Leasing is very common and is often used as a financing solution to access buildings and equipment without suffering large up-front cash outflows. Most of a company’s operating leases to date tended not to be shown on the balance sheet. Going forward the introduction of IFRS 16 requires both the asset and the liability to now be reflected on the balance sheet.

The majority of companies reporting under IFRS (typically larger companies or subsidiaries of large groups) will be affected. Whilst there can be a delay for those reporting under FRS102 or the reduced disclosure for SMEs in FRS101.

The new standard will affect nearly all frequently used financial ratios and performance metrics for example, gearing, current ratio, asset turnover, interest cover, earnings before interest, tax, depreciation and amortization (EBITDA), earnings before interest and taxes (EBIT), operating profit, net income, earnings per share (EPS), return on capital employed (ROCE), return on equity, (ROE), and operating cash flows. This means that the changes could affect loan covenants, credit ratings and lower borrowing costs without appropriate discussions with banks, other lenders and suppliers.

Companies and organisations that lease ‘big-ticket’ assets will be most affected by these rule changes. These assets could comprise property, airplanes, printing machines and technology for example. Whilst there may be an exemption for low value assets (typically $5,000 or less when new), many assets like photocopiers and cars have a value greater than this and will be brought into the regime.

These new standards mean that it could be difficult and costly to comply with the new lease rules, especially if companies do not have an in-house lease information system.

Tax impact

The current approach by HMRC is to continue the status quo of allowing the net operating lease cost as a deduction for tax purposes. In addition, HMRC has no desire to tax transitional adjustments for the new basis.  As IFRS 16 is worldwide, other countries may adopt a differing stance.

The introduction of IFRS 16 is likely to cause initial accounting adjustments which may be positive or negative depending on the previous treatment adopted. In the case of M&A activity and acquisitions/disposals the projected trading results and tax exposure will need to be forecast and reconciled.

Impact on industries

Nearly every industry uses leasing to gain access to assets but the terms and structure of the agreements are completely different for each industry. Various studies have been conducted on global lease capitalisation to determine the impact of new lease standards. The results show that most of the bigger industries have a median increase in debt of 22% of all companies. The industry worse affected by this is the retail industry with a 98% median debt increase, followed by airlines with 47% and professional services with 42%.

How we can help

We have Large Business experience and have helped a number of companies with the implementation and modelling of IFRS16. Through HLB our global network we can obtain guidance on a country by country basis.   If your company would like guidance, Hawsons are well placed to help you.  If you would like assistance on this, book your first free initial meeting with us here or telephone your local Hawsons office.

If you would like to see more about our large companies services click here.

 

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