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IFRS-16

Steve Fox

GUEST BLOG: Paradigm Shift – IFRS 16 and the built environment

Steven Fox, Corporate Real Estate Solutions, Qube Global Software

Attempts at cross-border convergence of accounting standards is hardly new, in fact there have been efforts to achieve this feat since at least the late 1940s when increased international flows of capital necessitated greater financial clarity.

Initially, efforts focused on harmonisation – reducing the inconsistencies between different reporting methods – but nowadays there is a greater focus on methodical cohesion to assure comparability between a given set of figures.

And with good reason, this approach has seen significant uptake across the globe, with the majority of developed nations using a now standardised set of reporting rules known as International Financial Reporting Standards (IFRS).

And while there has been considerable success since the introduction of IFRS, there continues to be amendments made to the foundations of the standard in order to achieve greater financial transparency between trading nations and businesses – particularly in the wake of the latest financial crisis. The new amendment, IFRS 16, will bring all lease obligations and related financial information onto the balance sheet for the first time – a paradigm shift for reporting.

Indeed, this is far from a minor change, the International Accounting Standards Body (IASB) estimates that the new standard will cause two trillion dollars’ worth of assets reappearing on the balance sheet. Irrespective of this, however, the amendment is ultimately being introduced for the right reasons. As IASB chairman, Hans Hoogervorst remarks, these new requirements will “[…] bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligation [and] providing much-needed transparency on companies’ lease assets and liabilities”.

Why is this important for the built environment? 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. A considerable task, no matter what size your business.

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 decision makers need to know?

Spreading the word

The main point of difference between IAS 17, the current regulation, 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 fundamentally change this. Come January 2019, it will no longer be acceptable for leased assets to lurk in the shadows, undeniably throwing certain revenue projections into question.

Asset turnover, operating expenditure, and equity will all be negatively impacted, whereas liabilities, reported debt, and recorded assets will increase dramatically. Clearly, this change will necessitate the need for frank conversations between 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.

Moving over

In terms of transition, executives have two options: modified retrospective or fully retrospective. 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. The complexity of transition cannot be understated, and it is generally agreed that specialist software will be required to make the process a success.

This seems an opportune moment for decision makers to consider how web-based applications like Qube Global Software’s IWMS solution, Horizon, 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 undoubtedly create a ‘new normal’. The new standard primarily implicates land and built assets (in addition to plant, machinery and equipment), therefore real estate professionals, and indeed other departments, will need to start involving themselves in achieving full compliance and maintenance of financial accuracy. Essentially, accountancy will begin formulate part of many professional’s remit, mostly as a matter of necessity. With trillions finding its way back onto the balance sheet, no one department will be able to orchestrate this slew of financial data, so a cross-department collaboration will be vital. The easiest way of achieving this will likely be through utilisation of technology that assists with organisation and comparison of data.