IFRS 16 Audit

What to look out for as you prepare for IFRS 16 year end

By Marty Jaynes Jul 9, 2021 12:19:32 PM
image alt What to look out for as you prepare for IFRS 16 year end

With the end of the financial year here in Australia, businesses need to take the time now to ensure their IFRS 16 accounting compliance is current and accurate. Any inaccuracies in your IFRS 16 accounting could result in big impacts on your balance sheet, so it’s important you understand what to look out for and current areas of audit concern.

Quadrent recently hosted a panel discussion to provide businesses with an understanding of what auditors will be looking for in IFRS 16 compliance now that the standards have been in place for a full year. Throughout the discussion, we got some best practice advice from a leader in the transport and logistics industry, Stephen Micallef – Group Financial Controller at Freightways. Our other panellists included John Askham – Director, Financial Accounting Advisory Services at EY and Stefan Iggo – CFO at Quadrent, with Damon Kennedy – Key Account Director at Quadrent chairing the conversation.

This article provides an overview of what the panel discussed and key takeaways for finance and accounting professionals reviewing their IFRS 16 accounting compliance at year end.

Click here to view our on-demand video of the conversation.

Completeness and accuracy of lease data: How Freightways got started with LOIS

At Freightways, Stephen realised that one of the biggest challenges with the IFRS 16 guidelines coming into effect would be gathering and collating all their lease data across the company. Stephen and the company’s finance team created a template to capture key data about the company’s leases. Once the templates were complete, Stephen’s team began reviewing and cross-referencing the information they received. On first stock take, the business had around 500 leases. While that gave the team a good idea of internal information, they needed external information as well. So, the team contacted their vendors to cross-reference their data with Freightway’s internal data. 

Once Stephen and his team completed the initial process of gathering lease data, they started uploading it to LOIS. It was a 12-month process and an important one in ensuring the initial data was accurate. Since the system has been in place since mid-2019, Freightways has been “business as usual” with their leases. LOIS enables the company to ensure accuracy in its IFRS 16 accounting while regularly sharing reports across all of Freightways’ businesses to keep information up to date and proactively manage its leases.

Establishing a system to centralise lease data

Before IFRS 16, Freightways’ lease data was decentralised. LOIS helped the company centralise its lease accounting and reporting, providing valuable data to analyse and inform stronger decision making. Across the businesses, Freightways can proactively review their leases and ensure they’re still getting value rather than rolling over contracts by default. It also helps each of Freightways’ businesses with high-quality data for stronger cash flow forecasting and modelling.

Stephen’s biggest piece of advice is to start early in bringing all of a company’s lease data into a central location. This doesn’t mean ongoing data collection should be centralised, though. It should be pushed out to those close to the data every day and effectively brought back to a central location to cross-check for accuracy. While this can be a big task, establishing processes for a more strategic view of a business’s leases provides finance and accounting teams with an opportunity to strategically partner with other areas within a company. Further, organisations with an “offence” rather than a “defence” approach to their data strategy are better placed to gain as much value as possible from the information. 

Low value and short-term leases

IFRS 16 compliance, especially in its beginning stages, was a large project. As a result, businesses tended to focus on large material items. However, there’s an opportunity for more accurate reporting and insightful data when low value and short-term leases are included as well. For example, leases on smaller IT equipment might auto-renew, and the business may be paying for equipment that’s no longer used. A business is also likely to start using control accounts to manage short-term leases, which prompts the company to follow up when lease data is incomplete. This provides businesses with stronger systems and processes, saving businesses money and ensuring more accurate disclosure data.

COVID accounting – making lease modifications efficient, compliant and accurate

COVID-19 has impacted many areas in financial statements, such as impairment testing and anything that involves forecasts. With property leases, for example, the International Accounting Standards Board (IASB) released guidance on rent concessions. Lessees impacted by lockdowns and restrictions may have had access to a range of concessions, such as deferred payments, rent reductions, rent forgiveness, or other changes to the lease terms. 

Under the regular IFRS 16 rules, accounting for rental concessions can be complicated and depends on the type of lease modification. The practical expedient provided means that if a lease concession was provided due to COVID-19 on payments due by 30 June 2021, and there are no other changes to the lease, businesses can ignore the regular modifications guidance and account for it as negative variable consideration. This will be accounted for as a credit to your business’s profit and loss.

In the early stages of the COVID-19 pandemic, the LOIS team put together processes to automate the modification process. As one of the most complicated parts of IFRS 16 accounting, automation provides efficiencies, accuracy and more time to focus on proactive lease management. 

What are auditor’s IFRS 16 focuses this reporting period?

Initially, auditors spent a lot of time on education when the IFRS 16 standards first came into effect. With most companies completing their first full year with the standards in place, auditors will be focused on compliance, particularly around lease modifications and changes to assumptions such as renewal options and the number of times that options will be renewed. 

Businesses should focus on four key areas, including a review of:

  • all leases 
  • judgements made in accounting for these leases
  • impairments that have arisen throughout the year
  • the validity of your business’s calculations from when the standards first came into effect.

Further, auditors will likely be completing substantive testing on profit and loss statements ensuring all leases are complete and not accounted for elsewhere in a company. Having the right systems in place, such as LOIS, can ensure information is always recorded correctly.

Areas of audit concern from our LOIS clients

There are two key areas of concern that drive businesses to use lease accounting software such as LOIS: — moving from spreadsheets to systems due to the overhead of manual processes and adjustments and ensuring compliance around impairments. There has been an emphasis from auditors on judgements around impairments, with the main variable being incremental borrowing rates (IBR). It’s important that businesses can demonstrate consistency in how their IBR is calculated, as any movements in the IBR can have implications across the company.

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Put effective systems in place for compliance and lease management now

Without centralised data and systems and processes to effectively manage a business’s leases, there’s an increased risk of non-compliance and last-minute heavy workloads to gather the required information. By viewing a business’s IFRS 16 compliance as a way to create efficiencies and strategic insights, a significant amount of value can be derived from establishing these systems and processes. 

At Quadrent, we can help you to establish the systems you need to accurately record your lease data and extract valuable insights for your business. Click here for more information.