Topical article by my colleague Roger Thornton and Jamie Tomlin of Moore Stephens as they address the impacts for tenants and landlords of incoming reporting standards that will transform lease accounting.

International Financial Reporting Standard (IFRS) 16 significantly changes lease accounting for tenants, requiring all tenants to report their property operating lease liabilities on their balance sheets.

Currently operating lease liabilities are not shown on the balance sheet, so analysts and investors have to guess what they are when assessing a company’s covenant. The idea behind the new standard is to bring greater transparency to companies’ assets and liabilities for analysts and investors. It seems harmless enough.

However, it is estimated that this will bring something like £2.3tn of lease commitments onto the balance sheets of the world’s listed companies for the first time. It is estimated there are £100bn of operating lease commitments in the top 50 FTSE 100 companies.

The businesses most likely to be affected by the new rules are those which are heavy users of real estate leases, so sectors such as retail, hotels and restaurants will be particularly affected. To take one example, it is estimated that the average reported balance sheet debt for retailers will triple.

Tenants that are most likely to see a big increase in their balance sheet debt will be those with large lease portfolios or large lease obligations relative to their size, and also businesses with a thin capital base compared to lease liabilities such as professional services firms. Companies with an already high debt level will also be adversely affected.

The new standard comes into operation on 1 January 2019 and the new accounting rules will apply to all real estate leases, except those with a term of less than 12 months, which do not need to be shown on balance sheet. Licences, which give a personal right to occupy rather than exclusive possession under a tenancy, are also outside the scope of the new rules. Business occupiers may need legal advice to analyse whether a particular arrangement is a lease or licence.