Time to act on IFRS 16

The introduction of the IFRS 16 lease accounting standard in April will be a big change for many local authorities. It may be tempting to treat the change as something technical that only affects the Statement of Accounts that can therefore be conveniently parked until accounts are prepared in 2021.  But there will be other consequences that need addressing now.

IFRS 16 will see a large increase in many local authorities’ recorded level of debt for three main reasons: many operating leases will come onto the balance sheet; leases will be measured over their expected life rather than the minimum term; and lease liabilities will now include any inflationary uplifts.

3rd LATIF NORTH
March 25th, 2020, Manchester
Council treasury investment & borrowing

The sudden increase in debt means the Prudential Indicators that councils will shortly approve for 2020/21 will need to be amended. Suitably large increases will be required for the capital financing requirement, the operational boundary, the authorised limit and the ratio of financing costs to net revenue stream. Failure to increase the authorised limit could lead to the local authority breaking the law with its first loan or lease next financial year.

The remeasurement of lease liabilities for changes in inflation and the expected term will count as capital expenditure. The capital programme budget will therefore need to include the estimated cost of this expenditure in 2020/21.

Finally, a small number of leases may have an additional revenue cost under the new standard. Long-term index-linked leases can have an accounting charge for interest that exceeds the cash payment in the early years, and since minimum revenue provision cannot be negative, it will not be possible to make the revenue cost equal to the cash payment as is currently the case.

Once you understand IFRS 16, and CIPFA’s chosen approach to transition, it is relatively simple to calculate the impact on debt, financing costs, capital expenditure and revenue for any lease using a spreadsheet. The problem comes when you have hundreds of leases, in which case a software solution is probably required.

And remembering that a lease is any contract that gives you to right to control an identified asset that you don’t own, most local authorities will have hundreds of leases especially when schools are included. Think of photocopiers, room hire and mobile phone contracts signed by service managers and headteachers as well as the more obvious vehicle and IT leases procured centrally.

So rather than sticking your head in the sand and waiting a year, treat 2019/20 as an opportunity to get your lease portfolio up to date and then understand the revenue, capital and balance sheet implications of the transition to IFRS 16 in April. Your 2020/21 audit will run much smoother and cheaper if you can lay the groundwork now.

David Green is strategic director at Arlingclose Limited