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Contract hire to maintain fleet popularity with implementation of IFRS167 reporting

Contract hire to maintain fleet popularity with implementation of IFRS167 reporting

Operating car lease and full-service leasing will continue as customers’ first choice for business mobility following the introduction of new international accounting standards, according to Alphabet.

The vehicle leasing and fleet management specialist has issued a briefing paper on the implementation of International Financial Reporting Standard 16 (IFRS 16), which is effective for accounting periods beginning on or after 1 January. 2019  

Clive Buhagiar, head of pricing and planning, Alphabet GB, said: “Irrespective of IFRS 16, leasing’s impacts on balance sheet, risk positioning and incorporated asset responsibilities are still lower than ownership of cars.”  

IFRS 16 abolishes the distinction between finance leases, currently shown on balance sheet, and operating leases, currently off-balance sheet. Instead, affected companies will show leased assets as ‘right to use assets’ in their financial reporting, which must include depreciation and interest cost on these assets and not the rental charge. The only leases exempt from IFRS 16 are low value assets (under $5,000 or equivalent) and short-term leases (under 12 months).   

Therefore, attention to IFRS 16 in the fleet operating and vehicle leasing sectors is mainly focused on its requirement for assets financed via operating lease - contract hire - to be brought on-balance sheet.  

That will change debt to equity relationships, gearing ratios and capital ratios. It will also affect the reporting of other financial metrics, such as earnings before interest, taxes, depreciation and amortisation. 

  IFRS 16 will initially only affect banks, listed companies and a few other, predominantly large, entities.  That means, says Alphabet, that around 90% of UK business will not be touched by the standard when it comes into effect.  

Moreover, the UK Financial Reporting Council (FRC) has said it is reconsidering whether key parts of IFRS 16 will be copied into UK accounting rules at all, due to concerns about their practicability for small and medium firms. If so, IFRS 16 will have no impact on the great majority of fleet operators for the foreseeable future. 

In respect of affected companies, the FRC said in April that it expected it would provide information on their progress towards implementation of IFRS 16 over the next 18 months, It predicts it will disclose the likely impacts of the new standard once they can be reasonably estimated.  

Mr Buhagiar said: “The question mark over whether the new lease accounting rules will apply to UK SMEs, together with the fact that it is too soon for feedback from companies implementing them, has undoubtedly contributed to uncertainty among fleet operators.  

“Whenever clear information is lacking, speculation tends to fill the vacuum. Some commentators have predicted that listed businesses will step away from vehicle leasing. Experts with fleet industry knowledge see it very differently, however.”  

British Vehicle Rental and Leasing Association chief executive Gerry Keaney says the popularity of vehicle leasing has little to do with balance sheet considerations.  

He said: “Its main value comes elsewhere: sheltering companies from the risk of fluctuating values, providing them with extra flexibility and purchase power and freeing-up precious working capital.”  

Alphabet believes that:          
  • With leasing, customers avoid potential investment in additional internal asset management resources required by wholly-owned vehicles such as purchasing, servicing, quarterly asset risk assessments and remarketing.          
  • Businesses that turn away from leasing also risk losing competitiveness when negotiating with supplier networks. Alphabet highlights that it can leverage economies of scale and expertise in purchasing, services and remarketing that enable it to offer highly competitive prices.           
  • Activating purchased vehicles will have a greater impact on balance sheets than leasing them because the full list price of the car will always be higher than its reporting value as a ‘Right of Use’ asset.          
  • With leasing, the asset risk and residual value risk remain with the leasing company whereas companies that own vehicles assume the risk themselves.  

What’s more, it has been suggested that companies affected by IFRS 16 might consider cashing-out their company drivers, so the business no longer provided any cars for mobile employees. In effect, companies that took this step would be increasing their dependence on ‘grey fleet’ to deliver competitive business mobility.  

Mr Buhagiar said: “Grey fleet’s drawbacks are well-documented, especially in terms of its hidden costs and duty of care liabilities. Given that the underlying purpose of IFRS 16 is to clarify the way leased assets are accounted for, it would be paradoxical if listed companies’ responses to it included making their employees’ essential mobility more opaque and harder to manage.”  

He continued: “The consumer credit market also looks set to tighten over the next 18 months or so, and this will affect the quality of vehicle employees can afford. The Bank of England warned again in April 2017 that personal debt is rising dangerously fast and the Financial Conduct Authority is specifically monitoring trends in private car finance.  

“While cash-in-lieu-of-car policies almost invariably compromise the quality of business-use vehicles - the average ‘grey fleet’ car is seven years old - liability for occupational road risk remains with the employer.”