IFRS 16

What it means

IFRS 16 is the IFRS standard on leases, under which lessees recognise almost all leases on the balance sheet as a right-of-use asset and a lease liability. For lessees it abolished the distinction between operating and finance leases, which still applies under Slovak rules.

Instead of rent expense, the lessee recognises depreciation of the right-of-use asset and interest on the liability. Total costs over the lease term are the same, but they are higher in the early years because interest on the larger liability is greatest at the start.

The standard significantly changes EBITDA and leverage for companies with many leases, such as retail chains, airlines or logistics firms. EBITDA rises because rent disappears from it, while reported debt increases at the same time.

How it works in practice

For each lease agreement, the lease term must be determined, including extension options the company is reasonably certain to exercise, along with the discount rate. The liability is the present value of future payments, and the right-of-use asset is derived from it.

Exemptions exist for short-term leases of up to 12 months and leases of low-value assets, which the lessee may continue to expense directly. With many contracts, software that handles calculations and changes automatically helps.

Slovak subsidiaries of foreign groups keep their books under Slovak procedures, where operating leases remain expenses, and prepare IFRS 16 adjustments for the group. These include lessor incentives such as a fit-out contribution or a rent-free period.

What to watch out for

The change in ratios under IFRS 16 can affect loan covenants. If the bank measures leverage under IFRS, lease liabilities will increase it, so loan agreements should state clearly whether ratios are calculated before or after IFRS 16.

Changes to leases, such as extensions, rent changes or indexation, require the liability to be remeasured. Without good contract records they are easily missed, and reported figures stop reflecting reality.