Do you have rented or leased equipment from Smartrak? Are you contemplating a lease vs buy decision? Planned changes to the accounting rules for leases may affect your approach.
New Zealand is adopting the new International Financial Reporting Standard IFRS 16 for financial years starting after 1 January 2019.
Most organisations won’t have to make changes to the accounting treatment for Smartrak leases as the individual value of hardware will be low enough to apply for an optional lessee exemption. However, there may be some benefits for your organisation to adopt the new standard.
Here is a summary of the accounting changes if you apply the standard and you are a lessee:
- The distinction between financial and operating leases disappears. If you control the use of the asset, it is a lease.
- Leases are created on the balance sheet as an asset and a corresponding liability.
- The asset is depreciated over the lease term, while the liability is reduced by the amount of principal each month – similar to a loan.
- On the profit and loss side, instead of a monthly lease or rental expense, there will be a depreciation expense and an interest expense.
This can lead to some big changes to your accounting results that may influence your decisions:
- Your business will become more asset rich, but more heavily indebted. Banking covenants may be affected.
- The overall pattern of expenses over the term of the lease will become front-end-loaded (because of the early-term interest on the lease balance). Earnings per share decrease in the short-term.
- Classification of expenses change. You no longer book a rental or operating lease charge and instead incur depreciation and interest charges. EBITDA increases for the duration of the lease.
Are these changes compulsory?
Not necessarily. If you are required to prepare financial statements that are IFRS-complaint, you need to adopt the standard. However, there are a few optional lessee exemptions within the standard that you can apply:
- If the lease term is short-term (less than 1 year).
- If the leases will end within 12 months of the date of first applying IFRS 16.
- If the individual value of the assets is low. There isn’t an official definition of ‘low’ but is generally considered to be <US$5,000. This exemption applies even if the aggregate value of your assets is not considered to be low.
If you decide to utilise one of these exemptions, you can continue to account for leased assets the way you always have.