With the introduction of the new International Financial Reporting Standard (IFRS) 16
, we are being told that change is afoot and to beware that the way companies’ performances are monitored will be changing.
So what is a tangible way in which IFRS 16 is affecting how companies’ financial performance is evaluated?
Well, analysts beware because change is coming to what EBITDA does for you analysis-wise!
EBITDA – Earnings Before Interest, Tax, Depreciation and Amortisation
When analysing a company’s capability to generate profits, analysts often look at a measure called Earnings Before Interest, Tax, Depreciation and Amortisation, typically referred to as “EBITDA”.
Under IAS 17, the previously effective standard, many lease transactions were accounted for as operating leases: this meant that the leased assets were not recognised in the balance sheet of the lessee.
Additionally, under IAS 17, rentals were presented in the profit and loss account in the period in which they were incurred. That meant that rental payments were included in the calculation of EBITDA AND had a negative impact on it.
The Changes Afoot
In accordance with the new IFRS 16, most lease agreements (up until recently classified as operating leases under IAS 17) will now be presented in a way similar to finance leases.
That means that the asset subject to a lease agreement will instead be recognised in the books of the lessee and will be depreciated over the lifetime of the lease.
But what does this mean for EBITDA, which is a measure that cannot include Depreciation?
One of the consequences of the new approach to leases is an increase of EBITDA in all entities, which previously relied on operating leases.
Why the increase? Because under IFRS 16, part of the entire cost of a lease will be accounted for as depreciation, and depreciation is not included in the calculation of EBITDA.
From 2019, with IFRS 16 application, all analysts will have to adapt to new EBITDA levels in their work.
The impact on EBITDA is just one example of the effects of the implementation of IFRS 16.
Do you have more observations to add on the impact of IFRS 16? Let us know in the comments below.
For detailed, up-to-date and practical training on IFRS 16 and how it applies to your work, you can access our IFRS 16 Update Module now (and gain your CPD certificate online).