The moment we’ve been bracing for is nearly here. From 1st January 2019, the International Accounting Standards Board will bring IFRS 16 into force – the new standard requiring organisations to reflect leases in their financial performance. As a result, over a trillion pounds will appear on balance sheets from the start of next year – affecting everything from net income to cash flows and operating profits.
A variety of sectors will feel the impact of these changes, with retail being a particularly noteworthy example. Why? In numerical terms, the sheer size of the lease portfolios being managed by these companies stands them out from the crowd. But, in addition, the current climate in retail – particularly in the UK and particularly on the High Street – magnifies even the smallest shifts in operating procedures. And IFRS 16 is no small shift, b any measure.
In working with a number of major names in industry – including Halfords – in readiness for IFRS 16’s introduction, it’s become clear that the adoption of the standard is a complex task and careful preparation is key. A major, perhaps the major, part of that process is enabling and encouraging collaboration between internal teams to deliver accuracy and efficiency.
Across many projects we’ve seen that although the division of labour between real estate and finance functions is evenly split, it is quite clearly divided. Traditionally, accounting is the remit of the finance department while leases – specifically those concerning equipment, estates and facilities – are the remit of the property or procurement teams. With the intricacies of those leases (negotiated by real estate) now having direct correlation on financial metrics such as P&L, gearing and liabilities, tax obligations and disclosures, it’s evident that finance and real estate leaders must collaborate to ensure true compliance.
In the first instance, there will need to be a more strategic approach to new leases which is agreed and adhered to company-wide. When considering this, organisations may even find that their previous approach is no longer in the best interests of the wider operation. As an example, retailers may look to shift focus to turnover-based agreements which align with overall financial performance – an added benefit here being that these variable leases don’t need to be reported as part of IFRS 16.
Future leases are one challenge, but arguably the bigger obstacle is identifying all existing leases within the business. Taking inventory and collating necessary data (lease terms, payment terms, renewal options) has been the most critical step, helping to prioritise the analysis of more complex agreements and providing the necessary data to decide on a model moving forward. Armed with this data and knowledge, real estate directors can add significant value to the overall approach.
For finance teams, it’s key to have an in-depth understanding of the legislation in order to identify exemptions and transitional reliefs – for example, how it impacts on capital, provisioning and tax payments through the timing of profit recognition. Modelling and forecasting will also be important in determining any changes required for loan agreements, debt covenants, bonuses, profit-sharing or compensation agreements. And, among all of this, the information needs effectively and clearly communicating to stakeholders.
However, the critical measure of success will be how closely the finance and real estate teams work together – along with members of HR, legal and procurement departments. Collaboration will be a cornerstone of effective IFRS 16 adoption, and where teams seek to act in isolation, they risk missing crucial nuances that may have a major impact – particularly if they’re trying to handle calculations across separate platforms.
In implementing the standard, fully comprehending its impact, providing full visibility and enabling collaboration, spreadsheets are simply not up to the task. Specialised systems will be required to handle and automate calculations that are otherwise time-consuming and prone to error – the potential costs and implications will make it too risky not to do so. Only by bringing process and departments together with one common approach can leaders meet the requirements and realise the benefits they could bring – with a truer balance sheet that more accurately reflects the business’s liabilities, ultimately attracting more inward investment.
Steven Fox is the head of corporate solutions at MRI Software, a US-based provider of real estate and investment management software to real estate owners, investors, and operators.