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When IFRS 16 becomes effective in 2019, it will result in a substantial change to many companies’ balance sheets. All leases will be recognized as assets and liabilities by lessees, better reflecting the underlying economics.
This change is expected to affect roughly half of all listed companies and will not be popular with everyone. Accounting changes are often controversial and can be met with warnings of adverse economic effects, defaults on debt covenants, and costs of system changes. The IASB has looked at all these possible risks very carefully and has concluded that the risks and costs are manageable.
First of all, IFRS 16 will not put the leasing industry out of business. Leases will remain attractive as a flexible source of finance. It will remain appealing to companies to lease assets so that they do not bear the risks of owning them. While the cosmetic accounting benefits of leasing will disappear, the real business benefits of leasing will not change as a result of the new standard.
Secondly, the IASB thinks it highly unlikely that the improved visibility of lease obligations will lead to significant effects in terms of the cost of borrowing and debt covenants. The majority of credit providers and rating agencies already take lease obligations into account when evaluating a company’s ability to pay its bills, albeit often in an imprecise manner. Moreover, many debt covenants are unaffected by changes in accounting requirements.
In sum, the IASB expects the benefits of IFRS 16 to greatly outweigh its costs. The new visibility of all leases will lead to better informed investment decisions by investors, and to more balanced lease-versus-buy decisions by management. IFRS 16 will lead to improved capital allocation, which should be beneficial for economic growth.