New standard

Recently, the Mexican Board for Research and Development of Financial Reporting Standards (CINIF for its acronym in Spanish) issued the standard D-5 applicable for Companies reporting periods under MFRS (Mexican Financial Reporting Standards) beginning on or after 1 January 2019.

Reasons to come up with a new standard

Leasing is an important and widely used financing solution. It enables companies to access and use property and equipment without incurring large cash outflows at the start as well as reduce its risks related to the ownership of the assets. It also provides flexibility and enables lessees to address the issue of obsolescence and residual value risk. In fact, leasing is sometimes the only way to obtain the use of a physical asset that is not available for purchase. It is important to mention this new MFRS affects all leases the Companies have in place from real state leases (offices, stores, warehouses) to machinery and transportation equipment.

Under the previous rules applicable until December 31, 2018 Bulletin D-5 (MFRS), lessees accounted for lease transactions either as operating or as finance leases, depending on complex rules and tests which, in practice, used ‘bright-lines’ resulting in all or nothing being recognized on balance sheet for sometimes economically similar lease transactions.

Responding to concerns about the lack of transparency of information about lease obligations, the CINIF initiated a project to improve the accounting for leases. To meet this objective, the CINIF agreed that a customer (lessee) leasing assets should recognize assets and liabilities arising from those leases. This is because at the start of a lease a lessee obtains the right to use an asset for a period of time and, if payments are made over time, incurs a liability to make lease payments. Contrary to that view, most leasing transactions were not reported on a lessee’s balance sheet applying previous lease accounting requirements. However, for many companies, the effect on reported assets and financial leverage was substantial. The absence of information about leases on the balance sheet meant that investors and analysts were not able to properly compare companies that borrow to buy assets with those that lease assets, without making adjustments.

The CINIF issued the new MFRS D-5 with the aim to improve financial reporting of leasing transactions by requiring companies to recognize lease assets and lease liabilities on the balance sheet. Both lessees and lessors need to evaluate the effect of the new standard on their business processes, financial statements, and internal controls prior to implementation. The new lease standard will increase visibility of companies’ lease commitments and better reflect economic reality. Furthermore, this standard will also make it easier for users of financial statements to compare companies that lease their assets with companies that borrow money to buy their assets, creating a more level playing field.

How the business operation will be impacted?

The new requirements eliminate nearly all off balance sheet accounting for lessees and redefine many commonly used financial metrics such as the gearing ratio and EBITDA. This will increase comparability, but may also affect covenants, credit ratings, borrowing costs and your stakeholders’ perception of you.

Lessees are significantly affected by the new standard. The lessors’ accounting largely remains unchanged. Nevertheless, they might see an important impact into the lease business model and products due to changes in needs and behaviors.

Financial cost of applying the new lease standards

The significance of the implementation costs depends on the size of a company’s lease portfolio, the terms and conditions of its leases and the systems already in place to account for leases. Is expected that companies with material off balance sheet leases will incur costs to (a) set up systems and processes, including educating staff; (b) determine the discount rates used to measure lease assets and lease liabilities on a present value basis; and (c) communicate changes to reported information to external parties.

Once a company has updated its systems to provide the information required by MFRS D-5, is expected costs to be only marginally higher compared to those incurred when applying the prior standard. The data required to apply the new standard is similar to that needed to apply the former standard, with the exception of discount rates that are required for all leases with the new standards.

How we can help

In J.A. del Rio we understand that the practical application of the sometimes form-driven, often complex, accounting literature and applying it to the specific facts and circumstances around your business can be challenging. Contact us to learn more about how we can help you ensure your financial reporting will be compliant with the leasing standard.