It has been over 20 years since the first accounting standard setter dared to propose that all future lease payments should be shown as a liability. This week a new International Financial Reporting Standard was published meaning that this will be a requirement for large companies from January 2019. There is no news yet as to when this change will be imposed on smaller businesses but it is almost certain to happen at some stage and may come into force at the same time (January 2019).
At the moment, company accounts include a note setting out what the future payments under leases will be. In many cases, company accounts only recognise as a liability lease payments which were actually due to be settled by the accounts date. For large and long term leases, such as for property, the difference can be enormous.
From 2019 when you sign a new lease for the use of an asset you will recognise as a liability all the future payments you commit to making (adjusted for interest if you want) and recognisea fixed asset for the same value. You then depreciate the asset over the lease term and pay the lease payments as they are due.
The big difference will be that many companies will show significantly higher fixed assets and liabilities. This may make suppliers and customers more nervous and may mean that businesses breach the covenant requirements of their bank loans and overdrafts.
There are lots of sensible provisions to minimise the disruption of this – for example, excluding leases of less than 12 months, excluding leases for individual small amounts and putting in special rules for dealing with break clauses and leases with rent based on turnover.
The change is unlikely to affect the tax position of companies, but it is much too early to be definite on that. There will however be some very different figures presented for “earnings before interest, tax depreciation and amortisation” (EBITDA) as lease payments previously included as operating costs will now be shown as depreciation and interest. EBITDA is often used by analysts and corporate financiers in valuing a business and several ratios will have to change as a result of this.
I expect the biggest impacts on accounts to be for companies in sectors with a high property cost, such as retail and agriculture. In areas like this, however, I think that everyone looking at accounts will understand the issue and it won’t cause too many problems. Smaller manufacturing and distribution businesses with leased properties may find that their accounts are significantly affected and the problems for them may be much greater.
While personally I think that these new rules will make accounts more easily understood and comparable, the change from current practice for many businesses will require a lot of work.
If you want to discuss how this may affect you, please call me on 07710 703 463.
David Gorton – Senior Partner