Why IASB introduced IFRS 16 to replace the IAS 17 ? (Leases)

The International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) for companies to follow when preparing their financial statements. One of the most significant changes to the IFRS in recent years is the introduction of IFRS 16, which deals with lease accounting. This new standard replaced IAS 17, which had been in use for several decades. In this article, we will explore the reasons behind the introduction of IFRS 16 and why it was necessary to replace IAS 17.

IAS 17: The Old Lease Accounting Standard

IAS 17, the old lease accounting standard, was introduced in 1982 and had not seen any significant changes since then. Under this standard, companies were required to classify their leases as either finance leases or operating leases. Finance leases were treated as if the company had purchased the asset and were recognized on the balance sheet as assets and liabilities. Operating leases, on the other hand, were treated as expenses and were not included on the balance sheet.

This meant that companies could use operating leases to avoid reporting lease liabilities on their balance sheets, which could have a significant impact on the financial statements. Many companies used this loophole to make their financial statements appear stronger than they actually were, leading to concerns about the transparency and accuracy of financial reporting.

The Introduction of IFRS 16

IFRS 16, which was introduced in January 2019, changed the way companies account for leases. Under this new standard, companies are required to recognize all leases on their balance sheets, whether they are finance leases or operating leases. This means that companies can no longer use operating leases to avoid reporting lease liabilities on their balance sheets.

IFRS 16 also requires companies to separate the lease liability and the right-of-use asset on their balance sheets. This means that companies must recognize the lease liability as a liability and the right-of-use asset as an asset. The lease liability must be measured at the present value of lease payments, while the right-of-use asset must be measured at the same amount as the lease liability, adjusted for any prepayments, lease incentives, and initial direct costs.

The Reasons behind the Introduction of IFRS 16

There were several reasons behind the introduction of IFRS 16, including:

1. Transparency: The introduction of IFRS 16 was aimed at increasing the transparency and accuracy of financial reporting. By requiring companies to recognize all leases on their balance sheets, the new standard ensures that financial statements provide a more accurate picture of a company's financial position.
2. International Consistency: Another reason for the introduction of IFRS 16 was to promote international consistency in lease accounting. Prior to the introduction of IFRS 16, different countries had different lease accounting standards, which made it difficult for investors to compare financial statements across borders. IFRS 16 provides a single, global standard for lease accounting, making it easier for investors to compare financial statements across countries.
3. Improved Decision Making: By requiring companies to recognize lease liabilities and right-of-use assets on their balance sheets, IFRS 16 provides investors and other stakeholders with more information about a company's financial position. This can help to improve decision making, as investors can make more informed decisions about investing in a company.
4. Closing the Loophole: As mentioned earlier, many companies used operating leases to avoid reporting lease liabilities on their balance sheets. The introduction of IFRS 16 closes this loophole, ensuring that companies cannot use operating leases to manipulate their financial statements.

Conclusion

The introduction of IFRS 16 was a significant change to lease accounting standards, replacing the outdated IAS 17. The new standard was introduced to increase transparency, promote international consistency, improve decision making