4 February, 2016
Listed companies will be required to bring around $2.8 trillion worth of lease commitments onto their balance sheets once changes to international accounting standards come into force, the International Accounting Standards Board (IASB) has said.
Under current accounting rules, companies only have to record the value of 'finance' leases on their balance sheets. These are leases under which most of the risks and rewards of ownership are transferred to the company from the owner, putting them in a broadly similar position as if they had purchased the asset outright. 'Operating' leases, under which the risks and rewards of ownership are not transferred, need only be disclosed in the notes of the company's financial statements.
The IASB said that the distinction between the two types of lease was "somewhat arbitrary", and made it difficult for investors to compare companies or fully establish the extent of a listed company's off-balance sheet obligations. From 2019, companies subject to the International Financial Reporting Standards (IFRS) will instead have to report all leases as assets and liabilities on their balance sheets, subject to exceptions for 'small ticket' items and leases of 12 months or less in length.
IASB chairman Hans Hoogervosrt said that the change would "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," he said.
The IFRS rules are designed as a common global standard to be used by listed companies when compiling their accounts, in order to make them understandable and easy to compare across international boundaries. More than 100 countries including those in the EU currently require or allow the use of IFRS, although the US is a notable exception.
US companies instead use the US Generally Accepted Accounting Principles (US GAAP), which are overseen by the Financial Accounting Standards Board (FASB). The FASB has worked in close collaboration with the IASB on the development of the new standard, and is expected to announce similar revisions shortly, according to the IASB.
Listed companies using IFRS or US GAAP are estimated to have around $3.3 trillion of lease commitments, over 85% of which do not appear on their balance sheets, according to the IASB. Over 14,000 of the 30,000 listed companies whose 2014 annual reports were reviewed by the standards-setting bodies disclosed information about their off-balance sheet lease commitments, the IASB said.
The Institute of Chartered Accountants in England and Wales (ICAEW) said that the impact of the new standard would "vary by business and sector", but would particularly affect businesses with a significant number of large leasing commitments. Retailers with large leased commercial property estates, aviation and energy companies would be particularly affected, the professional body 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," said Nigel
"The potential implications also go way beyond a mere change in accounting. 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 new standard, known as IFRS 16, is due to replace the existing International Accounting Standard (IAS) 17 on leases on 1 January 2017. The new standard will need to be endorsed by the EU before it will apply to EU member states.
For further information, please contact:
Ian Laing, Partner, Pinsent Masons
ian.laing@pinsentmasons.com
