New standard - Lease accounting

What does the new standard mean for your business?

Fundamental changes to the accounting for leases will have significant business implications in virtually every industry. The headline change is that almost all operating leases will now go onto the lessee's balance sheet. However, the profile of expenses will also change and there are a range of commercial and practical changes to consider.


Background

In early 2016 a new international accounting standard for leases was released

The new standard is mandatory from 1 January 2019 but many companies will want to transition retrospectively and need to present comparatives for the year before.

Putting leases on balance sheet will increase the focus on lease accounting and the practical and commercial implications, outlined in separate sections below, may be significant.

There are also complexities in the accounting, including a new definition of which arrangements should be treated as leases for accounting, which we explore in the publications above.

 

How will it affect your metrics?

The new accounting for leases will affect your financials and metrics. According to a recent PwC study, on transition to the new standard EBITDA will increase 13% and debt 22% for the average listed company.* When key leases are renewed, it will increase liabilities overnight and interest expense in the following years.

Companies will need to carefully manage their lease renewals and forecast lease positions so they can minimise earnings volatility and communicate clearly with stakeholders.

Our Lease Assessment App models the impact on your lease portfolio so you can start understanding your lease profile and have time to optimise it before the new standard arrives.

*Source: PwC’s global lease capitalisation study

 

PwC's Lease Assessment App

How will the new leasing standard affect you?

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Commercial impact

Although this is an accounting change, it will have implications across your business including:

  • Debt covenants - the increase in liabilities, gearing and interest means covenants may need to be re-negotiated
  • Employee incentives - performance hurdles may need to be re-negotiated
  • Dividend policy - the front-loading of expenses and a possible transition adjustment to equity may affect your dividend planning
  • Thin capitalisation - the changes to net debt could affect the tax deductibility of interest
  • Lease negotiations - while accounting should not be the key driver in commercial lease negotiations, companies may prefer shorter lease terms and different terms to minimise the lease liabilities

Many leases being negotiated now will extend past your transition date and you should consider these possible impacts during negotiations.

 

Practical challenges

There are several practical challenges, including:

  • Collecting data for all your leases - a recent study found 39% of companies don’t centrally manage their lease agreements*
  • Validating the quality of data on an ongoing basis
  • Regular re-assessments - due to CPI increases or market rent reviews, for example
  • Combining knowledge from different parts of your business, such as deciding whether to include extension options
  • Increased scrutiny from key stakeholders including investors, banks, customers and suppliers

For most companies, the significant changes to lease accounting mean that spreadsheet-based calculations will not be reliable or accurate enough.

*Source: PwC/CBRE US Lease Accounting Survey

 

 

While changes to lease accounting could significantly affect your financial reporting, the practical challenges of preparing your business for implementation could also be significant. Please contact us to discuss what the new Leases standard means for your business, what steps you should take and how we can help.

Contact us

Sean Rugers
Partner - Capital Markets and Accounting Advisory Services
Tel: +61 2 8266 0309
Email

Daniel Rosenberg
Retail & Consumer Leader, Financial Advisory
Tel: +61 3 8603 3886
Email

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