New lease accounting rule brings $3trn onto company balance sheets

COMPANIES in more than 100 countries will be forced to bring around $3tn of lease commitments onto their balance sheets in a major overhaul of international accounting rules governing how companies should report their leasing obligations.

Accounting standard setter the IASB today published IFRS 16 Leases, which requires companies to bring most leases on-balance sheet for the first time, recognising new assets and liabilities.

The new rules are intended to provide investors with more transparent and reliable information about a company’s leasing commitments, without having to make difficult estimates about a company’s true level of debt.

IASB chairman Hans Hoogervorst said: “These new accounting requirements bring lease accounting into the 21st Century, ending the guesswork involved when calculating a company’s often-substantial lease obligations.

“The new standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off balance sheet lease financing is no longer lurking in the shadows. It will also improve comparability between companies that lease and those that borrow to buy.”

Entities that have significant operating leases, such as lessees of real estate, large equipment and machinery, and transportation vehicles, will be most affected by the standard, which is effective 1 January 2019.

Nigel Sleigh-Johnson, head of ICAEW’s financial reporting faculty, said the standard, which he described as “one of the most significant developments” to date in international financial reporting, should not be understimated.

“It will particularly affect businesses with a significant number of material off-balance sheet leases, including those in the transportation and real estate sectors. Retailers and other companies with significant leased premises should also prepare for major changes,” he said. “There is much work for companies to do to understand and implement the changes, not least in the area of data collection, and this work should be started sooner rather than later.”

The potential implications also go way beyond a mere change in accounting, Sleigh-Johnson added.

“The standard will have a significant effect on financial ratios and debt covenants because of the leased assets and liabilities newly recognised on lessee balance sheets. Employee compensation arrangements, dividend planning and taxation may also be affected,” he said. The accounting changes do not affect cash flows directly. However, given the scale of the accounting change, KPMG said it expects that companies will be keen to understand the size of the lease liabilities arising from transactions they enter into between now and 2019.

Brian O’Donovan, UK partner in KPMG’s International Standards Group, said: “No one wants to see accounting drive business behaviours – the tail shouldn’t wag the dog. But if accounting consequences are in the mix when a company is considering a deal, then the mix will change. For example, this standard essentially kills sale-and-leaseback as an off-balance-sheet financing proposition.”

Short-term leases of less than 12 months and leases of low-value assets, such as personal computers, are exempt from the requirements. 

US counterpart FASB is set to announce its own standard on leases in the coming weeks, while the EU will need to formally endorse the standard before it can be used by European companies

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