IFRS 16 Leases: impact on financial statements under the Swiss Code of Obligations

IFRS 16 Leases brings fundamental changes for preparers of IFRS financial statements. In addition to the new accounting rules under IFRS, entities should also consider the potential impact on financial statements prepared under the Swiss Code of Obligations (Swiss CO).

Gesa Mannigel

Gesa Mannigel

Director Accounting Consulting Services, dipl. Auditor, PwC Switzerland

Irène Lüthy-Jegge

Irène Lüthy-Jegge

Senior Manager Accounting Consulting Services, dipl. Auditor, PwC Switzerland

The International Financial Reporting Standard on Leases (IFRS 16) introduces fundamental changes for lessees and therefore this article focuses on the impact of the standard from the lessee’s point of view. The biggest impact of IFRS 16 will be felt by lessees whose leases that were categorised as operating under IAS 17 as under IFRS 16, a right-of-use asset and the corresponding lease liabilities are now recognised on the balance sheet.

IFRS preparers have to make sure all contracts with a lease component are categorised accordingly. IFRS 16 defines a lease as a contract, or part of a contract, that conveys the right to use an asset for a period of time in exchange for consideration; for example in a rental agreement for property. With the introduction of IFRS 16, the standard setter wanted to ensure a more faithful representation of a lessee’s assets and liabilities on the balance sheet.

The Swiss Code of Obligations (Swiss CO) does not contain specific accounting rules for leases. However, Art. 959 CO does specify what items must be recognised on the balance sheet as assets and liabilities. According to the accounting literature, whether leases result in assets and liabilities being presented on the balance sheet, is up to the discretion of the preparing entity. Taking an economic standpoint, leases would most appropriately be recognised on the balance sheet of lessees as they are benefitting from the use of the asset. Conversely, taking a more legalistic approach since the lessee does not have legal ownership of the asset, it would not be recognised on the balance sheet. Given these two divergent approaches available, entities preparing Swiss CO financial statements have to decide whether leases are recognised on the balance sheet or merely disclosed in the notes.

Although the introduction of IFRS 16 does not directly influence this decision, IFRS preparers might reconsider their preferred approach to lease accounting under the Swiss CO. In our opinion, leases can be recognised under Swiss CO in accordance with the same principles as under IFRS 16 and the accounting aligned between the 2 sets of books.

Treatment of transition effects in Swiss CO financial statements

IFRS 16 is mandatory for reporting periods beginning on or after 1 January 2019. The standard can be applied either fully retrospectively, which results in an adjustment in the opening balance sheet of the earliest period presented and comparative amounts restated for each prior period presented, or through a modified approach, in which the opening balance of retained earnings on the date of initial application is adjusted.

Regardless of the approach chosen, existing leases will be subject to transition effects. Such effects are recognised in the opening balance sheet of the IFRS financial statements and adjusted via retained earnings.

IFRS preparers must change their accounting policy for operating leases due to the implementation of the new standard. For Swiss CO financial statements the question arises; what causes an accounting policy change under Swiss CO? With respect to IFRS, one could argue the change to IFRS 16 also causes a reassessment of the accounting policy under Swiss CO, which may result in the recognition of a right-of-use asset and a financial liability.

Contrary to IFRS, retrospective recognition of transition effects is not permitted in Swiss CO financial statements; instead, transitions are made prospectively. The corresponding effects are recognised in the current period’s income statement, typically classified as extraordinary and explained in the notes. The prior year’s financial statements serve as the basis for tax purposes and the appropriation of net profits.

Typically, the effects of transition lead to extraordinary line items requiring disclosure in the income statement and in the notes. When the modified transition method is applied under IFRS, the new standard requires IAS 17 operating lease liabilities as at 31 December 2018 to be reconciled with the IFRS 16 lease liability recognised on the balance sheet at 1 January 2019. The Swiss CO requires no such reconciliation. It does, however, require explanations of extraordinary, non-recurring or prior-period items in the income statement. As part of this disclosure, the notes have to include, as appropriate, explanations of the previous and new treatment of leases, including changes to the accounting policies.

There are essentially two options for presentation in Swiss CO financial statements:

Option I: Disclosing leases in the notes (see figure 1) or

Option II: Recognising leases on the balance sheet as of the introduction of IFRS 16 (see figure 2).

With either option, the preparer must disclose the accounting policies in the notes.

Figure 1: Leases – presentation option 1

In Swiss CO financial statements, leases are disclosed in the notes.

Under this presentation option, temporary tax differences will arise in the IFRS financial statements amounting the net lease liability. These temporary differences must be tracked and the tax effect reflected in the IFRS statements going forward - which leads to additional work.
Below is an example of an accounting policy disclosure under option 1:

Leasing contracts:

Lease payments are recognised as an expense in the period in which they occur. Under the strictly contractual interpretation of leasing contracts, right-of-use assets and lease liabilities are not recognised on the balance sheet. In Note X, the residual amount of lease liabilities is disclosed as per Art. 959c para 2, point 6 of the Swiss Code of Obligations.

Note X: residual amount of lease liabilities by term:

Up to 1 year 1–5 years Over 5 years
Figure 2: Leases – presentation option 2

Leasing contracts are recognised on the balance sheet of the Swiss CO financial statements after the implementation of IFRS 16

This option involves adopting the IFRS 16 figures for the Swiss CO financial statements. Accordingly, no temporary tax differences arise. There is, however, a transition effect as leasing contracts have not been recognised on the balance sheet until now.

When the full retrospective transition method is applied a net liability will exist at the transition date for current leases because of the frontloading effect of the interest charge . Whilst the right-of-use asset is depreciated on a linear basis, the decline in the lease liability is initially relatively minor. This due to the fact that in the initial periods the interest component is very high and the amortisation component correspondingly small; this relationship changes over the life of the agreement. Adjustments for effects from previous years under Swiss CO are only permissible in the current year’s income statement, which in the case of a net lease liability leads to an expense usually classified as extraordinary.

If the modified approach is applied, the right-of-use asset can be recognised at the amount of the lease liability (corrected for any prepaid or accrued lease payments).

If an entity, in exercising its judgement, decides that right-of-use assets from lessee arrangements are to be capitalised, the further question arises as to what information has to be disclosed in the notes. Below is an example illustrating an accounting policy and the relevant information in the notes.

In this example, the financial statements, which contain all lease agreements except those with short lease terms (up to 12 months) and underlying assets with a low value, the right-of-use asset is capitalised on the balance sheet and depreciated over the term of the lease agreement for the leased asset. On initial recognition, the right-of-use asset corresponds to the present value of the lease liability on commencement of the lease. The term of the lease is determined by the firmly agreed term of the contract and any extension options. The lease liability corresponds to the present value of future lease payments assuming an average implicit interest rate of X% reduced by the amount of the amortisation payments.

Both the right-of-use asset and the lease liability are recognised on the balance sheet. Below is an example for the annual disclosure under the statutory disclosure requirements.

Information on the balance sheet

The balance sheet value of the right-of-use assets is disclosed as follows for each class of assets’ underlying leases:

Balance sheet item Asset class Useful life Amount on 31 December XX
Office rent X years CHF X
Right-of-use assets Vehicles X years CHF X
Rent for IT equipment X years CHF X
Lease liabilities CHF X

Income statement

Income statements items Amount 1 January – 31 December XX
Depreciation of right-of-use assets CHF X
Interest expense, lease liabilities CHF X

Cash flow statement: separate lines

Cash flow statement item Amount 1 January – 31 December XX
Cash flow from operating or financing activities: Interest expense, lease liabilities CHF X
Cash flow from financing activities: Amortisation payments, lease instalments CHF X

Tax considerations

The treatment of transition effects under option II could lead to an impact on current taxes. Changes in accounting policies under Swiss CO occurring because of changes in the consolidated reporting standard rather than changes in the law are unusual. However, in our view the key principle that the taxation of a Swiss entity is based on the Swiss CO financial statements also applies in instances where changes have been made to an entity’s accounting policies, provided such changes are sufficiently justified. This means that transition effects would in principle also have an effect on taxable net profit. In our opinion, there are no apparent reasons to diverge from the Swiss CO financial statements for tax purposes when changing the accounting policies due to IFRS 16.

In practice, it would always be appropriate to seek a dialogue with the tax authorities and explain the background of these changes. Significant extraordinary income or expenses in particular are often challenged. It also makes sense from a taxation perspective to include a detailed description and background of transition effects in the notes to the financial statements.

In a nutshell

Under the new standard, lessees will have to show all material leases on the IFRS balance sheet by recognising a lease liability and a corresponding right-of-use asset. For IFRS preparers in Switzerland, the question then arises as to whether they can treat leases the same way in their Swiss CO financial statements as under IFRS 16. The decision on whether a lease gives rise to assets and liabilities that are recognised is up to the preparer’s discretion. The preparer must disclose the accounting principles for leases in the notes.

Entities adjust for the transition in lease accounting in their IFRS financial statements retrospectively (with an optional modified approach) via retained earnings. However, in their Swiss CO financial statements they must state transition effects prospectively in the income statement at the date of the transition. Since a change in the accounting policy leases might lead to significant extraordinary impacts, entities should provide appropriate explanations in the notes to the financial statements which is also essential to ensure acceptance for tax purposes.

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Gesa Mannigel

Gesa Mannigel

Director Accounting Consulting Services, dipl. Auditor, PwC Switzerland

+41 58 792 24 54

Irène Lüthy-Jegge

Irène Lüthy-Jegge

Senior Manager Accounting Consulting Services, dipl. Auditor, PwC Switzerland

+41 58 792 61 06

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