By Gareth Johnston, Director, Lisney
Change is on the way regarding how many UK corporate occupiers account for their leases following proposals that could come into effect at the end of this financial year.
Back in August 2010, the UK International Accounting Standards Board (IASB) issued proposals that will have implications for listed companies and others that report under the International Financial Reporting Standards (IFRS).
When adopted, the proposals will mean that most major UK corporate occupiers will have to record their lease obligations on their balance sheets.
The changes will impact on both the balance sheet and the profit and loss account of occupiers and are likely to lead to a broad review by corporate occupiers of their leasing strategies.
The proposed accounting standard removes the distinction between operating leases - which are currently treated as ‘off balance sheet’ - and all finance leases – ‘on balance sheet’. All leases, including sale and leaseback arrangements, would therefore be treated as ‘on balance sheet’.
Following industry consultation, the IASB proposes to continue to distinguish between different types of leases, with categories of ‘finance lease’ and ‘other than finance leases’ - the latter referring to property leases.
The IASB has made further revision to the August 2010 proposal, defining the lease term as the ‘minimum contractual term’ – which could be to a break option, plus an additional period where the lessee has a significant economic incentive to extend the term.
The lease liability will now be recognised on the balance sheet and calculated taking into account contingent rentals that depend on an index and lease payments that are reasonably certain.
The changes will have direct implications for gearing and banking covenants and careful management of lender relationships will be necessary through the transition.
The consultation period is at an end and it is anticipated that the IASB will release the final standard by the third quarter of 2011, with implementation expected to apply from 2013/14. As a result, companies need to be prepared for the changes by the end of the current financial year.
To ensure lease strategy can be considered it is critical that companies with UK leases have complete and accurate lease data information systems.
In preparation for the implementation of this new standard, an overview of leasehold portfolio strategies should be undertaken, focussed in particular on the timing of break options, rent review and expiry profiles, and acquisition strategy for new leases.