Decision time for real estate professionals: how will you implement new lease accounting standards?

With new lease accounting standards coming into effect, businesses must decide how to manage the transition and ensure their property management technology is up to the job

The impact of the IFRS 16 accounting standard will be huge for many publicly-listed companies. For the first time, almost all lease obligations will have to be accounted for on the balance sheet – that will see the average company’s debt increase by 22% according to analysis by PwC, and by significantly more in sectors where businesses have big portfolios of property leases, such as retail and leisure.

The new rules are likely to have profound effects on how businesses think about leases for many years to come, but the first challenge is to manage the transition to IFRS 16; that will require companies to look at the capabilities of their current property management technology and to consider the pros and cons of different adoption methods.

In drafting IFRS 16, the International Accounting Standards Board (slightly different rules apply in the US under the Financial Accounting Standards Board’s Topic 842 equivalent standard) has given companies two options for making the transition:

• Fully retrospective accounting – under this option, for reporting periods that end after the effective date of the new standard, companies report on all their leases on an IFRS 16 basis as if the standard had always been in place; they must also provide a comparison of how their reporting would have looked under the previous rules, so that the effect of the new standard is transparent and visible

• Modified retrospective accounting – this is a more straightforward approach that requires companies simply to apply IFRS 16 on their leases from the effective date onwards, with an adjustment of retained earnings made on the balance sheets, but no comparison with the old method

Both approaches have advantages and disadvantages. The fully retrospective method provides a much more detailed overview of the figures and how they’ve changed under IFRS 16, and is likely to be more accurate; but it requires businesses to produce two reports simultaneously, will almost certainly be more expensive and time-consuming to deliver, and will need a large amount of historic lease data.

By contrast, the modified retrospective option will not depend on so much data and is likely to be considerably less burdensome; but it will depend on estimates rather than definitive information and could be less accurate, which may have knock-on effects on other key financial metrics.

The basic capability of the company’s property management technology is going to be one consideration in this choice. For example, is your system capable of generating the data required for the fully retrospective accounting? Can it even cope with the data requirements under the modified approach, which will still be demanding? Are you thinking about investing in new technology as part of the shift to IFRS 16 and should this capability be part of that decision-making process?

It will also be valuable to model the effects on the balance sheet and broader company finances of the two different options before you make a definitive decision. This will require collaboration with the finance function – and property management technology that is capable of producing the outputs finance will require to carry out this work.

Making the effort now, ahead of time, will pay dividends, particularly for businesses with large lease exposures. The selected transition approach will potentially have an impact on company profitability for years after transition – until the final lease in place at the moment of transition expires – so it’s crucial to get it right.

Takeaways:

• New accounting standards that come into force in 2019 will require companies to record the value of real estate leases on their balance sheets
• The new standards give two interim options for compliance: full retrospection and partial or modified retrospections
• Both approaches have pros and cons, so real estate will need to consider the business’s individual circumstances to choose the right way forward
• The transition approach you choose could have an impact on your company’s profitability
• Plan ahead now to identify the best way to proceed before the new standards become operative

For more information on our lease accounting solution, please visit the IFRS 16 page.