Why the Lease Accounting Standard is being Replaced
Why IAS 17 is Being Replaced
The Off-Balance Sheet Loophole
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 close the loophole and 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.
Leases are classified as either operating or finance under IAS 17. However, IFRS 16 removes the dual classification model, so all leases that are greater than 12 months in length and valued at over $5000 will be treated as finance leases.