United Arab Emirates: CFO's Guide: Transition To IFRS 16

Last Updated: 27 June 2019
Article by Blaise Jenner

In this series we have previously explored the key IFRS 16 headlines, which groups will be most impacted by the new standard and how groups should be preparing for transition to IFRS 16. Building on the previous articles, we shall continue to consider key areas of analysis and judgement that should be considered as part of any IFRS 16 implementation exercise.

In this article, we focus in the importance and relevance of the choice of transition option when implementing IFRS 16 - considering the following questions:

  • What transition options are available under IFRS 16?
  • Why is transition choice important?
  • What are the key takeaways for the Middle East CFO?

What transition options are available under IFRS 16?

IFRS 16 allows a number of choices when choosing the transition method in applying the Standard. Choosing the most appropriate transition option will require careful analysis across a number of factors as highlighted in Section 2 of this article.

The transition choices available under IFRS 16 are:

Transition choice

Option 1 – Full retrospective approach

Option 2A – Modified retrospective approach

Option 2B – Modified retrospective approach (simplified)

Requirement

Adopt IFRS 16 as if the standard had been applied from inception of the lease contract

Adopt IFRS 16 from inception of the lease contract for calculation of IFRS 16 right of use asset (RoU Asset), while the Lease Liability is calculated on a forward-looking basis from the transition date

Adopt IFRS 16 by calculating the Lease Liability on a forward-looking basis from the transition date. RoU Asset is computed as being equal to the Lease Liability

Transition date

1 January 2018 (for calendar year ends)

1 January 2019 (for calendar year ends)

1 January 2019 (for calendar year ends)

Restatement of comparative financial information

Yes

No

No

Catch up adjustment in equity

Recorded as at 1 January 2018 (for calendar year ends)

Recorded as at 1 January 2019 (for calendar year ends)

Nil as asset and liability would be equal

Incremental borrowing rate (IBR) considerations

Use the IBR applicable historically

Use the IBR applicable at transition date

Use the IBR applicable at transition date


* Option 2B is a simplification of Option 2A, and can be elected on a lease-by-lease basis when adopting the modified retrospective approach.

Whatever the transition approach choice, there are four key practical expedients and exemptions available for all lessees:

  1. Utilise the Grandfathering provision in IFRS 16 during year of transition (to apply for all contracts if used);
  2. Exemption from IFRS 16 requirements for lease contracts with a lease term (as defined in IFRS 16) of 12 months or less (to apply for entire class of asset if used);
  3. Exemption from IFRS 16 requirements for lease contracts where the underlying asset is of low value (lease-by-lease basis choice); and
  4. Make an accounting policy choice to not separate non-lease components from lease components (to apply for entire class of asset if used).

Additionally, when applying Option 2A & 2B, lessees can also make use of one or more of the following practical expedients (on a lease-by-lease basis) for previously classified operating leases:

  1. Applying a single IBR to a portfolio of leases with reasonably similar characteristics;
  2. Relying on an onerous lease assessment performed in the last 'IAS 17 reporting period', as an alternative to performing an impairment review at the date of initial application of IFRS 16;
  3. Electing to treat certain lease contracts as short-term leases, when their lease term (as defined in IFRS 16) ends within 12 months of the initial IFRS 16 application date;
  4. Excluding initial direct costs from the measurement of the RoU Asset at the date of initial application; and
  5. Using hindsight, such as in determining the lease term if the contract contains options to extend or terminate the lease.

Why is transition choice important?

A group's choice of transition approach will have an impact on a number of financial and operational areas, including:

  • the comparability of the financial statements in the year of adoption - the full retrospective approach will provide the greatest comparability through the restatement of the comparative period;
  • the carrying amount of the assets and liabilities when the group first applies IFRS 16;
  • the group's net profit profile in the years after transition - often the full retrospective approach will provide the most favourable outcome, whilst the modified retrospective Option 2B will often provide the least favourable outcome;
  • the cost, timescale and manpower effort that will be invested by the group for the IFRS 16 implementation project - the largest cost and effect will ordinarily arise with the full retrospective approach, whilst the least cost and effort will ordinarily arise with the modified retrospective Option 2B;
  • the extent of information required within transition disclosures for the first reporting period after the adoption date, and the annual reporting period immediately preceding the adoption date - Transition Options 2A and 2B would require detailed reconciliations given the lack of comparability to prior year financial information;
  • the extent of practical expedients available to ease the implementation of IFRS 16 - as noted above, a number of additional expedients are available when Transition Options 2A and 2B are applied; and
  • the number and extent of data points required to implement the standard.

An in-depth qualitative and quantitative analysis of the trade-off between the various factors should be considered as part of identifying a preferred transition option.

Key takeaways for the Middle East CFO

The available IFRS 16 transition choices essentially provide a trade-off between implementation cost and the extent of disclosure and impact on a group's financial statements. A careful analysis is required on the choice of transition approach, as this will not only affect financial statements at the adoption date but also for future years. As part of this, groups should consider:

  • In many instances, the most straightforward modified retrospective Option 2B may be the most practical and cost efficient approach for groups with limited use of leases. Where a group, however, is more lease intensive it may become more relevant to consider the full retrospective approach - which provides greater comparability of presented financial information and potentially the least adverse impact on profitability post implementation;
  • The availability of data may impact the range of options available - for example where groups are not able to obtain key historical data for lease extensions, renewals, pricing changes and discount rates, such data gaps can impact the ability to apply the full retrospective approach;
  • As part of assessing transition options we would recommend entities to undertake the below key steps as part of identifying their preferred option:
  1. Consider the key impact areas (outlined above) and the group's preferences in each, including qualitative factors such as stakeholder needs and sensitivity, along with past precedence the group has adopted for recent accounting changes.
  2. Model the impact of the three IFRS 16 transition options on a relevant sample number of contracts to understand directional impact possibilities.
  3. Evaluate current data availability for applying all three approaches, along with timescale and external resources requirements (if any) to gather missing data points.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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