Draft Comment Letter - Post-Implementation Review of IFRS 16 Leases

Dr Andreas Barckow Chair International Accounting Standards Board Columbus Building 7 Westferry Circus Canary Wharf London E14 4HD

[Date]

Dear Dr Barckow

1The UK Endorsement Board (UKEB) is responsible for endorsement and adoption of IFRS Accounting Standards for use in the UK and therefore is the UK's National Standard Setter for IFRS Accounting Standards. The UKEB also leads the UK's engagement with the IFRS Foundation on the development of new standards, amendments and interpretations. This letter is intended to contribute to the Foundation's due process. The views expressed by the UKEB in this letter are separate from, and will not necessarily affect the conclusions in, any endorsement and adoption assessment on new or amended international accounting standards undertaken by the UKEB.

2There are currently approximately 1,500 entities with equity listed on the London Stock Exchange that prepare their financial statements in accordance with IFRS.¹ In addition, UK law allows unlisted companies the option to use IFRS and approximately 14,000 such companies currently take up this option.²

3The UKEB welcomes the opportunity to provide comments on the International Accounting Standards Board (IASB)'s Post-implementation Review of IFRS 16 Leases (PIR). Given that: a) a PIR is primarily focused on assessing whether the effects of applying a standard are as intended; and, b) the IASB has a number of active and pipeline projects in its workplan;

the UKEB's work has focused on identifying substantial and pervasive matters only.

4In developing this letter, the UKEB consulted with a range of stakeholders in the UK, including conducting a survey of preparers on the ongoing costs and benefits of applying the Standard.

5The UKEB has [tentatively] concluded: a) There is general support for IFRS 16, and no fatal flaws have been identified. b) The quality and comparability of financial information about leases is largely as expected. IFRS 16 disclosures are more useful than those previously reported under IAS 17. c) The ongoing costs of applying IFRS 16 appear to remain high. However, this was identified as a probable outcome in the IASB's Effects Analysis for IFRS 16. d) Consistent with the UKEB's response to the IASB's Post-implementation Review of IFRS 15 Revenue from Contracts with Customers we have not been made aware of any significant issues relating to the interaction between IFRS 15 and the requirements of IFRS 16 Leases.

6If you have any questions about this response, please contact the UKEB project team at [email protected].

Yours sincerely

Pauline Wallace Chair UK Endorsement Board

Appendix A: Questions on Request for Information: Post-implementation Review IFRS 16 Leases

Overall assessment of IFRS 16

Question 1—Overall assessment of IFRS 16

a) In your view, is IFRS 16 meeting its objective and are its core principles clear? If not, please explain why not. b) In your view, are the overall improvements to the quality and comparability of financial information about leases largely as the IASB expected? If your view is that the overall improvements are significantly lower than expected, please explain why. c) In your view, are the overall ongoing costs of applying the requirements and auditing and enforcing their application largely as the IASB expected? If your view is that the overall ongoing costs are significantly higher than expected, please explain why, how you would propose the IASB reduce these costs and how your proposals would affect the benefits of IFRS 16.

Objectives

The objective of IFRS 16 “is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions. This information gives a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance and cash flows of an entity.”³

A1The UKEB considers that the Standard is meeting its objective and that the core principles are clear. We have not been made aware of any fatal flaws in IFRS 16.

Improvements

IFRS 16 was expected to result in a more faithful representation of a company's assets and liabilities and greater transparency about the company's financial leverage and capital employed.

This was expected to⁴: a) reduce the need: i. for investors and analysts to make adjustments to amounts reported on a lessee's balance sheet and income statement; and ii. for companies to provide ‘non-GAAP’ information about leases. IFRS 16 provides a richer set of information than was available applying IAS 17, giving further insight into a company's operations. b) improve comparability between companies that lease assets and companies that borrow to buy assets. c) create a more level playing field in providing transparent information about leases to all market participants. A company will more accurately measure assets and liabilities arising from leases applying IFRS 16 as compared to the estimates made by only more sophisticated investors and analysts when companies applied IAS 17.

A2The UKEB considers that the quality and comparability of the financial information about leases have been improved, and those overall improvements are not significantly lower than expected.

A3While some users have suggested that they are recasting IFRS 16 disclosures back to IAS 17 numbers, the UKEB's Investor Advisory Group believes this effect is most likely transitory – mainly arising from long-dated leases and analysts' need for longer term trend data.

Ongoing Costs

IFRS 16 eliminated the classification of leases as either operating leases or finance leases for a lessee. Instead, almost all leases are treated in a similar way to finance leases applying IAS 17. Finance lease accounting was generally seen as more complex, and therefore more costly, to undertake, when compared to operating lease accounting.

The IASB expected that once a company had updated its systems to provide the information required by IFRS 16, the costs to be only marginally higher compared to those incurred when applying IAS 17. ⁵

The IASB believed the data required to apply IFRS 16 was similar to that needed to apply IAS 17, with the exception of discount rates that are required for all leases when applying IFRS 16.

The IASB did not expect that companies would need to reassess many lease liabilities. Even when a lease contains options to extend or terminate the lease, the IASB concluded that remeasurement of the lease liability is unlikely to be onerous because the threshold for reassessment is high.

The IASB concluded that changes to the lease term—and thereby a reassessment of the discount rate and lease payments—are expected only in a small number of cases.

A4The UKEB acknowledges that the ongoing costs of applying IFRS 16 appear to remain high. However, this is not wholly unexpected considering the IASB's Effects Analysis for IFRS 16 anticipated that there would be additional costs related to⁶: a) Determining discount rates; b) Initial direct costs; and, c) Remeasurement of lease assets and lease liabilities.

A5Outreach with our stakeholders suggested that there may be opportunities for mitigating some of these ongoing costs by considering simplification of some of the requirements in IFRS 16. The main drivers of the ongoing costs of applying IFRS 16 they highlighted are: a) remeasurement of lease assets and lease liabilities; b) collecting information for disclosures; and c) determining the appropriate discount rate.

A6Stakeholders also identified the short-term lease and low-cost exemptions as being less helpful than expected. They noted: a) The definition of short-term lease in IFRS 16 Appendix A Defined Terms creates a "brightline" of "12 months or less". They suggest this may be too restrictive in some circumstances. b) The guidance in IFRS 16 BC100, with the "US$5,000" is often treated as a "brightline" which then requires recognition of otherwise immaterial leases.

A7The UKEB has not had the opportunity to undertake the detailed research required to identify specific solutions at this time. However, the IASB could explore: a) Simplifying the discount rate requirements. For example, allowing a lessee to use its obtainable borrowing rate as an alternative to the lessee's incremental borrowing rate. b) Removing or amending the perceived "rule-based" low-value and short-term exemptions to support a more principle-based application of materiality to accounting for lease arrangements.

Usefulness of information resulting from lessees' application of judgement

Question 2—Usefulness of information resulting from lessees' application of judgement

a) Do you agree that the usefulness of financial information resulting from lessees' application of judgement is largely as the IASB expected? If your view is that lessees' application of judgement has a significant negative effect on the usefulness of financial information, please explain why. b) Do you agree that the requirements in IFRS 16 provide a clear and sufficient basis for entities to make appropriate judgements and that the requirements can be applied consistently? If not, please explain why not. c) If your view is that the IASB should improve the usefulness of financial information resulting from lessees' application of judgement, please explain: i. what amendments you propose the IASB make to the requirements (and how the benefits of the solution would outweigh the costs); or ii. what additional information about lessees' application of judgement you propose the IASB require entities to disclose (and how the benefits would outweigh the costs).

A8The UKEB considers that financial information resulting from lessees' application of judgement contributes to enhanced comparability as it allows an entity to present its assessment of the facts and circumstances.

Usefulness of information about lessees' lease-related cash flows

Question 3—Usefulness of information about lessees' lease-related cash flows

Do you agree that the improvements to the quality and comparability of financial information about lease-related cash flows that lessees present and disclose are largely as the IASB expected? If your view is that the improvements are significantly lower than expected, please explain why.

A9The UKEB's considers that lease-related cash flows should be addressed as part of the Statement of Cash Flows and Related matters project currently being undertaken by the IASB.

A10UKEB research⁷ related to the project on Cash Flows and Related Matters has indicated that stakeholders want better information on cash flows related to leases. Current disclosures do not generally allow users to link information between the statement of financial position, the income statement and the cash flows. This is particularly relevant where there has been merger and acquisition activity.

Ongoing costs for lessees of applying the measurement requirements

Question 4—Ongoing costs for lessees of applying the measurement requirements

a) Do you agree that the ongoing costs of applying the measurement requirements in IFRS 16 are largely as the IASB expected? If your view is that the ongoing costs are significantly higher than expected, please explain why, considering how any entity-specific facts and circumstances (such as IT solutions) add to these costs. b) If your view is that the ongoing costs are significantly higher than expected, please explain how you propose the IASB reduce these costs without a significant negative effect on the usefulness of financial information about leases.

A11As noted above (A4), the UKEB acknowledges that the ongoing costs of applying IFRS 16 appear to remain high. However, this is not unexpected considering the IASB's Effects Analysis for IFRS 16. There may be opportunities for mitigating some of these ongoing costs by considering simplification of some of the requirements in IFRS 16.

A12Please see response to Question 1.

Potential improvements to future transition requirement

Question 5—Potential improvements to future transition requirements

Based on your experience with the transition to IFRS 16, would you recommend the IASB does anything differently when developing transition requirements in future standard-setting projects? If so, please explain how your idea would ensure: a) users have enough information to allow them to understand the effect of any new requirements on entities' financial performance, financial position and cash flows; and b) preparers can appropriately reduce their transition costs when implementing new requirements for the first time.

A13The UKEB is not [currently] aware of any significant concerns with the transition requirements.

A14Preparers have indicated to the UKEB that they appreciated the practical expedient available on transition, this simplified their accounting at transition date.

A15However, it is possible that not requiring full retrospective application has contributed to some users recasting IFRS 16 disclosures back to IAS 17 numbers.

Other matters relevant to the assessment of the effects of IFRS 16

Question 6.1—Applying IFRS 16 with IFRS 9 to rent concessions

a) How often have you observed the type of rent concession described in Spotlight 6.1? b) Have you observed diversity in how lessees account for rent concessions that has had, or that you expect to have, a material effect on the amounts reported, thereby reducing the usefulness of information? c) If your view is that the IASB should act to improve the clarity of the requirements, please describe your proposed solution and explain how the benefits of the solution would outweigh the costs.

Spotlight 6.1: The IFRS Interpretations Committee (IFRIC) discussed how lessors should account for rent concessions involving the forgiveness of lease payments, which partially extinguishes the lessee's lease liability. They identified two ways for lessees to account for this: a) IFRS 9 Approach: Recognise the effect of forgiven lease payments in profit or loss at the date of the concession. b) IFRS 16 Approach: Recognise the effect as a decrease in the carrying amount of the right-of-use asset.

The Committee suggested that the IASB should clarify the distinction between a lease modification and an extinguishment of a lease liability, as the current lack of clarity could impact the usefulness of financial information.

A16The UKEB is aware of the IFRIC suggestion and acknowledge that there could be diversity in practice. However, the UKEB has not [to date] been made aware of pervasive concerns with applying IFRS 16 with IFRS 9 to rent concessions in the UK.

Question 6.2—Applying IFRS 16 with IFRS 15 when assessing whether the transfer of an asset in a sale and leaseback transaction is a sale

a) How often have you observed difficulties in assessing whether the transfer of an asset in a sale and leaseback transaction is a sale? b) Have you observed diversity in seller-lessees' assessments of the transfer of control that has had, or that you expect to have, a material effect on the amounts reported, thereby reducing the usefulness of information? c) If your view is that the IASB should act to help seller-lessees determine whether the transfer of an asset is a sale, please describe your proposed solution and explain how the benefits of the solution would outweigh the costs.

A17The UKEB's view remains consistent with its response to the IASB's Post-implementation Review of IFRS 15 Revenue from Contracts with Customers (Final Comment Letter - Post-Implementation Review of IFRS 15 Revenue from Contracts with Customers), "We have not been made aware of any significant issues relating to the interaction between IFRS 15 and the requirements of other IFRS, in particular IFRS 16 Leases".

Question 6.3—Applying IFRS 16 with IFRS 15 to gain or loss recognition in a sale and leaseback transaction

a) Do you agree that restricting the amount of gain (or loss) an entity recognises in a sale and leaseback transaction results in useful information? b) What new evidence or arguments have you identified since the IASB issued IFRS 16 that would indicate that the costs of applying the partial gain or loss recognition requirements, and the usefulness of the resulting information, differ significantly from those expected? c) If your view is that the IASB should improve the cost-benefit balance of applying the partial gain or loss recognition requirements, please describe your proposed solution.

A18The UKEB has [to date] not been made aware of any specific issues around applying the partial gain or loss recognition requirements.

Question 6.4—Other matters relevant to the assessment of the effects of IFRS 16

Are there any further matters the IASB should examine as part of the postimplementation review of IFRS 16? If so, please explain why, considering the objective of a post-implementation review.

A19The UKEB [to date] has not identified any other significant matters relevant to the assessment of the effects of IFRS 16.

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