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New accounting standard, IFRS 16 Leases — impact on facility agreements

On 13 January 2016, the International Accounting Standards Board (IASB) published a new accounting standard relating to the accounting treatment of leases―IFRS 16 Leases. The new accounting standard will take effect from 1 January 2019.

The IASB is seeking to ensure greater transparency in financial reporting under GAAP and IFRS. The new accounting standard will require lessees to recognise assets and liabilities for all identified leases (including so-called operating leases) of more than 12 months on their balance sheets. For many entities, the amount of newly recognised lease liabilities is expected to be significant.

The IASB and the US Financial Accounting Standards Board worked together on IFRS 16 Leases (and like changes to US GAAP) with a view to converging the accounting treatment for leases under IFRS and US GAAP, principally by agreeing that operating leases should be reflected on the lessee’s balance sheet. However, there are some differences under the two reporting regimes that will affect the presentation of leases in the financial statements. For example, under US GAAP, leases that have always been reported on balance sheet will continue to be reported separately from leases that are to be reported on balance sheet as a result of the changes, whereas IFRS will not provide for such a distinction. This article considers the impact on financial covenants from the IASB treatment of leases under IFRS 16 Leases.

In considering the changes, the IASB and the US Financial Accounting Standards Board ran a lengthy consultation process. It was noted that the loan documentation terms for many current deals will not address these changes. Borrowers and their lenders will need to consider the effect of IFRS 16 Leases on the calculations to be made under their facility agreements, in particular on any financial covenants or restrictions relating to the incurrence of financial indebtedness contained in such agreements.

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