Leases: the public sector and IFRS 16

05 March 2020

In 2019, a new leasing accounting standard, IFRS 16, came into effect for most IFRS reporters. This standard put operating leases – that is, traditional rental agreements - onto the balance sheet for the first time, with significant consequential effects on both the balance sheet and the income statement. At that time, the public sector was shielded from these changes, because the Government Financial Reporting Manual (FReM) delayed its adoption for public sector entities – that is until now. The IFRS 16 principles are becoming effective for most public sector entities in the current financial year.

So, what does this mean for you?

The impact of IFRS 16

The most significant impact of IFRS 16 is the recognition of a new type of assets, called ‘right-of-use’ assets, and liabilities (called, unsurprisingly, lease liabilities) in the lessee’s statement of financial position for almost all operating leases. There are some limited exemptions for short life and low value leases. The requirements apply to all leases including property rental agreements, as well as equipment leases and car leases.

These assets and liabilities are initially calculated by taking the sum of the unavoidable lease payments, discounted at an appropriate rate, and adjusted for some smaller items such as legal costs and property re-instatement expenses. After initial recognition, the assets are usually depreciated, unless they are measured using the revaluation model. The liabilities follow the effective interest rate method, resulting in the recognition of an interest expense.

How and when does this apply to the public sector?

The FReM incorporates the principles of IFRS 16 effective from 1 April 2022, with some minor modifications. The FReM applies to all public sector entities except for local government/local authorities and NHS Trusts, NHS Foundation Trusts, or Clinical Commissioning Groups (collectively NHS) which apply their own accounting manuals as explained below.

The NHS applies the Department of Health and Social Care Group Accounting Manual (GAM) which will separately incorporate the principles of IFRS 16 in the 2022-2023 edition and will mimic the FReM’s modifications.

For local authorities, the Code of Practice on Local Authority Accounting in the United Kingdom (Codes) has delayed the implementation of IFRS 16 to 1 April 2024. However, local authorities will be allowed to early adopt the IFRS 16 principles on 1 April 2022 or 1 April 2023 in accordance with the Codes.

What are the differences between IFRS 16 and the public sector requirements for lease accounting?

The major differences between IFRS 16 itself and the principles as contained in the FReM (and by extension the GAM) are as follows:

  • The definition of a contract is expanded to include intra-UK government agreements where non-performance may not be enforceable by law.
  • Peppercorn leases are scoped into lease accounting with associated special rules for their accounting, which is akin to the treatment of donated assets.
  • The short-term lease exemption choice is removed. This has the effect that short-term (less than one year) leases are expensed in the usual way.
  • If the interest rate implicit in the lease cannot be readily determined, the default rate to apply is the appropriate HM Treasury discount rate. The incremental borrowing rate may be used if
  • it can be demonstrated to be more accurate.

The choice between the cost and revaluation model in the subsequent measurement of right-of-use assets is removed and the revaluation model must be applied.
The FReM and the GAM also make modifications regarding the transitional provisions of IFRS 16. These modifications remove various options which are available under IFRS 16 for an entity to apply when initially adopting the standard. This ensures more consistent adoption across all public sector entities applying the FReM or GAM.

How can we help you?

RSM has a wealth of experience and expertise in dealing with public sector entities and their financial reporting requirements. Our team can assist you with the implementation of IFRS 16 and can provide tailored guidance in the practical challenges of applying these new principles.

To find out more, or do discuss how RSM can support you, please get in touch with Danielle Stewart OBE, or your usual RSM contact.

Danielle Stewart
Danielle Stewart OBE
Partner, Head of Financial Reporting
Danielle Stewart
Danielle Stewart OBE
Partner, Head of Financial Reporting