IFRS 16: Accounting for salary sacrifice vehicles

International Financial Reporting Standard (“IFRS”) 16 is an accounting standard for how organisations report on leases.It’s been in place since January 2019, and affects organisations reporting under IFRS, which includes publicly listed companies and their subsidiaries as well as certain public sector bodies, and may impact on how your organisation reports financial statements of lessees of property and high-value equipment.

IFRS 16 uses  the ‘right-of-use’ model for leases. This means if a company has control over, or the right to use an asset they’re renting, it’s classed as a lease for accounting purposes. The lease payments must be reported on as a liability on the company’s balance sheet, alongside a corresponding ( equal) asset representing the ‘right-of-use’ of the leased asset.

So, IFRS 16 no longer allows for significant financial liabilities to be held off-balance sheet, as permitted for certain types of leases (operating leases) under UK Generally Accepted Accounting Practice (“UK GAAP”). The aim is to make sure companies report information for all their leased assets in a standardised way to bring transparency and consistency.

Companies need to produce a set of comparative accounts for the prior year.

IFRS 16 replaced International Accounting Standard (“IAS”) 17, but this still applies to the many UK businesses that aren’t obliged to adopt IFRS.

IFRS16 works in a similar way to the reporting of other non-financial assets (e.g.property, plant and equipment) and financial liabilities:

• Balance sheet – lessees will need to show their right-of-use asset as a fixed asset and their obligation to make lease payments as a liability. The portion due within the next 12 months must be included within current liabilities.
  • The value of the right-of-use asset is set as the value of the liability. This is to make lease payments at the outset of the lease the asset and liability recognised within the balance sheet the same, so there’s no immediate impact on net assets.
• Income statement – lessees will depreciate the asset and recognise interest on the lease liability. 
  • The depreciation would usually be on a straight-line basis. But the interest expense will be front-end loaded, with higher interest charges recorded in the early years of the lease, even though the lease rentals remain constant throughout the term of the lease.
  • The service element of the lease, such as maintenance charges, don’t need to be capitalised and will continue to be charged directly to the income statement, sometimes referred to as the P&L account.

This means that - provided a company can demonstrate there would be no financial advantage, rather than having to account for all leases individually, there is scope to combine these into a portfolio where the nature of the asset and the underlying lease terms are similar. For example all car leases could be accounted for within a portfolio.

1. Identify all assets defined as leases - under IFRS 16 (this includes property, equipment, vehicles, etc).
2. Collect all the info on these leases – term, options at end of lease, rentals payable, interest rate of the lease if available, or operating leases that may not be available because it could be commercially sensitive, so the lessee will need to think about their incremental borrowing cost. This is the rate they’d pay to borrow over a similar term for a similar security, in a similar economic environment.
3. Account for the leases to recognise assets and liabilities - once all the information is gathered the calculation is relatively straightforward.A net present value calculation must be undertaken, calculating the value of the liability, and consequently the right-of-use asset, is not merely a case of multiplying the lease rentals by the lease term.

Bearing in mind that company car agreements are usually longer than one year, the agreements are accounted for as leases because:

• They identify the asset (in this case the car)
• The lease of a car would not qualify as a low-value assets, because a new car would typically be of high value
• They convey to the customer the right-to-control the use of that identified asset for a period of time in exchange for consideration
• The supplier has the right to direct how and for what purpose the cars are used throughout their period of use, in common with standard contract hire agreements, which might define the scope of the lessee’s right-of-use but do not prevent the customer from having the right to direct the use of the asset.

As they constitute leases, organisations should account for contract hire agreements in accordance with the lessee accounting treatment set out in IFRS 16. So the underlying nature of the lease, it’s an operating lease or finance lease, is no longer relevant for the lessee.

Salary sacrifice cars are typically leased by an employer via a contract hire agreement.

An employer using IFRS 16 should capitalise the lease liability and the right-of-use asset on the balance sheet, charging depreciation, interest and maintenance costs to the income statement.

The employer and employee will enter into a separate agreement via which the leased car is made available to the employee in return for the salary sacrifice.

One school of thought suggests that it's reasonable for the salary sacrifice agreement to be recognised as a ‘sub-lease’ because it conveys to the employee the right-to-control the use of an identified asset (the car) for a period of time in exchange for consideration.

Under IFRS 16, a lessor most classify each of its leases as an ‘operating lease’ or a ‘finance lease’:

• A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset
• A lease is classified as an operating lease if it doesn’t transfer all the risks and rewards incidental to ownership of an underlying asset

So salary sacrifice agreements with the employees can be classified as a sub-lease, in which case it should be recognised as an operating lease rather than a finance lease. They should be accounted for as such, per the lessor accounting treatment set out within IFRS 16.

This effectively means that the salary sacrifice is credited to the P&L account only, with no balance sheet implications.

Some may argue that the short-term employee benefit exemption available under IAS 19 should apply. Using this exemption then salary sacrifice agreement should be accounted via for solely the P&L account, again with no balance sheet implications.

In essence, whether the salary sacrifice agreement is accounted for using IFRS 16 or IAS 19 the accounting entries should be the same.

This is our interpretation of IFRS16 lease accounting treatment that typical schemes should apply in respect of the contract hire and salary sacrifice agreements.  This is based on the general vehicle leasing market treatments, which we’ve compiled to help customers consider their treatment for account purposes.

We don’t give accountancy related advice, or provide professional advice due to the complex nature of customers’ businesses and account practices.

We’d recommend you engage with your auditors, as they're best placed to advise the accounting treatment to be applied by each case.

In partnership with BCF WESSEX

BCF Wessex are tax and software consultants to the automotive industry. Their Gensen software offers industry-leading tax and sales calculations focused on speed and accuracy for OEMs, leasing companies and brokers.