The biggest shakeup of lease accounting rules in over 30 years will have a major effect on corporate real estate strategy moving forward.
This radical change, teamed with the increasing need to be agile in uncertain economic climates, will undoubtedly affect property portfolios of all sizes.
The new lease accounting standards released by the International Accounting Standards Board (IASB) will come into effect by January 2019. And much of the real estate sector is still assessing the changes to the leasing model that has been prevalent for so long.
What’s changing?
The current system allows for companies to treat their operating leases as ‘off balance sheet’, thereby understating assets and liabilities.
The new rules will seek to eliminate ‘off balance sheet’ accounting, with the aim of more transparency surrounding an organisations financial strength, with critical factors such as rent recognised as a liability. With leases now seen as ‘debt’, a company’s ability to take on further debt will also be influenced.
Will your company be effected?
Accounting bodies including those in the UK and US are aligning their policies to international accounting standards and are therefore adopting similar approaches to the IASB. The changes are therefore likely to impact many of the companies that currently file financial statements including:
- All public limited companies
- Central Government departments
- Private entities
- Non-profit organisations
What is the potential impact?
These changes will have a dramatic impact on the balance sheet and profit and loss account; therefore will need to be considered well in advance of the implementation date of the new standard.
According to the IFRS (International Financial Reporting Standards) 85 per cent of lease commitments are currently off balance sheet - once the new standards come into effect approximately $2.8 trillion worth of lease commitments will enter company balance sheets. The new accounting changes will impact reporting in terms of:
- From a lease’s start, viewing it on the balance sheet as an equal asset and liability
- An amortisation and interest payment will now be included in the P&L for leased assets
Cash flow will also now have to be separated into financing and interest sections, exemptions will include:
- Serviced contracts where the occupier signs a short-term contract with the landlord and does not retain control of the property
- Leases with less than 12 months to run
- Leases where the underlying asset value is under £5,000
What should you do?
In order to limit the impact of the new rules you should therefore consider:
- Shorter term leases – this will reduce the liability on the balance sheet and profit impact on financial statements. The utilisation of shorter, more flexible leases, serviced offices and co-working spaces will be key, creating more flexibility within your portfolio with limited impact on your balance sheet. Leases or licences of less than one year are potentially exempt from the requirement to record them on the balance sheet as a liability and could therefore represent a real benefit over longer term options.
- Information collation – The new standard will require detailed information to be collated on every lease. This is proving to be a significant administration burden for multi-site organisations who don’t have asset management IT systems. This needs to be addressed early to avoid last minute challenges and increased cost.
- Turnover based rents – If the rental amount is uncertain it will not need to be recognised on a balance sheet, rent agreements that are based on a percentage of turnover could prove very attractive to large retailers, banks and leisure operators.
To minimise the impact on your business you should take the following actions:
In recent years, we have witnessed a growing trend towards workforce mobility. Companies of all sizes are choosing agile real estate solutions to cater for the growing contingent workforce that favours flexibility over long-term roles. With a workforce that increasingly demands the ability to work where and when they choose, organisations need less conventional workspace.
The challenges facing corporate real estate departments have increased as they now have to assess a range of multi-site options and unify an increasingly disparate workforce.
To limit the effects of the new lease reporting companies will need a higher performing, more efficient real estate portfolio. This we predict will be made up of more and more short-term leases and flexible workplace options, accelerating changes that are already being made by businesses to drive flexibility and strategy alignment.
An adoption of a flexible RE strategy using month to month service agreements, third party co-working options or short term managed leases will keep real estate commitments low and off the corporate balance sheet. Increasingly Instant has seen large corporates taking up this kind of space. This strategy has provided flexible workspace that enables higher employee retention levels, and contributes significantly to improved productivity.
For more information on how Instant can help bring flexibility to your real estate portfolio and limit the effects of the new lease accounting rules call on 020 7298 0647 or email contact.us@theinstantgroup.com
