New Year, new accounting standard – make preparation for IFRS 16 one of your resolutions in 2017
The new lease accounting standard, IFRS 16, is set to radically change the way real estate leases are recognised in financial statements. The recognition of real estate leases on the Balance Sheet and their treatment in the P&L will result in changes significant enough to impact share price.
The clock is ticking!
The implementation date for the new standard is fast approaching, latest adoption in 2019.
For the majority of companies, the properties they lease today and new leases they enter into between now and 2019 will still be in place when the new standard comes into force.
For these leases, there are a number of choices available when adopting the standard for the first time. Each choice can have a significantly different impact on both Balance Sheet and P&L. Making an informed decision on the transition option, presents an opportunity to mitigate the impacts of the new standard. Under some options, companies may even see an improvement in key metrics.
So what are the options?
There are two main options for the transition of existing leases as at implementation date. The decision on which of these two options must be made a Group level, for all leases, not just for real estate leases.
Option 1 – Full Retrospective Approach
Calculate the Right-of-Use Asset and Lease Liability as at lease start and work forward to determine position as at implementation date.
|· Likely to provide lowest Balance Sheet impact
· Depending on portfolio structure, could show reduction in P&L compared to current financial treatment
|· Requires detailed historic data for all leases
· Resource intensive
· Requires restatement of comparatives
· Requires market data to determine appropriate discount rate
Option 2 – Modified Retrospective Approach
Permits a number of ‘short cuts’ for the initial calculation of the Right-of-Use Asset and Lease Liability in comparison to the Full Retrospective Approach. This approach is predominantly forward-looking from the date of implementation.
|· Does not require historic data for all leases
· Comparatively low resource requirement
· Does not require restatement of comparatives
· Does not require market data to determine appropriate discount rate
|· Likely to result in higher Balance Sheet impact compared to Full Retrospective Approach
· Likely to result in higher P&L impact
Under both the Full Retrospective Approach and the Modified Retrospective Approach, there are a number of subsequent decisions that can be made on a lease-by-lease basis for existing leases. These subsequent decisions also result in differences in the impact on Balance Sheet and P&L.
How do I determine the impacts?
There is no ‘one-size-fits-all’ solution for transitioning to IFRS 16. The optimum transition option from a financial perspective will vary from company to company, depending on:
- Structure and scale of the leased portfolio
- Prioritisation of key financial metrics
- Availability and quality of historic data
The decision as to which transition option to adopt should be made on an informed basis, only after detailed analysis of the impacts.
Step 1: The options for transition under IFRS 16 are complex and many. Speak to the experts to understand how these can be applied!
Step 2: Undertake analysis of the portfolio to determine those leases which fall outside the scope of IFRS 16 and the structure and scale of leases continuing beyond the implementation date.
Step 3: Model the financial impacts under each of the transition options, including impact on key financial metrics.
According to a recent survey by PwC, 70% of companies planned to start the transition process in 2016. If you haven’t yet, now is the time to start preparing!
Hannah Coleman is an Associate Partner in Strategic Consulting EMEA at Cushman & Wakefield.
Hannah specialises in supporting corporate occupiers with IFRS 16 implementation, strategic cost reduction and capital raising.
Our Strategic Consulting experts provide innovative real estate solutions to organisations with specialised requirements. Bringing together experts from finance, property and accounting, we support clients in the areas of Occupier Finance, Business Location & Incentives Advisory, Portfolio & Metro Strategy, Workplace Strategy & Change Management, Occupier Development, Centre of Excellence for Real Estate Analytics.
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