In February the Australian Accounting Standards Board (AASB) announced that it will be adopting the International Accounting Standards Board (IASB) new requirements on dealing with property leases on company's accounts.
The AASB have decided to adopt the standards following the release of the IFRS 16 Leases which set out to improve the financial reporting of company's leases.
The new standards will treat leases as one as opposed to the current arrangement of being either a finance or operating lease.
Therefore moving forward all companies will be required to recognize leased assets (as a right to use the property) and financial liabilities to pay rent on their balance sheets.
For all leases with a term greater than 1 year the leasee will need to recognize depreciation of lease assets separately from interests on lease liabilities in the income statement.
Bringing all leases onto balance sheets will give investors, banks and analyst a complete picture of a company including lease liabilities so a more accurate assessment can be made of company's liabilities.
The new standard will be an added administration burden for companies, especially companies who lease multiple properties (all existing leases at the time will need to be recorded as there are no grandfathering arrangements), in compiling and recording this information which will include all rental payments and rental escalation over the lease term.
With the requirement for all leases to be shown on balance sheets this may force some companies to review their leased portfolio requirements moving forward.
- The changes may result in companies looking more closely at the ideal lease term for their business and the impacts of longer term leases on the company's balance sheet compared with shorter term leases. This will be particularly challenging in the Design and Construct pre commitment industrial markets where landlords demand longer lease commitments.
- As opposed to long term leases companies may decide to purchase their next premises as opposed to lease. Once again this may be more of a consideration in the industrial market where long term leases are agreed and companies sometimes invest significant capital into the facility to meet their operational requirements. Companies may look to implement a strategy where larger facilities or strategic locations are owner occupied with smaller facilities and branches leased to maintain flexibility.
- A more considered approach may be taken by companies to reduce their lease footprint and rent costs with consolidating more of their oeprations to save on rent costs.
- What will be the best way to structure the next lease? Some matters that a company may need to consider are whether all leases should be negotiated on an effective lease basis, the rent review mechanisms and also whether an Option term should be negotiated or not. On the later under the new standard Option lease payments only have to be included when the lessee is reasonably certain to extend the period or when an event occurs within the lessee control which effects the exercise of Options.