March 5, 2019
On 13 January, 2016, the International Accounting Standard Board (IASB) announced the issuance of a new accounting standard: International Financial Reporting Standard (IFRS) 16, on leases, which took effect on 1 January 2019. The new standard has changed the basis of accounting for leases which was in force for more than thirty years. While IFRS 16 completely replaces the old rule under International Accounting Standard (IAS) 17, the major impact is on the recognition, measurement and disclosure requirements for lessees.
The new standard eliminates the classification of leases as either operating or finance for lessees and, instead, introduces a single lessee accounting model. According to an IASB survey conducted in 2016, listed companies around the world had around US$3.3 trillion worth of leases. Based on IAS 17 requirements, over 85% of the leases are labelled as operating leases and are not recorded on the balance sheet of these companies. This amounts to about $2.8 trillion worth of leases off the balance sheet of such entities.
Given the effective date of 1 January 2019 for the adoption of the new standard, most companies had about three years to evaluate the legal, commercial and financial reporting impact of the new standard on their financial positions and transactions. In this article, we have discussed the extent to which the new rule disrupts the Nigerian tax space, and the options available to companies and businesses moving forward.
In line with the Federal Inland Revenue Service (FIRS) information Circular No.2010/01 on Guidelines on the tax implication of Leases , a lease can be broadly defined as a contractual agreement between an owner (the lessor) and another party (the lessee) which conveys to the lessee the right to use the leased-asset for consideration usually periodic payments called rents. With the adoption of International Financial Reporting Standards (IFRS) in 2012, recognition of leases have been based on IAS 17 (the old rule).
Under the old rule, a lease arrangement is classified as either an operating lease or a finance lease. Finance leases are arrangements that transfer risk and rewards relating to the use of an asset from the lessor to the lessee. This means that in a finance lease arrangement, the lessee is deemed the economic owner of the asset since he is able to apply the asset to generate economic benefits from continuous usage. All other types of lease arrangements are classified as operating lease.
Under the old rule, lessees were required to recognize a finance lease arrangement as both an asset and a liability at an amount equal to the fair value (sale price agreed upon by a willing buyer and seller, assuming both parties enter the transaction freely and knowledgeably) of leased asset. Where this value is lower than the fair value, recognition should be based on the present value of the minimum lease payments to be made by the lessee.