Lease accounting

D-Day for lease accounting changes is rapidly approaching

On 1 January 2019 new accounting regulations will come into force that will result in some fundamental changes to business finances, decision-making and financial reports of profitability. For international companies (excluding the US, which operates under a different system), the IFRS (International Reporting Standard) 16 will replace the current IAS (International Accounting Standard) 17 accounting model.

Essentially, under the new IFRS 16, anything that looks or behaves like a lease or that contains an ‘embedded’ lease will be included in the new regulations. The term ‘lease’ in this instance can refer to property, personal property, machinery and equipment. For most real estate, the impact will be substantial with almost all leases being brought onto the balance sheet as an asset and a liability.

Leases will be capitalised based on who controls the right to use the asset. In future, some leases may, therefore, become service agreements to avoid them being capitalised, but another entity must have control over the right of use. Serviced offices and collaborative workspace may receive a major boost from the changes.

In terms of what is included under the IFRS 16, the rental costs, along with any fixed or predictable increases, are incorporated. Service charges and ancillary costs are generally excluded where they are charged based on actual cost, whatever that may be. Where a deal is agreed with a cap on service charges, and where the cap level is likely to be lower than the landlord’s cost, the service charge would be treated as rent and capitalised.

It has been noted that there will be some questions over mandated costs such as property tax (business rates in the UK) due to the fact that they are often included in the rents internationally but in some countries, including the UK, they are required to be paid by the tenant to a third party (the local authority).

What you need to know:

  • After 1 January 2019, all leases of one year or more will be on the balance sheet, both as an asset (right to use property) and as a liability (obligation to pay for that use).
  • The accounts for year-ends in 2018 will need to carry an estimate of the effect of the accounting changes and the 2017 accounts should carry some form of impact assessment.
  • The present value of the rents will be depreciated over the term in a straight line and interest will be applied to the undepreciated liability.
  • As far as sale and leaseback transactions are concerned, there will be a change in the way revenues are recognised – profits from the sale will be captured on the balance sheet and depreciated over the lease term via the profit and loss statement.
  • Accounting for owned property remains relatively straightforward – land does not depreciate, other assets are typically depreciated in a straight line over the life of the assets.
  • Long leases may be heavily disincentivised at the outset, although a balanced portfolio of values and expiry dates will not have too punitive an effect.

In order to prepare for the introduction of IFRS 16 it is critical that you review your current active lease portfolio to analyse the impact of the accounting measures.

Further information

For more details on IFRS 16, contact Savills Occupier Services team

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