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Article:

Methods and Options to Adopting IFRS 16

10 December 2019

Background

For year-ends 31 December 2019 and onwards, the long awaited new accounting standard regarding leases (NZ IFRS 16 Leases) comes into effect.

NZ IFRS 16 is a unique accounting standard in that it has multiple options available as to how it can be initially adopted by an entity.

The nature and scope of work to be undertaken to adopt NZ IFRS 16 will in part be a direct result of which adoption option(s) and entity ultimately elects.

This Cheat Sheet has been produced as a high-level overview of the adoption options that exist, together with the benefits and shortfalls thereof.

 

Need assistance with your adoption of NZ IFRS 16?

BDO IFRS Advisory is a dedicated service line available to assist entities in adopting NZ IFRS 16. Further details are provided on the following page for your information.

 

What is covered in the Cheat Sheet

In order to navigate through this area of NZ IFRS 16, this Cheat Sheet is broken down into the following sections:

  1. Before you start… consider your group reporting requirements
  2. The three methods of adopting NZ IFRS 16
  3. Additional adoption options available
  4. Concluding thoughts

 

Before you start… consider your group reporting requirements

Entities within a consolidated reporting group need to be applying the same accounting treatment… including the way in which NZ IFRS 16 is initially adopted (i.e. use of exactly the same adoption options).

Therefore, if your entity is not the Parent of the consolidated reporting group, decisions regarding which adoption methods and options to be used may not necessarily be yours to make.

In these situations, make sure you obtain clarification and confirmation from your (ultimate) Parent entity as to on what basis they will need [NZ] IFRS 16 numbers to be provided to them.

Failure to confirm this, and then pushing ahead and adopting NZ IFRS 16 on a different basis, will require you to either (i) “unpick” and then “rework” your NZ IFRS 16 adoption accounting, and/or (ii) prepare (and then maintain on an ongoing basis) a “second book” of NZ IFRS 16 numbers solely for group reporting. 

 

The three methods of adopting NZ IFRS 16

Broadly speaking, there are three over-arching methods to adopt NZ IFRS 16.

In deciding between these, an entity will need to weigh-up (i) the need for comparative information, versus (ii) the time and cost to execute.

As we will discuss below, the nature and age of an entity’s lease population may render certain adoption methods practicably onerous (if not completely unfeasible).

 

Method 1 – Fully Retrospective Method (FRM)

HIGH TIME & COST

Key points to note

  • Requires prior year comparatives to be restated.
  • Requires NZ IFRS 16 to be applied in full, from the beginning of each and every lease.

Why might an entity want to use this method?

  • If there is an absolute need for restated prior year comparatives.

What are the drawbacks that need to be considered?

  • To apply NZ IFRS 16 in full from the beginning of each and very lease, and entity would need to:
  • Obtain historic information (e.g. discount rates, initial direct costs etc.)
  • Make management judgements without the use of hindsight (e.g. use or non-use of renewal options etc.), and
  • Identify and then process adjustments relating to events that have occurred over the life of the lease such as (i) lease modifications, (ii) variable lease payments, and (iii) changes in management judgements.

 

  • As such, the FRM may be “problematic” (if not impossible) for entities with older lease populations.

 

Method 2 – Modified Retrospective Method (MRM)

MODERATE TIME & COST

Key points to note

  • Prohibits prior year comparatives to be restated.
  • Previous Finance leases are brought over unchanged.
  • For previous Operating leases:
  • Lease liability is based on remaining payments and current discount rates.
  • RoU asset calculated on a rolled forward basis, but using the current discount rate.
  • Difference between the Lease liability and RoU asset is recognised in opening Retained earnings.

 

  • Has other adoption options available to make the adoption accounting less onerous (see below).

Why might an entity want to use this method?

  • There is less of a need for restated prior year comparatives.
  • Entity wants the values upon adoption to reflect those that would be present mid-lease (i.e. a higher Lease liability compared to the RoU asset).

What are the drawbacks that need to be considered?

  • Having to calculate the RoU asset on a rolled forward basis will still require time and cost.
  • For exiting Finance leases, not being able to use the other adoption options (i.e. must be brought over at their previous carrying amounts).

 

Method 3 – “Simplified” Modified Retrospective Method (S-MRM)

LOWER TIME & COST

Key points to note

  • As above for the MRM, but with the difference (“simplification”) that:
  • The RoU asset is set equal to the Lease liability (plus/minus any prior period lease-related accruals)
  • As such, no adjustment to opening Retained earnings is needed.
  • Can be applied on lease-by-lease basis if preferred (i.e. can have certain leases on the MRM, and others on the S-MRM).

Why might an entity want to use this method?

  • There is less of a need for restated prior year comparatives.
  • Entity wants to adopt NZ IFRS 16 on a “clean slate” basis, (easier for users to understand, and lower time and cost to implement).

What are the drawbacks that need to be considered?

  • The RoU asset will “technically” be higher than it otherwise would be, leading to slightly higher amortisation expense in subsequent years.
  • Same restriction around leases previously classified as Finance leases as for MRM above.

 

Additional adoption options available

Where an entity has elected to adopt NZ IFRS 16 using either the MRM or the S-MRM, there are five additional adoption options (applicable on a lease-by-lease basis) available for leases previously classified as Operating leases to make the adoption process less onerous.

These are NOT available where an entity elects to adopt NZ IFRS 16 using the FRM, and NOT available to leases previously classified as Finance leases.

a. Portfolio discount rate option

Allows more “aggressive” grouping of leases for the purposes of applying discount rates.

Consequence of not utilising:

  • Potentially more discount rates required for adoption accounting.
b. Leases expiring within 12 months option

For leases that expire within 12 months of NZ IFRS 16 being adopted, these can continue being recognised in profit or loss rather than being brought onto balance sheet.

Consequence of not utilising:

  • Potentially more leases to be brought on balance sheet.
c. Ignore previous direct costs option

When determining the RoU asset at adoption date, an entity can disregard having to go back and identify, capitalise, and then roll-forward, any initial direct costs incurred at the start of a lease.

Consequence of not utilising:

  • Additional time and cost to adopt NZ IFRS 16.
  • The unamortised portion of these costs would be recognised in profit or loss a second time (via the RoU asset’s subsequent amortisation over the remaining lease term).
d. Simplified impairment upon adoption option

The RoU asset is required to be assessed for impairment upon adoption.

However, in the prior period an entity would have made an onerous lease assessment, which largely follows the same principles and measurement requirements.

Therefore, this option allows an entity to use its previous onerous lease assessment as its adoption date impairment assessment of its RoU assets.

Consequence of not utilising:

  • Additional time and cost to adopt NZ IFRS 16.
e. Use of hindsight option

When determining the lease-term with respect to the use or non-use of renewal and termination options, an entity can use current information it has as at adoption date (i.e. it can use hindsight with respect to facts, circumstances, and events that have already transpired).

Consequence of not utilising:

  • Historic management judgements and estimates as detailed in the FRM would need to be worked through and applied, resulting in additional time and cost to adopt NZ IFRS 16.

 

Concluding thoughts

However, entities should feel comfortable in electing to adopt NZ IFRS 16 on a basis that minimises the time and cost of adoption, without the fear of pushback from stakeholders, given:

  • The options have been included in NZ IFRS 16 for a reason, and only after balanced and robust consultation in finalising NZ IFRS 16, and
  • Many large, global, listed entities have adopted such an approach.

Also, whilst some entities might feel that because stakeholders typically require fully comparative information (and as such would demand/expected use of the FRM), bridging the “adoption explanation gap” might be better met (and on a more cost effective basis) with the required transition disclosures[1] together with any other relevant information required (rather than full blown and problematic retrospective application and restatement of comparative information).

 

How can BDO New Zealand help?

The accounting world is changing constantly as businesses become more driven by compliance, and technology changes in terms of how we process information. The modern accountant is more than just a number cruncher - they are a business adviser and financial specialist rolled into one.

BDO’s IFRS Advisory team has specialised in keeping up to date with changing accounting standards so that you don’t have to. We can advise you on how to manage the transition towards NZ IFRS 16 and keep your business moving in the right direction.

For more information and resources on NZ IFRS 16 visit BDO’s dedicated Adopting NZ IFRS 16 webpage on our website.

To discuss the ways the BDO can assist with your business’ adoption of NZ IFRS 16, contact the team today.