The new IFRS 16 accounting standard will come into force on January 1, 2019. The standard will regulate the valuation and accounting of leases – and thereby tenancy agreements as well. Many companies have only this year left to adapt their lease accounting arrangements to the new standard. Corporates in particular (i.e. companies whose core business is not real estate) are struggling to obtain all the information they need to make the necessary changes. Drees & Sommer is assisting companies develop and implement professional rental management procedures as part of their real estate management operations.
There is still some need for action when it comes to IFRS 16. This is evident from the fact alone that the German Financial Reporting Enforcement Panel (DPR) has expressly stated that it will pay particular attention in special audits in 2018 to new International Financial Reporting Standards (IFRSs). And this is despite of the fact that the subject was already on their agenda in 2017. Time is growing short for capital market-oriented companies – especially those listed on a stock exchange – whose accounts are prepared in line with the international accounting principles issued by the International Accounting Standards Board (IASB). In specific terms, companies involved in retail, logistics, transportation or telecommunications are particularly affected, as are hotels and banks. These types of companies tend to have buildings or other high-value assets that they rent out or lease to third parties. Up to now, these have generally been shown as operating leases in the notes to the accounts rather than in the balance sheet.
IFRS 16: not just a finance matter but a real estate matter as well
Thomas Häusser, Partner at Drees & Sommer SE, explains the practical challenges facing companies affected by the changes: ‘IFRS 16 isn’t just a matter for the Finance department – it’s a matter for the Real Estate department as well. However, Finance department colleagues often take on real-estate-related tasks that are outside their area of expertise. In some cases, this may be due to the fact that no centralized real estate management function exists, or that the necessary budget hasn’t been provided for such a function’.
Veronika Deuser, a Project Partner at Drees & Sommer SE, has inter alia provided assistance to a company listed on Germany’s MDAX index in setting up a professional real estate management function. As she put it: ‘Dealing with IFRS 16 requires a tremendous amount of time and effort.
In many companies it is often the case that nobody knows which properties throughout the world they actually have on their books.
Lists of rental agreements have to be laboriously compiled by local offices on site. Often it is not clear where contracts are stored or if they exist at all. Any changes to reported book value, whether in respect of new rental agreements or changes to existing rental agreements, also have to be reported. This means that companies have to have efficient and effective processes in place to ensure all changes can be regularly documented and reported both now and in the future.
An end to balance sheet cosmetics
Under IFRS 16, leaseholders (e.g. property tenants) will be obliged to disclose rights of use and attributable liabilities from 2019 onwards. Rental agreements will therefore be seen as a form of credit finance. This means that rental agreements will be shown as assets on the asset side of the balance sheet and also as payment obligations (in the form of liabilities) on the liability side of the balance sheet. Compared to the previously applicable accounting principle (IAS 17), there are very few exceptions to this. For example, agreements with a term of less than twelve months do not need to be recognized. Low-value assets are also excluded.
However, this does not mean that the consequences of IFRS 16 are merely longer balance sheets. The standard also has an impact on the profit and loss account, and on the determination of important indicators such as equity ratio, debt ratio, return on assets, EBIT and EBITDA. In turn, this can negatively impact the credit score or rating. ‘If they haven’t done so already, companies affected by these changes should prepare for the introduction of the new standard and see it as an opportunity. Because the requirements heralded by IFRS 16 provide a unique opportunity for the real estate management functions of many corporates not only to create transparency but also to gear themselves up to a new level,’ said Veronica Deuser.