IN 2005, the US Securities and Exchange Commission (SEC) estimated that US public companies may have approximately US$1.25 trillion worth of leases off-balance-sheet.
The current lease accounting requirement under International Accounting Standard 17 Leases (“IAS 17”) has been criticised for failing to meet the needs of users of financial statements, as IAS 17 does not require lessees to recognise assets and liabilities arising from long-term operating leases. These are required to be disclosed only in the notes to the financial statements. Additional disclosures provide information about a company’s undiscounted commitments on off-balance-sheet leases only in the notes to the financial statements (as required by IAS 17) but they are not sufficient for some investors and analysts. They often estimate a company’s assets and lease liabilities based on the limited information available, by using techniques that yield estimates but which may not be accurate and may vary widely.
Responding to concerns about the lack of transparency in information about lease obligations, the International Accounting Standards Board (“IASB”) and the Financial Accounting Standards Board (“FASB”) initiated a project to improve accounting for leases. Finally, in January 2016, the IASB said that IFRS 16 Leases is effective for annual periods beginning on or after January 1, 2019, which requires lessees to recognise assets (right-of-use asset) and liabilities for most leases.
In effect, Thailand has adopted all IFRS standards with a one-year delay from the equivalent IFRS Standard’s effective date, with the exception of the standards relating to financial instruments (IAS 32 Financial Instruments: presentation; IFRS 7 Financial Instruments: Disclosures, and IFRS 9 Financial Instruments) and first time adoption (IFRS 1 First-time Adoption of International Financial Reporting Standards). It means under Thai Financial Reporting Standard 16 (“TFRS 16”) “leasing” will be adopted for the annual period beginning on or after January 1, 2020. Lessors suffer no significant impact from TFRS 16. However, many sectors such as airlines, retailers, healthcare, transport and logistics will be affected by TFRS 16, because it covers not only machinery but also property rent. However, lessees may elect to account for lease payments as an expense on a straight-line basis over the lease term or another systematic basis for the following two types of leases: 1) those with a lease term of 12 months or less and containing no purchase options – this election is made by the class of underlying asset; and 2) leases where the underlying asset has a low value when new (such as personal computers or small items of office furniture) – this election can be made on a lease-by-lease basis.
In addition, key financial metrics will also be affected by TFRS 16. For leases previously classified as a finance lease, there will be no significant change to the key financial metrics derived from the company’s TFRS financial statements. In contrast, for leases previously classified as operating leases, there will be significant changes in some financial metrics if those metrics were based on the amount recognised in TFRS financial statements.
Metric leverage: It is the common method of calculating liabilities/equity.
It increases when financial liabilities increase (and equity is expected to decrease). Applying TFRS 16 to an individual lease, the carrying amount of the lease asset would typically reduce more quickly than the carrying amount of the lease liability. This is because, in each period of the lease, the lease assets typically depreciate on a straight-line basis, and the lease liability is (a) reduced by the amount of lease payment made and (b) increased by the interest reducing over the life of the lease. This could impact debt covenants.
Metric current ratio: It’s a common method of calculating current assets/current liabilities
This could impact debt covenants.
Metric assets turnover: This is a common method of calculation – sales/total assets
They will decrease because lease assets (the right-of-use asset) will be recognised as part of total assets.
Metric EBITDA: This is a common method of calculating earnings before interest, tax, depreciation and amortisation (EBITDA)
They increase because expenses for off-balance-sheet leases are excluded, as EBITDA does not include the depreciation expense of the right-of-use asset and the interest expense whereas the operating lease expense under Thai Accounting Standard 17 (“TAS 17”) is included in EBITDA.
The knock-on effects of TFRS 16 are potentially significant for many Thai entities. Entities would be well advised to consider the knock-on effects in the following areas: performance indicators, bonus targets and executive remuneration schemes, contingent consideration in business combination, tax, debt covenants, ability to pay dividends and regulatory capital requirements.
To avoid unforeseen and potentially undesirable consequences, contractual arrangements may need to be renegotiated and for arrangement under negotiation between now and transition to TFRS 16, the effects of the new accounting carefully considered and pre-empted.
KIATNIYOM KUNTISOOK IS PARTNER, Audit & Assurance Deloitte Thailand