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How will the new accounting standard for leases affect my business?

A new international accounting standard dealing with leases was issued in January 2016 – IFRS 16. It is currently expected that the new standard will be effective for accounting periods beginning on or after 1 January 2019, with UK GAAP expected to converge at the same time. The key change introduced by the new leasing standard is that the distinction between operating and finance leases will essentially be eliminated. The vast majority of leases will be treated in a manner consistent to the current treatment of finance leases – the company would recognise an asset, being their right to use the asset and a liability, representing the present value of their obligation to pay for that asset.

As a result, virtually all property leases will be brought "on balance sheet". Whilst this may have a limited impact on net asset values this change has the potential to cause some significant changes:

  • Gearing ratios will be affected due to the increase in total debt. This may lead to covenant breaches where loan covenants are based on total debt;
  • Operating profit will be affected as the straight line operating lease expense is replaced with two expenses: a straight line depreciation charge and an interest charge on the financing. The latter element will be weighted towards the earlier part of the lease term. Whilst the total lease charges over the lease term will remain unchanged, the charges will be higher in the earlier part of the lease term. Where covenants are based on EBITDA breaches may potentially occur due to the change in accounting standard

We can assist companies to review leases in place and assess the impact of the new accounting standard. We can assist your finance team in preparing the financial statements for the first year of adoption of the new leasing standard and advise on any transitional disclosures.

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