Important changes to accounting standards come into force on January 1st, with significant implications for how leases are treated in accounts and simplified rules for balance recognition.
The latest amendments to FRS 102 are intended to further align Ireland accounting practices with IFRS international standards. FRS 102 was introduced in 2015 to replace the old Irish GAAP standards and applies to most Irish companies that do not have to follow the IFRS directly.
On-balance accounting for operating leases
The biggest changes relate to operating leases, or those where the lease contract permits use of an asset without any transfer of property rights. In Irish accounting practice, these types of leases have always been treated differently to finance leases, where the contract does stipulate the eventual transfer of ownership of the asset. Up until now, there’s been no requirement to record assets held under an operating lease on the company balance sheet.
But from January 1st, that will change. The amended FRS 102 includes a new balance sheet category for ‘right of use’ (RoU) assets – i.e. those held under an operating lease. The value of RoU assets must be recorded along with a corresponding lease liability, or the value of future lease payments.
The changes will be felt most keenly in the real estate sector, where leaseholds without transfer of ownership rights are the norm, and also in plant, machinery and vehicle hire. In practical terms, companies renting property and equipment that will eventually be returned to the owner face a switch from accounting for a fixed periodic rent expense to having to consider depreciation of the asset’s value and interest on the lease liability.
While the new rules will apply to most operating leases, exemptions remain for short-term leases under 12 months and for certain low-value assets like IT equipment. These can continue to be treated as ‘straight line’ rental expenses in profit and loss accounts only.
Revenue recognition based on transfer of control
The other key change to be aware of in FRS 102 is the introduction of a new revenue recognition model. Under the existing system, consideration of when revenue is earned has been based on analysis of transfer of risk and reward between vendor and customer.
From January 1st, emphasis will switch to considering when control of an asset changes hand. In support of this, the new standards introduce a much more prescriptive five-step model for working out when control transfers. This should provide greater clarity to accountants and finance teams, but also sets the bar higher for ensuring the standards are followed to the letter.
If you have not already reviewed your accounting practices in lieu of these changes, especially with regards to any operating leases you hold, the time to act is now. Importantly, the changes to accounting treatment could have real world consequences for your business. The removal of operating leases from operating expenses will push EBITDA up, while the depreciation of RoU assets and liabilities on the balance sheet will affect net profit calculations. These could all have implications for financial performance reporting, potentially affecting debt covenants and investor relations. To discuss the changes and find out how they affect you, get in touch to speak with one of our accounting experts in your area. Alternatively, fill the form below.
