Lease Changes under International Financial Reporting Standards

There have been quite a few client queries regarding an upcoming change in the way leases are accounting for under International Financial Reporting Standards – specifically IFRS16 which is effective for accounting periods from January 2019.

Whilst the majority of our SME automotive clients prepare their accounts under FRS102, the change in International Standards merits review as the change may apply to competitors against whose accounts we benchmark, those part of international groups may have to align their reporting formats, in addition the change may raise questions from financiers.

A common corporate structure for automotive businesses can involve the dealership property being owned by a holding company or pension fund and rent charged to the trading subsidiary. The rental payments would generally be classed as operating lease payments and accounted for in the P&L as a current year expense. IFRS 16 will require lessees to account for all leases on their balance sheets, including those which had previously been treated as operating leases, including leases of commercial property, equipment and vehicles. The standard requires the lessee to recognise the future commitments under the lease, along with a corresponding asset to reflect the right to occupy and use the property or plant concerned. In summary the change will have the following effects:

  • Balance sheet assets and liabilities may increase significantly which is likely to have a material impact upon covenant calculations.
  • As costs are skewed towards the earlier years, the liability may exceed the corresponding asset, again affecting possible stakeholder decisions.
  • The nature of costs in the P&L will change, with a positive impact on EBITDA but greater depreciation and finance costs reported.
  • Existing bonus and internal remuneration structures may be affected.

In addition to the impact on the automotive retailer, it is also worth consideration of the effect on the customer, for example those with large car fleets who are currently accounting for these “off balance sheet”. Changes in the customers reporting may impact their ability to access finance and they may need to be prepared to explain the difference in accounting treatment from one year to the next.

If you would like to discuss this blog in more detail, please email Ginni Cooper or call us on 01772 821 021.

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