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New accounting rules about leasing contracts may just make flexible workspaces the most viable way forward for businesses, but the effects extend far beyond cost, writes Alexander Garrett
It’s been up and running since January and IFRS 16 – the new accounting standard that transforms the way leases are accounted for – has become reality for any company with significant leases on its books. The previous distinction between operating and financial leases is now history. But while we all knew that this would create a headache for those working in accounts and finance, it turns out that the impact is being felt much more widely. In particular, the stimulus that the accounting standard provides to adopt flexible office working is something that is making those in other departments sit up and take notice.
A quick rewind. IFRS 16 was conceived by the International Accounting Standards Board and ensures that contractual commitments for assets like office space can no longer be tucked away in the small print – but must be fully recorded as liabilities on the balance sheet. Contracts of less than 12 months are generally exempted, which is why many are predicting that IFRS 16 will provide the catalyst for more companies to consider renting short-term flexible workspace.
Finance and Procurement: time is running out. The key responsibility for complying with the new standard falls to Finance supported by their Procurement team, and many large enterprises have had a dedicated project team on it for the last three years.
Research by KPMG late in 2018 found that, with 90 days to go before the new standard was introduced on 1 January 2019, just three per cent of firms were ready, from some 800 polled worldwide. Deloitte’s Readiness Survey echoed this, and found 34 per cent of respondents expected to finalise their implementation during 2019.
IT: there is a need to invest. Many lessees have relied in the past on spreadsheets to manage and account for their leases, says PwC. “With the complexity of the new leases standard bringing all leases on balance sheet, using spreadsheets may not be cost-efficient and can lead to errors feeding into financial reporting,” the firm advises. “Entities need to think about implementing sustainable lease software solutions that are capable of dealing with the new lease accounting requirements.”
Real estate: thinking outside the box. The first task for the property or real estate team is reviewing the existing portfolio of office leases. “It’s critical that you review your current active lease portfolio to analyse the impact of the accounting measures,” says Julian Lyon, director of corporate account management at Savills. Which leases will need to be reported on the balance sheet? Which can be considered exempt, either because the rental period is less than 12 months, or because the lessee doesn’t have full access to the asset, in the terms set out under IFRS 16? Secondly, there may be an opportunity to re-negotiate existing leases to shorten the period and reduce liabilities. Third, it’s time to re-consider your future strategy. For one thing, sale-and-leaseback looks a lot less attractive.
KPMG says: “The new standard largely eliminates sale-and-leaseback transactions as a potential source of off-balance-sheet finance. Under the new standard, a seller-tenant always recognises a sale-and-leaseback transaction on-balance-sheet unless the leaseback is short or the underlying asset is of low value.” And more significantly, it’s time to take a hard look at short-term flexible workspace as an alternative to long-term leases.
HR sense an opportunity. First, HR has to deal with the issue that remuneration is often tied to financial performance, and so incentive packages may need to be reviewed when key profit ratios are likely to be negatively impacted by the new accounting standards. On the plus side, flexible workspace facilitates flexible working, and as such, IFRS 16 presents an opportunity to offer employees an option that they increasingly want.
As the UK’s Chartered Institute for Personnel and Development puts it: “We believe HR can make a strong case for using flexibility to develop greater diversity, brand competitiveness and increasing levels of job satisfaction and commitment from workers.”
Communications: raising awareness is required. Companies with large-scale leasing commitments will see a significant uplift in their gearing which will impact a range of financial ratios and metrics and could affect loan covenants, credit ratings and borrowing costs. So IFRS 16 is a topic that needs to be addressed by every part of the communications team: external relations, internal relations and investor relations.
When hotel group Radisson announced its results for the first nine months of 2018, they didn’t include IFRS 16 – but the group did give a projection of how the new accounting standard would affect those results, saying: “Earnings before tax is estimated to be negatively impacted by between €15m and €20m in 2019, based on the current portfolio of lease contracts.” Companies will be looking for the silver lining when they talk to both shareholders and media – and a strategy that will see the impact on the balance sheet reduced over time. And moving towards flexible workspaces may fit the brief perfectly.
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Alexander Garrett is a British freelance journalist who writes on a wide range of business issues for the UK press.