Steven Fox, Corporate Real Estate Solutions, Qube Global Software
Leasing is a widely used source of financing in the UK. It allows businesses of all sizes access to property, plant, machinery and equipment without the need for large initial investment.
Traditionally however, the majority of leases have not been reported on balance sheet. The reason for this is that up until now, many leases have been categorised as ‘operating leases’ which are only included as rent expense in income statements.
This has historically presented a challenge for investors looking to compare companies. Some investors have even gone so far as to suggest that reporting leases in this way is misleading as it can create an unrealistic picture of leverage and leased assets used, leading to an overestimation of liabilities.
In light of these criticisms, the current standard on accounting for property leases, IAS 17, will no longer apply within any country that operates under International Financial Reporting Standards (IFRS) from the 1st January 2019. The IFRS 16 update will establish the principles for recognition, measurement, presentation and disclosure of leases.
For the first time, almost all lease obligations will have to be accounted for. This will lead to the ‘reappearance’ of trillions of pounds worth of assets appearing on the balance sheets of IFRS compliant companies. At the instance of transition significant increases will appear in the value of an organisation’s gearing and liabilities, impacting deferred tax, disclosures, bonus targets (if calculated on EBITDA) and more.
Given this, there is a clear and present need for finance professionals to get to grips with this change ahead of the 2019 deadline. However, while accounting standards have traditionally been the reserve of the finance department, leases – specifically those concerning equipment, estates, and facilities are the remit of real estate and facilities management.
It’s evident then that finance and real estate leaders must collaborate to ensure true compliance.
Working in partnership
In many cases, the division of labour between real estate, FM and finance functions is likely to be quite evenly split. For real estate directors, the challenges will include identifying all property leases within the business – a complex task for larger companies. They will also need to check that their systems are capable of capturing the right information and monitoring this on an ongoing basis. If not, a reconsideration of the business lease strategy will be required.
Real estate’s role
Real estate is going to have to become more strategic in the way it approaches new leases: the impact of every lease covered by IFRS 16 will need to be considered in this context.
It may even find that its preferred approach to property leases is no longer in the best interests of the business. Procurement and finance teams, for example, will need to be involved in discussions over whether new assets need to be leased or bought.
Taking inventory of all existing lease agreements and collating the necessary data, including lease terms, renewal options and payment terms is a critical first step, prioritising the analysis of more complex or significant leases.
Property management technology tools can provide this data and inform both the best way to account for existing leases under the new standards and the right leasing strategy going forward.
Armed with this data and a practical knowledge and experience, real estate directors can add significant strategic value when working alongside finance. That may represent a new way of operating at many companies – traditionally real estate decisions would have been made without any involvement from finance departments – so it is important that both teams work collaboratively on the business’s response to the reforms as equal partners.
For finance teams, key tasks will include having an in-depth understanding of the legislation in order to be able to identify exemptions and transitional reliefs. For example, how it impacts on capital, provisioning, and even tax payments through the timing of profit recognition.
It will also entail carefully modelling the impact on financial results and statements. This will include determining whether any changes need to be made to loan agreements, debt covenants, bonus, profit-sharing or compensation agreements. Pro-forma financial information will also need to be prepared and information gaps created by subsidiaries and foreign affiliates identified. What’s more, these changes and their consequences need to be clearly communicated to all stakeholders.
A critical measure of success for finance teams in the run up to 2019 will be how closely they work with real estate, FM and procurement. These groups must learn to integrate and collaborate if they wish to be fully compliant with these new standards. Only by working closely together can leaders see the true benefit of these changes, with a truer balance sheet that more accurately reflects the business’s liabilities, ultimately attracting more inward investment.