Leases: International Financial Reporting Standard 16 (IFRS 16) is relatively a new accounting standard that came into effect in 2019 superseding IAS 17. After IFRS 16, International Accounting Standards Board (IASB) has issued only two standards: IFRS 17, insurance contract, which is effective in 2023 financial year and IFRS 18, a recent IFRS release that will replace IAS 1 and be effective in 2027. Surprises!!! One will be Eighteen in 2027. In this article, we will explore the specific challenges and opportunities that Ethiopia encounters in adopting and implementing IFRS 16.

Following the issue of the Proclamation no. 847/2014, Ethiopia has adopted IFRS by law. The Accounting and Auditing Board of Ethiopia (AABE) is vested with multiple powers and duties by Proclamation among which are to set criteria to distinguish and register reporting entities as either public interest entities or small and medium enterprises. Following this many companies have adopted full IFRS. Those companies are required to fully comply with all IFRS requirements in preparation of their financial statements.

One of the standards is IFRS 16, which has brought significant changes to lease accounting practices worldwide. Ethiopia, like other countries, faces unique challenges and opportunities in implementing IFRS 16.

IFRS 16 was initially proposed by Sir David Tweedie, Ex-chairman, IASB, the idea came to  his mind in one of his flights, he said to himself “One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet,” as most of the western airlines operates aircrafts on rental basis. Of course, he did it. You may wonder, “How did he do it?” Well, it is simple, by introducing right of use asset concept which require recognition of leased assets as right of use asset on the balance sheet of the lessee and the corresponding lease liability. Eventually, this concept has come to be IFRS 16. Of course, the concept of IFRS 16 was first proposed in 2009 and has passed through a couple of exposure drafts and more than five hundred comments before it is issued as the 16th standard of IFRS in January 2016. 

Challenges of IFRS 16 Adoption in Ethiopia 

Limited awareness and understanding

One of the primary challenges faced by Ethiopian companies in adopting IFRS 16 is the limited awareness and understanding of the standard.

Many entities lack the resources and expertise to comprehend the complexities of IFRS 16. This lack of awareness and understanding can hinder effective adoption and compliance.

Data availability and quality

IFRS 16 requires detailed data on lease agreements, including lease terms, payments, and lease modifications. In Ethiopia, where record-keeping and data management practices vary across companies, ensuring the availability and quality of data can be a challenge. Companies struggle to collect and consolidate lease data accurately, which has an impact on the accuracy and reliability of financial statements.

Some of the common issues include:

• • Absence of explicit or implied interest rate in the lease contract. Most lease contracts do not have explicit or implied interest rates, which has resulted in the application of incremental borrowing rates for the particular entity in question. These incremental borrowing rates might vary between companies, which might result in different measurements for similar lease in different entities.
• • The lease contracts are not drafted to fit and identify which contracts are or contain leases and apply the definition of a lease consistently across different types of arrangements.
• • Data required to measure and account for leases, such as lease terms, payments, options, extensions, and modifications are not adequately included in the lease contracts.

"One of the primary challenges faced by Ethiopian companies in adopting IFRS 16 is the limited awareness and understanding of the standard."

Technical expertise and capacity

Adopting IFRS 16 requires technical expertise in lease accounting and financial reporting. Ethiopia faces a shortage of professionals with the necessary skills and knowledge to effectively adopt the standard. This shortage leads to challenges in interpreting and applying the complex requirements of IFRS 16, potentially resulting in errors or inconsistencies in financial reporting.

System and technology limitations

The adoption of IFRS 16 often necessitates the use of specialized lease accounting software or modifications to existing systems particularly those that have a significant number of leases such as financial institutions, insurance companies, and companies with many rented outlets and warehouses. In Ethiopia, where technological infrastructure and access to advanced systems are limited, companies struggle to adopt the necessary technology to comply with IFRS 16. This has posed challenges in accurately measuring and reporting lease obligations and assets.

"Ethiopia faces a shortage of professionals with the necessary skills and knowledge to effectively adopt the standard. "

IFRS 16 lease expenses tax treatment

IFRS 16 introduces the requirement to recognize amortization and interest expenses for lease transactions. However, it’s important to note that these expenses are not tax-deductible. It is possible that these expenses may not be adjusted for tax purposes. According to Regulation 410/2017, Article 34, lease payments (annual lease payment in accordance with the rental agreement) made for business assets held under capital goods lease agreements are considered deductible business expenses, while the corresponding depreciation is not allowed. Currently, there is no clear policy established by companies regarding the treatment of current tax expenses and deferred taxes arising from lease transactions.

Lease contract diversity

Ethiopia is a country with a diverse range of industries and sectors. Lease contracts vary significantly across these industries, making it challenging to develop standardized approaches to lease accounting. The diverse nature of lease contracts requires careful consideration and tailored accounting treatments, which added complexity to the implementation process.

Opportunities of IFRS 16 Adoption in Ethiopia

Improved transparency and comparability

IFRS 16 aims to improve transparency in lease accounting by requiring companies to recognize lease obligations and assets on their balance sheets. This increased transparency can enhance the comparability of financial statements across companies. Investors and stakeholders, particularly with the coming of the capital market, will have a clearer understanding of a company’s lease commitments, facilitating better decision-making and risk assessment.

Enhanced financial reporting quality

Adopting IFRS 16 leads to improved financial reporting quality in Ethiopia. The standard requires companies to provide more detailed and comprehensive disclosures related to lease agreements. This increased level of disclosure can enhance the relevance and reliability of financial statements, providing stakeholders with a more accurate picture of the company’s financial position and performance.

Improved access to financing

IFRS 16 adoption can improve access to financing. By recognizing lease obligations and assets on the balance sheet, companies may be able to present a stronger financial position to lenders and investors. This can increase their credibility and creditworthiness, making it easier to secure loans and attract investments.

Standardization and harmonization

Adopting IFRS 16 aligns Ethiopia with global accounting standards, promoting standardization and harmonization of lease accounting practices. This alignment can facilitate cross-border transactions, attract foreign investment, and enhance the integration of Ethiopia’s economy into the global market. It also simplifies financial reporting for multinational companies operating in Ethiopia.

Professional development and capacity building

IFRS 16 adoption provides opportunities for professional development and capacity-building. Training programs and certifications in lease accounting can enhance the skills and knowledge of professionals, enabling them to effectively adopt and comply with IFRS 16. This can contribute to the growth of the accounting profession in Ethiopia.

It can be concluded that the adoption of IFRS 16 in Ethiopia presents both challenges and opportunities. Overcoming the challenges of limited awareness, data availability, technical expertise, system limitations, and lease contract diversity is crucial for successful implementation and follow-up. By addressing these challenges, companies can benefit from improved transparency, enhanced financial reporting quality, improved access to financing, standardization, and professional development. Embracing IFRS 16 can contribute to the growth and development of Ethiopia's economy and strengthen its integration into the global financial landscape.

The adoption of IFRS 16 has significant implications for the financial reporting and performance of lessees, and companies should carefully assess the impact of the lease before the lease agreement is concluded. Moreover, IFRS 16 poses significant challenges in terms of data collection, estimation, measurement, disclosure, and audit. Particularly for companies with many lease arrangements, those companies may need to invest in new systems, processes, and skills to comply with the IFRS 16 standard. Strong regulatory and institutional frameworks should also be established to apply the standard in a consistent and reliable way.