Impact of IFRS 16 on balance sheets and income statements
New guidance on accounting for leases, which will be brought in by the International Accounting Standards Board (IASB) under its IFRS 16 standard, will come into force at the start of 2019 and will cover everything from equipment to real estate. The primary principle is that lessees will have to report all leases on their balance sheet, with some exemptions, but the far-reaching implications are proving hard for some companies to grasp.
The fleet industry, which operates on lease contracts, is trying to help its clients understand the full implications of the regulations. In part, this involves reassuring them that their fleet operations will only be partly affected by the new regulations, which depend on the definition of the right of use of an underlying asset.
"I don't think it will affect the fleet world too much," says Gilles Momper, chief financial officer of ALD. "All the studies show it will mainly impact real estate and property leasing. Vehicle and equipment leasing only represents 5% of right-of-use impact on the balance sheet. I believe the advantages of the full-service leasing product remain, which is for our customers to have an outsourcing solution to manage their fleet and all the services around it. So they have a very competitive offering and very predictable fleet costs. Last, but not least, because of IFRS 16 they will not have the full amount of their fleet on the balance sheet, only the right-of-use portion."
Experience and knowledge
ALD Automotive is the operational leasing and fleet management subsidiaries of Societe Generale Group. The company is one of the largest providers of fleet services in Europe. Internationally, it provides support and funding solutions in 43 countries. Momper has extensive experience in the automotive industry and became group CFO in 2012. He and his IFRS 16 project director, Pascal Mennicken, have each been with the company for more than ten years and understand well how to help customers adapt to new regulation.
"It does affect the fleet world a bit, but the financial impact on the balance sheet is quite limited," remarks Mennicken. "At ALD Automotive, our advice is to simplify the norm and the accounting treatment. There are two areas where clients should carefully study the options offered by the new standard. The first option relates to services, and IFRS 16 offers the possibility to keep services inside the calculation for right of use. At ALD Automotive, we believe this option is quite interesting for simplifying the reconciliation between the invoice and the IFRS calculation file, which will be on the same basis and, therefore, simpler.
"The second option that could be carefully studied is the rate at which we should discount the cash flows. There is a lot of debate about this, and our advice is to use only one rate to discount all cash flows for the assets, which is the customer's incremental borrowing rate. If we use one rate for one period, for all assets, then it is easy to document. There is a clear audit trail and company headquarters can easily control the subsidiaries."
Unwelcome but undervalued
It is no secret that many finance directors have greeted IFRS 16 with a lack of enthusiasm, not least because it piles more pressure on an already burdensome process of regulatory compliance. However, in the fleet space there are some positives that should not be overlooked.
"It is aiming to improve the quality of financial information provided by financial statements," says Momper. "The main issue is the unnecessary complexity of the accounting treatment. For instance, the disconnection in the P&L charges, and the invoices that are sent to customers. It emphasises the need for each company to have an internal project team to deal with IFRS 16, to consider all possibilities offered by the norm and find the right balance of all the options offered by the standard to have a smooth implementation. We are providing customers with some advice on how to adopt the new standards, and we will be ready to provide them with all the necessary data to book their fleet."
"The complexity of the norm makes it unpopular among some CFOs, but others point out that it can be simplified," agrees Mennicken. "We should not forget that it has some very positive impact. For instance, EBITDA will be improved by the standard, so some CFOs are very interested in this financial impact. We must try to understand a complex standard and we must look at how to organise the company to treat the norm in the proper way. There are questions, for example, about the capacity of software to handle all of the options, so it must be simplified by looking at all the options and finding out what works best for your company."
There are IT and process challenges that arise from IFRS 16, as well as the task of identifying and preparing all of the necessary data on lease contracts across an organisation. But fleet services providers such as ALD Automotive are aware of their duty to help their clients attain compliance and unearth the positives.
"Our customers are not choosing full-service leasing because of an accounting standard," notes Momper. "They choose it because it provides an outsourced solution for a non-core activity. It provides them with predictable costs for their fleet and it delivers them from the hassle of managing their own fleet. ALD Automotive has set up a cross-functional team of IT, finance and sales. We want to be ready for implementation, so we need to have all the necessary data ready to provide to our customers. And we also want this team to act as consultants to help our customers fully understand the new norm, and find the right balance among all the possible options."
Mennicken adds, "The impact on fleet processes is limited and there is no real impact on how cars are procured. So the advantages of full-service leasing remain. The right of use generated by the fleet is not very important in terms of the standard. At ALD Automotive, we are happy to help our customers with the transition. We act as consultants, meeting our customers to discuss the standard, their options and the specificities of our business.
"We come with an inventory file showing the fleet and the impact on their balance sheet of right of use calculations. We look at different options and discuss different rates to discount the cash flows and demonstrate the real balance sheet impact. They can then choose an option based on concrete facts."
Staying ahead of the curve
The fleet industry is always changing and the key drivers are likely to be technological innovation, as well as regulation. "Our industry is evolving to integrate the new digital lifestyle and technological progress. Telematics, for instance, is a major change in the way we can interact with our customers and in the way our customers can monitor fuel consumption, fleet cost and even the safety behaviour of their drivers," Momper explains.
"In the next five years, the major change will be the pollution restriction rules that big cities will put in place," says Mennicken. "It is unacceptable for companies to have cars parked that will not be used, so we are working with our customers to have a green fleet that will respect all of the rules to ensure that you can drive your car every day."
These trends are likely to have a more marked effect on the procurement of fleet services than IFRS 16, which is an additional regulatory burden but can be handled easily with the right input from fleet partners.