Clive Jarvis, Group Financial Controller at Regus, looks at key changes to International Accounting Standards and what this will mean for office lessors and lessees.
From trucks and aeroplanes to manufacturing and construction equipment, companies lease a wide variety of resources beyond real estate. The advantages of leasing include reducing the risks of asset ownership, raising funds, obtaining tax benefits and having greater flexibility to adapt to technological developments and changing business needs.
By 2019, businesses will be required to record leaseholds on their accounts in a very different way. While your business’ cash flow won’t undergo any changes, the revised leasing standard will have a large impact on the presentation of your financial statements, so you’ll need to discuss it with your stakeholders.
So, what are the key differences, and how can lessors and lessees prepare for them?
The story so far
Under the current accounting standards, leases must be defined as either finance or operating leases. Operating leases are treated as expenses on your income statement, leaving the balance sheet unaffected. Finance leases, on the other hand, are treated as both assets and liabilities on the balance sheet.
Many felt that this model lacked transparency, and failed to give an accurate picture of leasing transactions and businesses’ long-term financial obligations. In a nutshell, they’re as clear as mud, and there have consequently been widespread calls to update and improve lease accounting standards.
On 13 January 2016, the International Accounting Standards Board issued their new standards, with the US-based Financial Accounting Standards Board following suit on 25 February 25.
What will change and when?
The new rules will apply to public companies from 1 January 2019, and to non-public companies the following year. The most significant change is that the distinction between operating leases and finance leases will disappear, meaning that all leases will be capitalised. It's expected that trillions of dollars worth of leases will be brought onto company books as a result. Additionally, most operating leases will see a higher income statement impact to begin with, meaning that the cost of leases will initially be higher.
Public companies will be required to retrospectively apply the new standards to their 2017 and 2018 financial statements, with non-public companies doing the same for 2018 and 2019.
What does this mean for businesses?
More leases on balance sheets means assets and liabilities will increase for many companies. Some may want to consider short-term leases in order to offset the effect on their financial statements. Given that some of the fiscal advantages of leasing will be reduced, businesses may also want to re-evaluate the merits of ownership. Real estate professionals should urge clients to consider their portfolios in good time, in order to assess the potential impact of the accounting changes and explore alternative strategies for dealing with them.
As well as calculating the monetary value of any leases added to the balance sheet, businesses will also need to address how their accounting software will cope with the changes, and whether any updates need to be made. If new lease systems or internal controls need to be implemented, it's important that companies plan ahead so that they have sufficient resources to deal with the new rules once they come into effect.