A Brief History of IFRS 16
After the accounting scandals of the early 2000s, there was a major push by the accounting standards boards to close accounting loopholes and increase transparency into the true financial position of corporations. One of the loopholes identified was the operating lease loophole under IAS 17 which allowed companies to report operating leases in the footnotes of financial disclosures. In an effort to close that loophole and increase transparency, the International Accounting Standards Board (IASB) released IFRS 16 in January of 2016.
The Current Standard: IAS 17
IAS 17 Leases (1997) is the current lease accounting standard for all companies that report under international financial reporting standards. IAS 17 uses a dual model classification approach. One classification, finance leases, are capitalized on the statement of financial position as an asset and liability and reported on the profit and loss statement as an interest and depreciation expense. The other classification, operating leases, are reported in the footnotes of financial statements.
Keeping operating leases off of the balance sheet is believed to obscure the true nature of a company’s liabilities from potential investors. While major investment firms have methods to take operating lease liabilities into account, the average investor does not.
To increase transparency into corporations’ true lease liabilities, the IASB developed a new standard that eliminated the operating lease classification.
The New Standard: IFRS 16
IFRS 16 will replace IAS 17 starting on 1 January 2019. The major change from IAS 17 is that all leases will now be treated as finance leases, with exceptions for short-term and low-value leases. In other words, all leases that were treated as operating leases in the past will now be capitalized on the statement of financial position, and reported as an interest and depreciation expense on the statement of profit and loss. As a result of the change, operating leases totaling more than 2 trillion USD are expected to move onto corporate balance sheets.
For a complete timeline of the events that led up to the release of IFRS 16, read below.
Timeline: The History of Lease Accounting (IFRS 16)
IAS 17 Accounting for Leases (1982) was issued with an effective date of 1 January 1984.
The Group of Four Plus One (G4 + 1) which includes Australia, Canada, New Zealand, the United Kingdom, and the United States plus the IASB published a discussion paper for a converged standard for lessees which called for the elimination of operating leases.
IAS 17 Leases (1997) was issued with an effective date of 1 January 1999. This superseded the previous IAS 17 Accounting for Leases, of 1984. Under IAS 17, leases had to be classified as either operating leases or finance leases. Operating leases were reported as an expense on the income statement and in the footnotes of financial disclosures. Finance leases had to be reported as an asset and liability on the statement of financial position.
G4 + 1 began work on a converged standard for lessors building on the 1996 discussion paper.
The IASB began work on a new lease accounting standard intended to close the loophole of off-balance operating leases.
The IASB released a Discussion Paper covering preliminary views on the creation of a new lease accounting standard and invited comments. The discussion paper proposed moving all leases onto the balance sheet to be capitalized as an asset and liability.
The IASB released the first Exposure Draft for the new lease accounting standard and invited comments. The draft established the model to report all leases on the balance sheet as an asset and liability. In general this model was met with criticism.
The IASB released the second Exposure Draft after multiple discussions with stakeholders and several revisions. This model solidified parts of the new standard, including the model to bring all leases, except short-term leases, onto the balance sheet.