06 December 2019
The Financial Reporting Council (FRC) has published a thematic review of IFRS 16 interim disclosures by lessees about the implementation of IFRS 16. The thematic review provides examples of good practice in interim reports and identifies disclosure improvements for full year accounts. The review also highlights the areas that the FRC expects companies to focus on for their follow up review of year-end disclosures.<
The FRC considers there is scope for improving disclosures to meet the overall disclosure objective in IFRS 16 by:
- providing clearer communication of transition choices and practical expedients applied;
- enhancing explanations of the nature and effect of changes in accounting policies; and
- explaining specific judgements applied by the company on adopting IFRS 16.
Transition choices and practical expedients
The FRC considered that there is scope for improving disclosures relating to transition to IFRS 16. Companies should ensure they disclose all practical expedients that have been applied on adoption of the standard. The FRC noted companies that did not disclose use of the practical expedient not to reassess whether contracts contain a lease, had not disclosed evidence of reassessing their leases under IFRS 16 criteria.
The FRC also highlighted that the companies should ensure clarity of disclosures between those relating to application of one-off practical expedients on transition and ongoing recognition exemptions, in particular whether a company had adopted the practical expedient on transition relating to leases that end within 12 months of the date of initial application of IFRS 16 or the accounting policy recognition exemption in IFRS 16 for short term leases.
Changes in accounting policies
The FRC considered that generally disclosures explaining the nature and effect of changes in accounting policies were good and clear on the impact of IFRS 16 on the balance sheet, with better disclosures showing the line-by-line impact including the derecognition of onerous lease provisions. However, the FRC noted very little explanation on the impact on companies profit and loss which companies should consider providing, even where the impact is less significant.
The FRC encourages clear disclosure of circumstances in which IBR or the rate implicit in the lease are used, and where in the cash flow statement interest cash flows are presented.
Full retrospective adopters were reminded of the need to present a third balance sheet at the beginning of the restated comparative period.
Specific judgements relating to IFRS 16 should be clearly explained, including the judgement reached and its impact. The most common judgement identified was in relation to lease extension or termination options, with good disclosure clearly explaining what judgement had been taken and why. For companies that identified the calculation of the discount rate as a key judgement, disclosures generally did not include the sensitivity of the discount rate to changes in assumptions. This is a requirement of IAS 1 as the judgement involves estimation uncertainty. Other specific issues for modified retrospective adopters
Right of use asset
For companies adopting modified retrospective transition the FRC highlighted several areas for companies to improve their disclosure in year-end reporting.
Under the modified retrospective approach, on a lease by lease basis companies can elect to measure the right of use asset at:
- the carrying amount as if the standard had been applied since commencement date, discounted at the incremental borrowing rate (IBR) at the date of initial application; or
- at an amount equal to the lease liability adjusted for prepaid/accrued lease payments.
The FRC noted that several companies referred to measuring the asset as though the standard had been applied since commencement of the lease, without reference to the IBR on the date of initial application. For companies that used both methods, the FRC noted that good examples clearly explained the circumstances and why both methods had been chosen.
Companies applying the modified retrospective transition must disclose the weighted average IBR applied to lease liabilities at the date of transition and a reconciliation from IAS 17 operating lease commitment to the IFRS 16 liability recognised on initial application. The most useful disclosures included a range of IBRs applied and clearly explained each item in the lease liability reconciliation.
Companies should make it clear that comparative performance measures in the front half have not been restated.
The use of alternative performance measures (APM’s) continues to be an ongoing area of focus for the FRC. Where companies have used APMs, it should be clear that measures under IFRS 16 and comparatives prepared under IAS 17 are not comparable.
The FRC notes that IAS 17-based figures presented for periods after adoption of IFRS 16 are APMs. Companies are encouraged to ensure that they are following the ESMA guidance on APMs, in particular:
- ensuring the front half discussion has equal prominence to reported figures under IFRS 16 and IAS 17 APM’s;
- clearly defining, explaining and showing the calculation of any IAS 17 APMs; and
- ensuring that the statutory figures and IAS 17 APMs are clearly labelled.
The FRC reminds companies of the requirement to disclose additional qualitative and quantitative information about leasing activities necessary to meet the disclosure objective in IFRS 16, including (but not limited to) future cash outflows from lease extension options and variable lease payments, restrictions or covenants imposed by leases.
The FRC will review the full year accounts of companies in their sample who had room to improve disclosures, as well as reviewing the full year accounts for other companies. The FRC notes that year-end IFRS disclosures are more extensive than those required for interim reporting and encourages companies to ensure that:
- explanation of the impact of transition is comprehensive and clearly linked to other information disclosed in the annual report;
- changes to accounting policies and key judgements are company specific and clearly articulated;
- disclosures meet the overall disclosure objective of IFRS 16; and
- any new APM’s follow ESMA guidance.