IFRS 16: Be Prepared With Workday Financials

July 26, 2018 Dan Haigh, Matt Welch, and Anh Le

As a financial analyst, have you ever struggled to understand a company’s assessment of its lease liabilities? Or have you ever debated with your finance stakeholders on whether a lease should be recognized as a liability or an expense? These “hard” conversations will no longer occur by the end of this year.

The Financial Accounting Standards Board (FASB) and the International Financial Reporting Standards (IFRS) issued new guidelines for leases. After 15 December 2018, under these new standards (known as ASC 842 and IFRS 16), companies will be required to recognize and provide lease assets and liabilities on a balance sheet. While this will necessitate significant changes for many organizations, Workday Financial Solution is already prepared for this new mandate. 

What is impacted?

The day-to-day functions of companies that lease major assets (lessees) are greatly impacted by this new standard, even though the lessors’ accounting efforts remain largely unchanged. This will affect a wide variety of sectors, from airlines that lease aircraft to retailers that lease stores. The larger the lease portfolio, the greater the impact on key reporting metrics.
The new guidelines will impact lessees’ accounting in these ways:

  • Change to recognition pattern: There is no longer any distinction between the operating lease and the financial lease. Instead, the ‘right-of-use’ asset (right to use the leased item for the leased term) and the lease liability (obligation to pay the rentals) are recognized in the balance sheet accounts .
  • The balance sheet (BS) grow: Long-term, high-value assets (valuing $5,000 or more when new, and the lease term lasts more than 12 months) will be recognized on the BS accounts.
  • Gearing ratios increase.
  • Capital ratios increase.
  • Change to expense characters: rent expenses are replaced with depreciation and interest expenses.
  • Earnings before interest, tax, and amortization (EBIDA) will increase with the onset of the new guidelines, while EBITA (profit before tax) will remain the same over the lease term.

These changes could mean the cost of implementation — while continuing to comply with the new Standard — could be significant for most lessees, especially if they do not already have an in-house lease information system.

How can Workday help?

Workday’s Supplier Contract functionality has been available since the Workday Financials began. And through this solution, clients will easily meet the new guidelines. However, some clients have been reluctant to make use of the powerful features for scheduling purchase orders and supplier invoices, instead they needlessly complicate the process by doing a lot of the work outside of Workday. These new accounting guidelines provide a great excuse to adopt the Supplier Contract Functionality. 

Moreover, new features and enhancements are delivered with each Workday release, working to streamline the transition process for lessees. Here are a few noteworthy enhancements:

  • ASC 842 Operating Leases (Full Lifecycle Accounting). The new lease treatment is accomplished through the initial recognition of lease asset and liability, the creation of an expense recognition and the various supplier invoice schedules.  
  • Finance Lease and Operating Lease IFRS (Full Lifecycle Accounting): The new lease treatment is accomplished through the initial recognition of lease asset and liability, the creation of the expense recognition, the supplier invoice schedules and the multi-book business assets accounting model.
  • Comparative Reporting and Cumulative Adjustments: Workday provides an alternate contract model and various data sources, available for modified and full retrospective disclosures and cumulative adjustments
  • Conversion from Existing Standards: Workday provides enhanced support for migration of active contracts.
  • Lease Amendments: Workday provides lease modifications; including date changes, lessor incentives, and discount rates.

Separating lease components

Most of the lessees’ time will need to be spent examining their leases, to identify the contracts. Workday Financials users then can record the lease and non-lease components in separate Supplier Contract Types in Workday.

To streamline this process, Workday delivers options to users so they can manage the Lease Initial Recognition and measurement, as well as subsequent measurements. With each new update, Workday provides security segments on Supplier Contract to ensure the system’s internal controls are in place for auditing purposes.
 

Accounting that reflects

Below is a glance at the fundamental changes in the accounting treatment of the lease.
New Standard

New Standard

 

Old Standard

Right-of-use asset

xx

Right-of-use asset

0

Lease liability

(xx)

Lease liability

0

 

Operating expense

xx

 

Operating expense

xx

Depreciation

xx

Depreciation

0

Interest expense

xx

Interest expense

0

Under the new standard, balance sheets will be grossed up and both income statements and cash flow presentations will change. This can be managed seamlessly in Workday by editing the Accounting Posting rules. Moreover, users are able to set up lease calculations by accessing the Accounting Method tool in the supplier contract.

Tax treatment

Even though lessees will have higher accounting expenses at the start of the lease, they won’t necessarily have higher tax deductions. Deductibility of lease rentals will be governed by the local tax legislation, which may not change. Differences between accounting and tax treatments will require a tax affecting accounting adjustments. But fortunately, the capability to process tax adjustment accounting journals already exists in Workday.

Intercompany Leases

The treatment for intercompany leases will be supported with a post-WD30 release. Users will no longer need to post manual journals to transfer leases between companies. Currently, Supplier Contracts for Operating and Financial Lease Types are restricted to a single company (the header company and line company must be the same). Intercompany functionality will be reviewed for inclusion in a future update.

Want to learn more about how Appirio and Workday can strengthen your financial operational capabilities? Check out our blog to see what technology trends are current today. Want to sit down with an Appirio Workday expert? This September and October, we’ll be attending the Sydney HR Tech Summit and Workday Rising (in Las Vegas this year), just look for the Appirio logo.

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