Businesses that lease their premises should start taking action to avoid being caught-out by changes to accounting due to come into effect in January 2019.
The advice comes from real estate consultancy GVA, which is preparing clients for the IFRS 16 accounting standard, which requires companies to separate their operating and finance leases.
The new regulations, which will apply from January 2019, seek to bring consistency to lease accounting, and comparability and transparency with respect to lease obligations.
This will require companies to recognise their existing lease liabilities on their balance sheets, covering items from photocopiers, to cars and property. At present this is not required.
The new standard represents a significant change from the existing approach and will impact businesses across all sectors that rely on leases (for values above £5,000 and terms over 12 months) as part of their business model.
Companies may also see greater incentives to restructure leases, a decrease in profitability ratios and a fall in reported equity, as well as impacts on covenants and borrowing costs.
Chris Norcup, Director in the Midlands Lease Consultancy team at GVA, said: “With an estimated 85% of lease commitments not appearing on balance sheets under the current system, the introduction of IFRS 16 will have a significant impact on all companies who rely upon material operating leases as part of their day-to-day business activities.
“We recently held an event for clients to provide advice and information on IFRS 16 and we were surprised by the number who were not aware of the impending changes and therefore weren’t prepared for the implications that this could have on their businesses.
“There is a considerable amount of preparation that needs to be undertaken ahead of the accounting changes and few people really appreciate how these changes will affect company accounts.
“One thing is for sure, there will be a realisation that the way companies occupy property will influence business decisions and there will be increased recognition at board level.
“These changes will impact on high level strategic property decisions and lease considerations in terms of break options, the impact of rent reviews, turnover rents, RPI rents and rent free periods. There was also a considerable amount of discussion regarding the modelling appraisals methods.”
GVA has developed a financial model which is capable of capturing all the required lease information needed to assess the impact of the transition to IFRS16. The model can look at individual leases as well as providing an overall lease portfolio view. It will also help to appraise the financial metrics involved in making lease vs buy decisions.