Accounting for Retail: IFRS 16 ushers in new season
As summer fades and autumn takes hold, so too do the new accounting rules for retailers regarding international leasing standards. IFRS 16 aims to bring all companies’ leases onto their […]
As summer fades and autumn takes hold, so too do the new accounting rules for retailers regarding international leasing standards. IFRS 16 aims to bring all companies’ leases onto their balance sheets for 2019 accounting periods onwards, meaning a big shakeup of how retailers’ finances are presented.
In brief, the changes mean that both assets and liabilities will rise substantially on the balance sheet, with debt increasing by roughly 100% for most businesses. On the P&L, current operating lease expenses will be replaced by depreciation of the lease asset and an interest expense on the lease liability. While the depreciation charge will be straight-line, the finance charge will be higher in the earlier years of the lease than the later ones.
To begin with, companies will be reporting higher operating profits as the interest cost will drop below the line, and EBITDA will look healthier as it will exclude both interest and depreciation. The challenge for companies is to really get their heads around the changes and explain what they mean in business terms.
Communicating the changes
For businesses, effectively communicating the changes in their accounts to different stakeholders is imperative. Julie Carlyle, Head of Retail at EY, says: “You cannot over emphasise how critical it is for people to get to grips with this. Conversations with analysts, shareholders and banks are happening, but I would like to see these conversations being more advanced.”
However, knowing what to communicate and how can be a real challenge too. Implementation of the new rules is proving tough, largely because retailers don’t just lease property, they lease many assets used within their stores and other premises – large retailers might have between 5,000 and 10,000 leases.
Digging for Data
Managing the data surrounding all these leases then becomes a significant project: companies which have not previously maintained accurate operating lease data now have to collect an estimated minimum of 25 to 80 data points for each lease, with some of the information relating to contracts dating back 30 years (often pre-dating their electronic records).
Once the data is established, retailers need to work out how to present it: leases worth less than $5,000 (£3,860) can be kept off the balance sheet and addressed in another way on a lease-by-lease basis. Leases for fewer than 12 months can also be expensed, again on a case-by-case basis. Then there are issues such as variable lease payments, options to extend the lease, and early termination clauses.
The complexities in the standard, with the various exemptions, all need to be modelled to ensure the right choices are implemented, as any decisions made will have a massive impact for many years to come. Retailers need to determine what they want to achieve early on, answering strategic questions about the impact on the income statement, discount rate and transition. And as with communication about the changes to the accounts, these strategic discussions should involve colleagues from across the company with a view to building a robust long-term plan.
Getting up to speed
It is estimated that 85% of lease obligations do not currently appear in the liabilities of lessees. And while IFRS 16 is not effective until 1 January 2019, its significant scope may require immediate action. That’s why at Reed Business School we’ve developed a course for professionals working in companies with lease or rental agreements to help them perform an impact assessment of this wide ranging new standard.
Our course will: examine the impact of the new standard on companies that enter into contracts as lessees; review the principal current requirements of IAS 17; and provide a headline service of the principal changes to lease accounting, including identifying what planning responses and new information might be required.
Delegates will learn about: the difference between a lease and a rental agreement; changes to accounting for existing finance leases; the new treatment of old operating leases; short lease simplifications; changes in vocabulary of the standard; and the possible impact on borrowing covenants.
Find out more about the course and book a place on it here.