Lease accounting changes: know your next move
In January 2016 the International Accounting Standards Board (IASB) issued its definitive guide to the new lease accounting standards which all companies reporting under the IASB need to comply with by 2019. Though they have been on the cards since 2006, many businesses are still underprepared for compliance with these changes and for their subsequent impact.
Operating leases are currently treated as “off balance sheet” and all finance leases are “on balance sheet”. The new standard removes this distinction and from 2019 every contract with an identifiable lease including real estate and equipment – will be treated as on balance sheet. Broadly, an occupier’s obligation to pay rent will be recognised as a liability on its balance sheet.
All businesses, in every sector, in every country governed by the IASB and FASB, will be required to comply with the new standards. These changes will most dramatically increase the need for companies that rely heavily on leasing (such as retailers, leisure operators and banks) to report their leasing obligations.
As a result of the incoming new standards, businesses are likely to see the following effects:
- Inflated assets and liabilities following the inclusion of all leases on the balance sheet
- A higher income statement treatment in the early years of the lease. With the International Financial Reporting Standards (IFRS) there will be a higher charge to the income statement because of the amortisation and interest charges. This charge will reduce over the lease term until such a time when there is a change in the terms and it is reassessed
- The need to collect the data and calculate the impact may result in a significant administrative burden for companies
The bottom line is that there is no way around these changes and no safe haven, so what do businesses need to do to get things in order ahead of 2019?
First and foremost, avoid being lulled into a false sense of security by the 2019 deadline. While the IASB has given this date as the point of compliance, many businesses will electively start reporting from the end of 2018. Therefore there is a need to start preparing now for the changes to give adequate time to deal with the administrative aspects and gather the data needed. Businesses should begin by analysing the impact of their leased property portfolio on their financial statements and armed with this information, begin to evaluate alternative strategies to reshape their portfolio.
For those multinationals with global reach and multiple office locations across the world, the need to comprehensively analyse their property portfolio in a joined-up effort should form the starting point for their preparations. However, regardless of the size of the company there is a need to ensure that your advisers are also ready for the changes and can quickly get access to the relevant paperwork and detail about leases.
Looking more broadly at the commercial real estate market, the impact may be seen in a number of ways, with businesses looking at the following options and alternatives:
- Shorter term leases to reduce balance sheet and profit impact on their financial statement. It is worth noting that short term leases – those under 12 months – are exempt under the IASB standards
- More turnover rents. Rents that are uncertain (ie by linking to turnover) will not need to be recognised on the balance sheets and could therefore be attractive to occupiers
- A possible move towards the ownership of property. Depending on business maturity and lifecycle this may be advantageous for some businesses given that there will no longer be an off balance sheet advantage of leasing
The new standards will also have substantial impact on the appetite for sale and leasebacks. For many businesses, selling their property and then leasing it back from the new owner has been used as a way to raise capital. From 2019, this will no longer be as financially advantageous for businesses and so the next two and a half years present an opportunity for property owners to still be able to explore such deals and secure favourable accounting treatment ahead of the changes coming in.
The impact will be felt by business, investors and the market alike, but the message to property occupiers is that they no longer have the luxury of time when it comes to preparing for these changes. Business, regardless of size or sector, need to mobilise. Getting in shape ready for the new standards and carefully assessing the changes that need to be made to real estate strategy will allow occupiers to be both prepared and in a position to take advantage of opportunities or new deals that may arise.