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IFRS 16 Leases and Its Impact on Company’s Financial Reporting, Financial Ratios and Performance Metrics

Author

Listed:
  • Eleonora Stancheva-Todorova

    (Sofia University, Faculty of Economics and Business Administration, Bulgaria)

  • Nadya Velinova-Sokolova

    (Sofia University, Faculty of Economics and Business Administration, Bulgaria)

Abstract

The new Leases Standard, IFRS 16, was released by the International Accounting Standards Board in January 2016 and superseded IAS 17 Leases for reporting periods beginning on or after 1 January 2019. The new rules introduce asymmetrical models of the lessee and lessor accounting. Finance lease/operating lease distinction is no longer relevant for lessees but has been retained for lessors. The impact of IFRS 16 depends on a company’s relative number of existing operating lease arrangements and varies across industries. In this paper we have discussed the IFRS 16 effects on lessee’s financial statements, financial ratios and key performance indicators. These effects have been illustrated in the case of a food retailer as retailers will be most heavily impacted by the changes in the lease requirements. The implementation of the new accounting rules will lead to an increase in leased assets (the right-of-use assets) and financial liabilities on the balance sheet of the lessees with material former off-balance sheet leases and their EBITDA will increase substantially. To be more precise, we have split the analysis of the effects on company’s profit or loss into “individual lease” and “portfolio of lease” cases. In both cases there will be a reduction in entity’s equity compared to the former rules of IAS 17. The expected effects on profit before tax will be insignificant for many companies because of the “portfolio” effect. Operating profit will increase due to the reclassification of former lease expenses into depreciation and amortisation expenses and finance costs. Entities with material off-balance sheet lease commitments will encounter significant changes in their key financial metrics such as leverage ratio, return on invested capital and valuation multiples. Their leverage will increase significantly and interest coverage will decrease. The effect on company’s debt covenants from IFRS 16 implementation has also been discussed.

Suggested Citation

  • Eleonora Stancheva-Todorova & Nadya Velinova-Sokolova, 2019. "IFRS 16 Leases and Its Impact on Company’s Financial Reporting, Financial Ratios and Performance Metrics," Economic Alternatives, University of National and World Economy, Sofia, Bulgaria, issue 1, pages 44-62, March.
    • Handle: RePEc:nwe:eajour:y:2019:i:1:p:44-62
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    Citations

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    Cited by:

    1. Białek-Jaworska Anna & Dobroszek Justyna & Szatkowska Paulina, 2022. "Does the IFRS 16 affect the key ratios of listed companies? Evidence from Poland," International Journal of Management and Economics, Warsaw School of Economics, Collegium of World Economy, vol. 58(3), pages 299-315, September.
    2. Slater, Philip J. & Greenfield, Alfred & Godfrey, Earl & Policastro, Felice, 2024. "Losing altitude: The impact of new leasing standards on the liquidity, leverage, profitability and valuation of U.S. and European airlines," Journal of Air Transport Management, Elsevier, vol. 117(C).

    More about this item

    Keywords

    financial ratios; IFRS 16 application; effects; company’s financial statements; performance metrics;
    All these keywords.

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M48 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Government Policy and Regulation

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