International Financial Reporting Standards (IFRS) were initially introduced as an attempt to harmonise the way accounting was carried out across the European Union, but these specifications have since become a global practice due to their success at providing real financial clarity. Thanks to IFRS, an organisation will know virtually all pertinent financial information when looking to merge or acquire with another enterprise. However, there continues to be amendments made to the foundations, with the ultimate aim of giving a more comprehensive picture of what is going on within a given organisation.
The UK has operated under IFRS since 2005, and while some have speculated that Brexit may jeopardise the continuation of this, it’s mostly agreed that the standard (and all subsequent updates) will remain active if and when the UK leaves the EU. And so, from 1st January 2019 a new standard will be ushered in, fundamentally changing the way in which businesses report and disclose leasing information – IFRS 16.
These changes will have a significant impact on some organisations and the International Accounting Standards Board anticipates that the value of many businesses’ off balance sheet leases will be equivalent to as much, if not more than, the value of their total assets.
In essence, then, the purpose of the update is to establish the principles for acknowledgement, measurement, and disclosure of leases. For the first time, all lease obligations will appear on the balance sheet, an unprecedented change causing a projected US $2.8 trillion swell in ‘reappearing’ financial information. But while this seems dramatic on first inspection, it’s ultimately for the greater good, providing business leaders with total assurance of what they are dealing with, both internally and externally.
But why is this important for FM? Well, both existing and new leases will now be reported for the first time, meaning first and foremost that any business with a leasing strategy or extensive portfolio of leased assets will need to begin laying the groundwork in order to be fully compliant come January 2019. Secondly, IFRS 16 by its very nature will significantly impact listed companies of all types and their profit projections, so the need for absolute clarity on the topic is paramount if leaders wish to placate shareholders. Thirdly, as a result of this new requirement, the real estate and wider built environment will likely begin to assume responsibility for financial reporting. So what do FMs and those in the wider built environment need to know?
GETTING EVERYONE ON THE SAME PAGE
The main point of difference between the current regulation, IAS 17, and IFRS 16 is that finance and operating leases will both subsequently appear on the balance sheet. Under the new standard, operating leases will also report depreciation and interest separately. IAS 17 makes it difficult for financial statement users to clearly see the effect of operating leases and therefore obstructs useful comparisons with other companies. Essentially, under the current standard you cannot distinguish between those who lease and those who buy. IFRS 16 will completely change this. As IASB Chairman Hans Hoogervorst remarks, “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”.
Moreover, with operating leases being capitalised, there will also be a shift in financial metrics, particularly for those that have a large number of these leases. Asset turnover, operating expenditure and equity will be negatively impacted, whereas liabilities, reported debt, and recorded assets will increase dramatically. Clearly, this change will necessitate the need for frank conversations between FMs, real estate professionals, the C-suite, and wider company shareholders. With the goalposts moving under IFRS 16 (particularly metrics such as EBITDA), KPIs could essentially become unachievable, therefore decision makers will need to begin the process of acclimatising shareholders to these changes as soon as possible.
In terms of transition, executives have two options: modified retrospective or fully retrospective. Each approach has its pros and cons, so selection must be approached on a case-by-case basis. It is generally understood that fully retrospective accounting offers a more meticulous comparison of an organisation between old and new standards, but it also demands that two simultaneous reports be drafted, inevitably costing more in time and money. This seems an opportune moment for decision makers to consider how web-based applications can help prepare and maintain all pertinent financial information, thus alleviating much of the labour-intensive work required in order to be fully compliant come January 2019.
EMBRACING COLLABORATIVE REPORTING
Accountancy has always been the reserve of the finance department, but IFRS 16 will create a ‘new normal’. The new standard primarily implicates land and built assets (in addition to plant, machinery and equipment), therefore real estate professionals must begin to involve themselves in achieving full compliance and maintenance of financial accuracy. Essentially, accountancy will formulate part of their remit.
But IFRS 16 implicates both finance and operational leases, therefore bringing anyone handling leased equipment into the fray. FM service providers, like most service based businesses, lease a large majority of expensive machinery to keep operational costs lean. FMs have also typically overseen the leasing of estates and facilities, so IFRS 16 will undoubtedly engender a more collaborative approach going forward, mostly as a matter of necessity. As discussed, this update will see trillions of dollars finding their way back onto the balance sheet. No one department will be able to orchestrate this slew of financial data, so FM will need to be prepared to offer analysis and expertise.
WHAT’S NOT COVERED?
While the update is a significant and somewhat overwhelming change to financial reporting, organisations would do well to not lose sight of the details – in particular, what is not in need of disclosure under IFRS 16. Leasing arrangements for natural gas and minerals, service concessions, smaller inexpensive equipment leases, and intellectual property licensing are all exempt, among many others. Business leaders and FMs who are extensive users of these kinds of leasing arrangements should familiarise themselves with the intricacies of the update in order to collate the right information when initiating a formal transition.
International listed companies should pay close attention to reporting consistency throughout their supply chains, doing so will ensure veracity and total compliance when operating across borders. This is particularly important for businesses working in the US, as organisations will have need to meet a Financial Accounting Standards Board (FASB) specific standard in addition to IFRS 16.