This year, some occupiers may find that some of their leasing deals show up as a liability on their balance sheets. Since the start of 2019, new accounting rules (known as IFRS 16) have been introduced for all UK publicly listed companies, which will have a significant effect on any firm that has signed long-term property leases, says BE Offices financial director, Simon Rusk. As a result, Rusk argues that flexible office providers are experiencing a wave of demand as occupiers seek to protect their balance sheets.
Previously, a lessee would happily sign a lease commitment where rent is expensed in the profit and loss with no balance sheet implications. This effectively meant long term occupational costs were not shown in the accounts.
IFRS 16 effectively rips up these rules for lessees and the ability to push lease obligations off the balance sheet. From 1 January 2019, an occupier’s balance sheet will have to recognise a right of use asset and a lease liability based upon the discounted rental payments due under the lease. At inception, both this new asset and liability will be the same.
Rather than expensing rent, the lessee will depreciate the right of use asset over the lease term. IFRS 16 could result in a front loaded lease expense hitting earnings immediately after signing a lease. To add further complication, the right of use asset value and/or lease liability could be re-measured based upon rent reviews or mid rent review comparisons of the rent paid to similar property rents (effectively marking to market). This could result in a large disparity between the asset and the liability.
IFRS 16 will affect or impact almost all frequently used financial and performance matrices including interest cover, EBITDA, EBIT, gearing and current ratios. EBT, interest cover and operating profit will be negatively impacted whilst EBIT and EBITDA could improve as rent is effectively converted to depreciation and interest. Credit ratings could also be affected.
Co-working office boost?
One of the key exemptions (subject to certain conditions) from IFRS 16 is the non-recognition of liabilities of 12 months or less which means that aside from all the other benefits, a flexible occupational licence will not be caught by IFRS 16. That is, any occupier signing a flexible licence will not have to place assets or liabilities on the balance sheet and merely expense the licence fee in the normal manner through the profit and loss.
This is a major advantage to any large occupier with no impact on any covenant or performance matrices and no complicated calculation or re-measurement of a right of use asset and lease liability which could result in large decreases in net assets.
While IFRS 16 only applies to quoted or international companies it is only a matter of time before UK GAAP adopts a similar framework to IFRS 16, making these same rules apply to smaller companies.
This overtly complicated accounting standard is just another reason why occupiers are choosing flexible workspace. Here at BE Offices and through our BeSpoke turnkey offering to larger corporates we have experienced a surge in demand as a result of the implications of IFRS 16 in 2019.
