Will you also be hit by the new lease accounting standards?

An article in the Australian Financial Review on 6 September 2018 points to impacts of the new lease accounting standard on Myer and Woolworths when they come into effect next January. Under the new accounting standards AASB 16, Pepper Property believes that while a number of companies are actively considering their real estate, many are underestimating the impacts. Unlike the current lease accounting standard, AASB 16 sees lease payments capitalised and included as a balance sheet liability.

Pepper Property has worked with several entities on lease re-formatting, developing property usage structures that are less intensive from a balance sheet perspective, but sees a number of entities which do not appear to be considering more effective leases.

Changes to come
“We continue to see tenants operating under a strategy that nothing changes but the accounting”, structuring adviser Andrew Foster said. “However, Pepper believes there will be meaningful changes. While lending covenants will be grandfathered, it is unrealistic to think five years from now that companies will be preparing audited accounts based upon today’s accounting standard, which will be well and truly out of date. Similarly, compensation structures based upon ROCE, EBIT, even EPS, could be impacted. Again, there may be a transition period, but at some point, it will not be practical to be preparing accounts under accounting policies that are out of date”

For banks, it is definitely meaningful, as indications are that they will need to include the lease asset in their risk weighted assets, against which they hold capital.

Lowest cost isn’t necessarily best
There is a mindset in property that it is always better to pay $99 per year rather than $100 irrespective of whether the $100 per year lease is better or worse in terms of the ongoing obligations it creates. This no longer applies when a lease consumes balance sheet capacity. It could, and most likely will be better to structure a lease that may cost more in terms of cash payment but utilise less balance sheet capacity. “As a parallel, we all accept that we pay more for taxis per kilometre than companies acquiring cars, but taxis can often win-out because there is no capital requirement.” Foster said. “This mindset now needs to permeate tenancy decisions, or as it is now called under the new accounting standard, buying a right to use asset.

What to do
Any lease decision needs to be a comprehensive cashflow and balance sheet exercise. Lease analysis needs to assess impacts of leases, such as lease tenure vs cost, and other lease structuring arrangements, of which there a number of solutions, on a multi-dimensional basis taking into account balance sheet usage.

For more information, please contact:
Andrew Foster
Divisional Director
Pepper Property
+612 7801 4209
+61 408 673 513