IAS 17 is the current lease accounting standard governing all countries that report under International Financial Reporting Standards. IFRS 16 will replace IAS 17 for public companies on the first fiscal year on or after January 1, 2019. Private companies will follow one year later.
Why it is Being Replaced
IAS 17 classifies leases as either finance or operating leases. Finance leases are capitalized on the statement of financial position and reported on the profit and loss statement as an interest and depreciation expense. However, operating leases are reported in the footnotes of financial statements, not capitalized on the statement of financial position.
This method of reporting operating leases decreases transparency into the true financial position of companies. As a result, it is difficult for smaller investors with limited resources to accurately value companies.
To increase transparency, the International Accounting Standards Board (IASB) developed a new lease accounting standard called IFRS 16. The new standard will no longer classify leases as operating or finance. Instead, companies will account for all leases longer than 12 months with a value over $5000 as finance leases.
A lease that meets any of the following tests is classified as a finance lease under IAS 17:
- The underlying asset transfers ownership to the lessee at the end of term
- There is an option to purchase the underlying asset that is likely to be exercised
- The lease term is for the major part of the remaining economic life of the asset
- The present value of lease payments is greater than or equal to substantially all of the fair value of the asset
- The asset is specialized to the extent that it is only useful to the lessee