businesses that operate internationally may need to adjust their lease accounting procedures to accommodate for any local changes or interpretations of the standard.

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