A major shift in accounting standards affecting leasing arrangements will take effect in 2019. In January of that year, the Philippines will adopt the International Financial Reporting Standard or IFRS 16, the new accounting standard governing leases.
According to IFRS, the body that sets international accounting standards, the objective of IFRS 16 is to “report information that (a) faithfully represents lease transactions and (b) provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.” It adds: “To meet that objective, a lessee should recognize assets and liabilities arising from a lease.”
IFRS 16 requires a single lease accounting model, and this means lessees must recognize assets and liabilities for all leases with a term of more than 12 months. “A lessee is required to recognize a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments,” the IFRS explains.
The single lease accounting standard effectively blurs the distinction between the two types of leases that we have described in past issues of this column: the financial lease and the operating lease.
A financial lease, as we have explained, is similar to a bank loan, with the leasing company extending credit to finance the purchase of an asset. The difference between a financial lease and a loan is that ownership of the asset stays with the lessor while the lessee pays for the equipment until the end of the finance lease. At the end of the lease – normally a three-to five-year period – the lessor executes a deed of sale to transfer ownership of the asset to the lessee.
An operating lease is a “true lease,” because the lessee pays only for the use of the asset. The asset is not turned over to the lessee at the end of the lease contract. Currently, operating leases are “off-balance-sheet” items, as no asset (or the right to use the asset) is recognized. Without an asset, there is also no liability.
Under new accounting rules to be adopted beginning 2019, financial leases will continue to be treated as they are – with the right to use an asset under a financial lease recorded under the assets section of the balance sheet, and the monthly obligations of the lessor to the lessee reflected under liabilities.
Operating leases will have to be treated the same way.
Three advantages remain
Major industry players like BDO Leasing and Finance Inc. do not expect a huge disruption from the impending shift to IFRS 16.
Roberto Lapid, vice chairman and president of BDO Leasing, told The Manila Times lessees would have to make adjustments come 2019.
“For us, it’s business as usual. There is no effect on us,” he says.
But there will still be advantages, even for BDO Leasing clients with operating leases, Lapid says.
“One is we don’t have chattel mortgage feels for both financial leases and operating leases. Secondly there are yet no changes in the tax consideration, so if you do an operating lease, the rental expense will be deductible from the income statement,” he explains.
“If you do a financial lease, it’s still the same as a loan, you deduct the interest expense, then you have the non-cash expense, which is depreciation,” he adds.
There is a third advantage for BDO Leasing clients with operating leases, which are serviced by BDO Rental, Inc., a wholly owned subsidiary.
BDO Rental is registered with the Bureau of Internal Revenue as a value-added tax or VAT taxpayer, which means the VAT payments may be used by a lessee as input VAT credits to reduce VAT payments.
“If the lessee would like to take advantage of the VAT—value-added tax—they book the lease in BDO Rental,” Lapid says.
Lapid says there is no conscious effort to focus on financial leases ahead of the shift to IFRS 16, as such arrangements already constitute the bulk of the business.
Says Lapid: “As a natural force, financial lease still takes precedence over the operating lease to more borrowers. Because the primary objective is for them to save on chattel fees, it will have no effect on our market.”