Changes in Lease Accounting

Accounting treatment for leases will change from 2019, but companies should start to work on the new standards now, advises Assurance Partner Susan Foong.

Leasing is one way for companies to utilise buildings or equipment without owning them. There are many advantages to a finance or operating lease; among them capital outlay, cash flow, and flexibility. Under the current accounting standard on leases (FRS 17), operating leases are “off balance sheet” and not reported as liabilities on the balance sheet.

Upcoming Changes in Lease Accounting

This is set to change from 2019 when the Singapore equivalent leases standard FRS 116 issued by the Accounting Standards Council comes into effect. FRS 116 replaces the existing FRS 17 and is effective for accounting periods beginning on or after 1 January 2019. The new standard seeks to improve comparability between companies that lease and those that purchase assets. The changes found in FRS 116 aim to provide relevant information that faithfully represents lease liabilities and to improve the quality of financial reporting for leases.

Accounting for operating and finance leases by lessors remain largely unchanged from FRS 17. For a lessee, FRS 116 eliminates the distinction between an operating lease and a finance lease. Under FRS 116, lessees shall assess, on entering into a contract, if the contract is or contains a lease. Leases must be clearly distinguished from service contracts and the right of the lessee to control the leased asset is the key indicator.

At the commencement date of a lease contract, when the asset becomes available for use by the lessee, a lessee shall capitalise a ‘right-of-use’ asset and recognise a corresponding lease liability on the balance sheet. Depreciation shall be charged on the right-of-use assets and shown separately from finance costs on the lease liability, both presented in the statement of profit or loss.

Exemptions

There are two exemptions which, if elected by lessees, will permit lessees to simplify the accounting treatment. These exemptions are for short term leases, where the lease term is of 12 months or less; and for leases where the underlying asset is of low value. This shall be based on the value of the asset when it is new, regardless of the age of the asset being leased. Examples include tablet and personal computers and small items of office furniture and telephones. Lease payments for these eligible leases shall be recognised as an expense in the statement of profit or loss on a straight line basis, or another systematic basis, if it is more representative of the lessee’s benefit, over the lease term. This is similar to the current operating lease treatment in FRS 17.

Complying with the New Standard

Although it may appear that businesses still have two years to prepare for the new accounting standard, companies should start to familiarise themselves with the requirements of the new standard, consider the impact on their balance sheets and ensure that they will be able to comply with the new standard.

For businesses with a significant number of lease contracts, applying FRS 116 for the first time will potentially change key performance measures, including gearing ratios and other key financial ratios, profit before interest and tax, assets and liabilities and non-FRS performance measures commonly included in loan covenants. Liabilities will be higher even as the entity reports higher assets on their balance sheet.

As a result, companies have to take into consideration the business and commercial preparation challenges such as lease negotiations, reassessment of contract terms and financing arrangements. In terms of industry sectors, retail, airlines and other transport industries have been identified as those most likely to be affected.

Next Steps

Entities:

• Will need to start collecting information on existing and new leases to measure right-of-use assets and lease liabilities.
• Should consider whether any new internal procedures and internal controls are needed to ensure that new leases are recognised.
• Should review covenants in loan and finance agreements and assess whether the changes under FRS 116 might cause any covenants to be breached. If so, they should consider the need for renegotiation of loans or leases.

Please contact your regular contacts at Baker Tilly TFW for assistance in accounting issues relating to the implementation of the new leases standard. A copy of the FRS 116 can be obtained at www.asc.gov.sg.

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