Retail Sector Significantly Impacted by New Lease Accounting Rules

“It feels like retail is now closer to the precipice” Theo Paphitis is quoted in the Daily Telegraph Business Section (05/11/18). He was speaking specifically post-budget but whenever the retail sector is mentioned it is generally with a cloud foreshadowing doom. The online retailers, falling footfall in malls, empty shops in the high street all seem harbingers of doom.

In a recent Financial Times article (28/10/18) Jonathan Eley writes that “New rules on how retailers account for the cost of renting their premises are likely to have a significant impact on profits and valuations...” Those new rules, of course, are the 2016 published IFRS 16 lease accounting standard which has a deadline adoption and implementation date this coming January.

From 1^st January 2019, most leases will need to be treated for accountancy purposes as if they were finance type leases – all leased assets (with just a couple of exceptions) will appear on the balance sheet along with all associated committed liabilities. Published in 2016 by the International Accounting Standards Board (IASB) IFRS 16 the new lease accounting standard sets out to accomplish this by requiring the reclassification of all leases extant for annual accounting periods beginning on or after 1st January 2019.

The FT suggests “the objective is to improve comparability and accuracy of company accounts and retail is the sector where the changes will have the biggest impact”.

In 2016 the IASB estimated that retailers across the globe had some $571 billion of future obligation payments that were not recorded on their balance sheets.

Eley continues “…and could even force some (retailers) to renegotiate debt agreements, analysts and advisors have warned”.

Even though retailers are aware of the impact that does not mean that they are not aware of the effort that is going to be needed to correctly calculate the values under the new leasing standard for literally hundreds or even thousands of operating type leases previously expensed under the old regime.

Help is at hand and indeed some large retailers have already gone a long way down the line by seeking the assistance of auditors or by utilising the available functionality of lease accounting software to help ease them to compliance and a transparency which they may not resent but don’t necessarily welcome. Other retailers have been slower to act and though adoption will come they are still some way behind the curve when it comes to meeting the deadline.

Change - How is IFRS 16 being tackled in the retail sector?

Whether the fully retrospective approach (applying the standard to every lease from its inception and then adopting the values calculated in the first accounting period after the deadline) or the modified approach (leases are accounted for as if they started on the 1^st January 2019) financial metrics such as EBITDA, Net Income, Tax and Accounting Profit, Net Debt and EPS will be affected – and consequently so will some managerial bonuses!

By way of illustration Tesco have adopted the former approach (fully retrospective) which will entail them restating their previous year accounts which whilst onerous on the finance department does have the benefit of giving investors, lenders and stakeholders a base for comparison. John Lewis however, partner owned, has taken the simpler modified approach. In either case, though there is much “grunt” work to be done in assembling the lease data, collating it, identifying services from assets and then reclassifying the accounting treatment.

A simpler transition to compliance has been implemented by more than just one or two high street names – they have looked for and identified solutions that will upload the data to cloud-based storage, have that data processed by a cloud-based “purpose-built” proven application and discovered that they now have a complete software solution that will not just manage an existing  lease portfolio as it matured and grew but one that would address the transition of that portfolio to the new standard by reclassifying operating leases, identifying non-lease components, generating the necessary journals entries for general ledgers and recognising and making available the expedients available in the standard. Production of reports – it goes without saying! Audit trail tracking updates and changes to leases, assets and commitments – necessary and built-in! New leases post the deadline will, of course, be correctly treated from an accountancy treatment from day 1, post-January 2019.

Conclusion - Where should the retail sector shop to find a solution?

The retail sector is often cited as a bellwether of the economy and though many working in the arguably already beleaguered sector will view the implementation of IFRS 16 as wieldy, onerous and even unnecessary when the dust clears everything from a comparison and transparency perspective will be equitable – the reporting of results may change, the financial metrics may change but the sector will hopefully open for business as usual.

Software solutions do exist and here at Innervision, LOIS Lease Accounting (LLA) has been purposely developed to recognise, face and execute the task of completing the transition of any lease portfolio to the new lease accounting standard but any piece of software is only as good as the people who use it and with this in mind above we have seen 5 steps to a successful implementation of such a suite. Knowing the challenges to be faced and how to avoid them is key to realising the full benefit of implementation.

Overcoming these challenges with the implementation of new software will generally result in a business benefitting from reduced costs and increased efficiency but in this case, it will transform a possibly neglected lease portfolio into a fully auditable and accurate record of each asset under lease and the associated financial liabilities.

Time is off the essence, disruption must be kept to a minimum, training is key, data entry should be post-transition, support is paramount.

Finally, this blog wishes to remind all lessees that in this time of change where existing leases may be reclassified and future leases will need to have a record of any updates, extensions or adjustments then a portfolio system with full audit trail will be essential and LOIS Lease Accounting (LLA) from Innervision is just such a process and system. LLA is a cloud-based solution that while easy to implement is well proven and purpose built to assist companies in transitioning to IFRS 16 compliance. Time is running out but adoption today and use of just such a system will allow you to accurately and easily accomplish the implementation of IFRS 16 on time.

For further insight and information on how the retail sector will be impacted by the new lease accounting standards - IFRS and ASC 843, view our eBook: Industry Focus - How The Retail Industry is Impacted by IFRS 16 by following the link below.

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Disclaimer: this article contains general information about the new lease accounting standards only and should NOT be viewed in any way as professional advice or service. The Publisher will not be responsible for any losses or damages of any kind incurred by the reader whether directly or indirectly arising from the use of the information found within this article.