New Lease Accounting Standard – don’t be caught unawares
Expert warns employee bonus plans and business sale contracts to be adversely affected by new accounting standard.
Businesses are seriously underestimating the time, cost and effort it will take to get ready for the new Lease Accounting Standard, warns a leading corporate accounting expert.
Chris King, a partner in Pilot Chartered Accountants Corporate Advisory team, says upcoming changes to the Lease Accounting Standard could substantially impact the financial statements for all businesses with operating leases, including their ability to borrow funds.
The new standard, which comes into effect on 1 January 2019, will require operating leases to be recognised on the balance sheet instead of being the current rental or lease payment expense.
According to King the changes aim to create more transparency around lease commitments.
He says the new standard will impact any businesses that rent premises and lease equipment or motor vehicles, most notably affecting businesses in the construction, not-for- profit, childcare and education, retail and manufacturing sectors.
“These changes will seriously impact key financial metrics such as gearing ratios, current ratios and EBITDA (earnings before interest, tax, depreciation and amortisation),” says King.
“As an example, anyone dealing with contracts that have earn-outs based upon an EBITDA multiple or employee bonuses based on EBITDA achievement, could potentially pay a lot more than they anticipated based upon the new standard.
“Current ratios, which for many organisations are close to 1:1, may drop below this benchmark threshold, potentially leading others to question their financial viability.
“The benchmarks you use will need to be adjusted to account for the changes, particularly if they have been set covenants by external parties like banks, financiers and regulators.
“The term of the lease will have a significant impact on the value of the lease asset and lease liability.”
King also warned that the changes to the leases standard had the potential to turn a small company into a large company under the Corporations Act 2001.
“This would trigger auditing and reporting obligations for companies that previously had no ASIC obligations,” he says.
“Businesses should be talking to their advisors now to understand the impact the new standard will have on your business to reduce any potential issues and minimise implementation and compliance risk.”
The new changes will most likely impact:
- existing licensing arrangements;
- key profitability measures;
- balance sheets;
- banking covenants; and
- contractual arrangements (including performance bonuses) that are linked to financial performance.