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The effect of the adoption of IFRS 16 on distributable profits

07 September 2018

Companies may find that the adoption of IFRS 16 Leases for periods beginning on or after 1 January 2019 has an effect on the level of profits they have available for distribution sooner than they anticipated.


What is the problem?

Realised profits are calculated by reference to an individual company’s relevant accounts that reflect the accounting standards that are applicable to the period for which they are prepared. However, for distributions made in the period in which a new or revised standard is to be adopted, the common law capital maintenance rules require that any new accounting standards are taken into consideration from the first day of the accounting period in which they are to be adopted. This applies even where they were not applied in the relevant accounts being used.

Unless it is an early adopter, for a company with a 31 December year-end that adopts IFRS or FRS 101, the adoption of IFRS 16 will be relevant to the determination of the expected level of profits available for distribution from 1 January 2019. It is important to note this is the date the distribution is declared, not the period it relates to (ie a 31 December 2018 year-end final dividend declared in 2019 would be caught).

Directors must, therefore, take particular care over the transitional effects of adopting new accounting standards when deciding on the timing and value of any dividends they pay or declare between the first day of the first accounting period in which new standards are adopted and the publication of the first set of financial statements prepared in compliance with them.


Effective date of IFRS 16 for distributions

Last financial statements prepared in accordance with IAS 17 (year-end)

31 Dec 2018

31 Mar 2019

30 Jun 2019

30 Sep 2019

IFRS 16 affects final dividends declared/ interim dividends paid on or after

1 Jan 2019

1 Apr 2019

1 Jul 2019

1 Oct 2019


What is the impact?

There are many ways in which the adoption of IFRS 16 may be applied on transition – many of these options will have an impact on distributable profits. For example, a lessee applying IFRS 16 using the fully retrospective approach should generally expect to see an impact on distributable profits. There will also likely be an impact for those companies applying the modified retrospective approach whereby the right-of-use asset is calculated as if IFRS 16 applied from the commencement date of the lease but applying the lessee’s incremental borrowing rate from the date of initial application.

Importantly, it is our experience that the full nature and extent of the effect of adopting IFRS 16, especially with the range of transition choices, does not become clear until a robust implementation exercise has been carried out. Paying a dividend without understanding the full implications of adopting this new standard will increase the risk of it subsequently being determined to be illegal.


What can you do?

If a company wishes to make use of the reserves that will (or may) be consumed by transitional adjustments, it will need to pay an interim dividend (or declare a final dividend) before the first day of the first accounting period in which the company adopts the new requirements. Note, however, that where this approach is taken, directors must still consider whether any losses have arisen under the old IFRS requirements since the date of the company’s last ‘relevant accounts’ on which the dividend has been based (often the last set of annual accounts prepared), as well as their other fiduciary duties, before paying the dividend.

Where a company elects instead to pay an interim dividend (or declare a final dividend) after the first day of the first accounting period in which it adopts IFRS 16, directors would be well advised to prepare a new set of accounts that include the effects of transition to this new standard. Without such accounts, it may be difficult to defend their judgement regarding the profits that the company has available for distribution.

For help and advice on the determination of realised profits in the context of distributions, please contact Richard Matthews.


Read more on IFRS 16

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