Leasing standard implementation is now urgent priority for finance teams

It seems as though we have been talking about the new accounting standard for leases for decades. That is almost true – there was an exposure draft back in 2010 – although the new standard bears little resemblance to that proposal. And IFRS 16 was published three and a half years ago in January 2016.

In essence, the new standard ends the distinction between operating and finance leases from the lessee’s perspective. In future, the lessee will recognise a right-of-use asset and lease liability for all material leases with a term of more than 12 months.

We now have all of the accounting guidance that is needed to apply this standard in the public sector – the Treasury published an update to its application guidance in April 2019.

As Healthcare Finance went to press, we were awaiting the imminent publication of the final piece of the jigsaw – the guidance on how the standard will affect public sector budgets. Our understanding is that the budgeting will follow the accounting, which means that after 2020/21 all lease contracts will have a CDEL impact but the budgets will be revised to take account of the new requirements.

So, there is no longer any excuse to put off implementation. In fact, with a conservative estimate of 55,000 leases across the public sector, this should now be an urgent project. 

The application date may be 1 April 2020, but the 2020/21 financial plans will have to be completed before that and will have to reflect the financial impact of this standard.

Organisations that apply European Union adopted IFRS – the commercial sector, including a few companies within the Department of Health and Social Care group, such as NHS Property Services – are already deep into the application of this standard as it is applicable for accounting periods starting on or after 1 January 2019. The NHS can therefore learn a number of lessons from them.

Adopting this standard will require system change and will have an impact outside of the finance department. The standard requires that the question ‘does this contract contain a lease?’ be asked at a contract negotiation stage.

In some cases, the answer will clearly be ‘no’ as there is no asset involved in the contract. However, where the contract refers to an asset, explicitly or implicitly, then the lease assessment will have to be undertaken.

So, for example, managed service contracts and contracts for continuing care placements that look like service contracts may include a lease as a service is delivered using an identifiable asset. This means that any staff member who has delegated authority to sign a contract needs to know enough to at least ensure that they contact someone in finance to tell them about the new arrangement.

Recording all of the information necessary to assess the accounting treatment and make the appropriate calculations may need more than a spreadsheet. It will depend, in part, on the number and the complexity of the leases an organisation has.

We all know that spreadsheets can contain errors and it is far too easy to overwrite a cell or calculation, but using a spreadsheet does not require any further investment. There is a cost/benefit assessment to be made.

We asked NHS bodies back in January whether they were contemplating a lease management system, and only one had purchased one at that stage. We will be asking the question again as part of our year-end survey and it may well be that the answer will change.

The latest version of the application guidance from the Treasury (dated April 2019) provides a worked example of how lease liabilities will be discounted and how the discount rate will be issued to public sector bodies.

It also confirms that the right of use asset will be subsequently measured using a fair value or revalued amount less subsequent depreciation rather than cost.

Initially, the Treasury had indicated that the cost model would be used meaning assets would be measured at cost less accumulated depreciation. However, this would not be consistent with the approach taken for owned assets, so the revaluation model will be adopted.

Having said that, it is expected that for most leases, a suitable proxy for fair value or current value in existing use will be historic depreciated cost. Whether this proxy can be used will be assessed on the same basis as currently happens for purchased assets. For leases that do not contain provision to regularly update the lease payment, and where the value of the underlying asset is likely to fluctuate significantly, a professional revaluation will be needed.

This is most likely to be the case for property leases. The example in the guidance involves a 30-year lease with only one rent review scheduled for the end of year 15 where the market for the property is active and volatile.