Retailers set for more change & rising liability levels with new accounting standards

pencil, paper, pen, study, learningBy Simon Fonteyn, managing director, Leasing Information Systems.

As if retail tenants do not have enough concerns in this ever-changing landscape with consumer spending decreasing, top brands collapsing, online retailing continuing to grow in popularity and the implications of the entry of Amazon and other international mega-retailers into the Australian space.

They now need to prepare for a new global accounting standard, set to turn their balance sheets, systems and processes upside down and dramatically increase their liabilities. A new global accounting standard, known as IFRS16, will come into effect in Australia on January 1 2019 and radically change the way leases are recognised in financial statements with a range of ramifications for the retail sector.

Besides a whole lot of additional paperwork, administration and new systems required for retail tenants to comply with this new standard, there will be far reaching implications in relation to loans and finance with leases over one year in length to be recorded on the balance sheet as a liability.

The major changes that will be introduced as part of IFRS16 require a retailer to recognise a “right of use” asset and liability equal to the present value of all future known occupancy costs, less any lease incentives. The asset could also recognise indirect lease costs such as leasing fees, design fees, surveys and any estimated make good obligations. Options on leases can also be included, if there is reasonable certainty that option terms will be exercised. This will require either a valuation or management to justify a valuation using current lease evidence of comparable rental amount.

For retailers, the liability implications of IFRS16 are far-reaching and will hit hard, causing rising debt levels which will require all retailers at best to renegotiate their debt covenants with their financiers. A recent PriceWaterhouse Coopers global study revealed that the retail sector will be one of the industries hardest hit and estimated there will be a 90 per cent increase in debt for all retailers, with a 41 per cent increase in EBITDA as a direct result of the implementation of this new accounting standard. This significant blanket increase will result from the lease liability, with 95 per cent of all retailers in leased premises. Similarly, the increase in EBITDA will stem from the fact that rental expenses, which typically represent between 5 to 30 per cent of a retailers P&L cost, will disappear and be replaced with amortisation and interest expenses of the liability, which are excluded from EBITDA.

Retailers need to start to prepare for these changes now and implement lease management systems to capture rental data that can value their lease portfolio on a continual basis. Or they face a real nightmare in 2019. The new accounting standard will come as a shock to many retailers who are not prepared, when it quietly comes into play in January 2019. It will create yet another financial obstacle for the dynamic retail sector, which is constantly evolving and battling the impacts of technology and changes to consumer spending patterns.

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Comments

2 comments

  1. Don Gilbert posted on July 10, 2017

    Interesting article. I covered this possibility in 2007 in my paper "Settling Rental Disputes by Expert Determination" which was awarded "Best Research Paper" at the second WAVO ("World Assoc of Valuation Organisations') Conference in Beijing, Peoples Republic of China, following on from the first WAVO Conference in Singapore, where I picked up on the valuation of Intangible Assets. And that a lease is an Intangible Asset ................ I present examples of what could add value to a lease and or what diminishes the value of a lease or creates negative value I have invented software; to assist to help one evaluate and present to the parties what the "reasonable rent" ought to be. It is extremely worrying that Retailers now have real solutions to address disproportionate charging and paying of rent, yet are not taking up the offers we presenting. My Old Friend and Colleague and Mentor used to say (and he was a Scotsman); "Don you do NOT win hard dollars on soft arguments. You need hard numbers to win hard dollars." And that is what my Software does. Accompanied by a Report that explains why.

  2. Mike Leask posted on July 10, 2017

    This is just the tip of the iceberg! Retailers who have existing debt covenants need to work with their bankers/lenders NOW to familiarise their existing and future (post IFRS16) financial reporting processes. A banker/financier who doesn't understand a retailers huge (leasehold) debts will not be willing to extend any new cash flow lending and likely be reticent to extend funds for new capital outlays for new premises. Whilst accountants recognise the corresponding "right-of-use" asset, in reality a default on a lease will potentially terminate the asset and crystalise the debt. Unfortunately, that is what the bankers/lenders will focus on! Retailers need have time on their hands but it is rapidly running out!

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