The challenge of IFRS compliance

Nimita Shah – Audit Manager

As IFRS introduced critical new accounting standards on revenue recognition, leases and financial instruments, many small businesses are being faced with the challenges of implementing these complex new standards which are drastically changing the way revenue and operating leases are accounted for.

Businesses increasingly shop around for their audit services, but a lack of preparation could be preventing them from getting value for money. Instead of employing specialists to prepare their accounts and make sure all their documentation is in order, some businesses are attempting to do it themselves. This can lead to increasing compliance costs and a costly, lengthy and inefficient audit.

If finance teams are unaware of the latest standards there is a risk of IFRS compliance issues arising.

What is IFRS 15?

Revenue from Contracts with Customers will have a significant impact on the timing of revenue recognition for many companies. Failure to apply IFRS 15 properly could lead to a material misstatement of revenue and profit in a business’ financial statements. This standard come into force for accounting periods commencing on or after 1 January 2018, in conjunction with IFRS 9: Financial Instruments which covers three main topics: classification and measurement of financial instruments, impairment of financial assets and hedge accounting.

What is IFRS 16?

Leases comes into effect for periods commencing on or after 1 January 2019. The new standard requires lessees to recognise all leases including operating leases on the balance sheet, thereby introducing a “right of use” asset and a corresponding lease liability. Almost all companies have operating leases as lessees and will therefore be affected by the introduction of this standard.

The new leasing standard could significantly affect a company’s gearing ratio and EBITDA as operating leases rentals are no longer recognised in the profit and loss but replaced with the depreciation of the “right of use” asset and an annual interest charge for the lease liability. Therefore borrowing covenants, credit ratings and dividend planning could be affected by this standard.

Businesses need to ensure they invest sufficient time during their year-end preparation to ensure a smooth transition to the new IFRS standards and be in a better position to iron out any issues.   Inadequate preparation could leave businesses without a clear indication of the impact of the new standards on their income statements and balance sheets

Why is IFRS 16 so challenging to implement?

IFRS 16 is particularly challenging for businesses to implement as they will need to gather information on all of their leases. Companies will need to determine a discount rate to calculate the present value of minimum lease payments.  The discount rate can be determined using the interest rate implicit in a lease, this is particularly challenging if there is a portfolio of property leases as often interest rates are not written into property leases and it can be difficult and costly to determine the present value of the minimum lease payments that equals the fair value of the asset. The alternative is to obtain an incremental borrowing rate at the date of initial application.  This represents the rate of interest that a lessee would have to pay for borrowing funds to obtain an asset of a similar value, over a similar period, with comparable security and economic environment.

Need help understanding your accounting compliance?

Menzies can help businesses understand their compliance requirements and manage the practical challenges of implementing the new IFRS standards. We can also provide clients with support on possible options presented to management and help companies reach strategic decisions.

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