Chris King, a Partner in Pilot’s Corporate Advisory team, explains how your financial statements could be about to change dramatically – and in many ways for the worse – due to the latest change in financial accounting rules and best practice.
Effective from 1 January 2019, the new lease accounting standards will substantially impact the financial statements and financial ratios for all businesses with operating leases.
The new standard will require these leases to be recognised on the balance sheet instead of being the current rental or lease payment expenses. This seeks to create more transparency around a business’ lease commitments. These changes will impact key financial metrics such as gearing ratios, asset turnover and EBITDA.
Exemptions apply to short term leases (those of a period of 12 months or less) and leases of low value assets (less than $5,000).
The standard has the potential to impact:
- key profitability measures;
- balance sheet; and
- debt serviceability measures.
Impact on your Financial Statements
The balance sheet will now recognise a right-of-use asset, depreciated over the term of the lease. A lease liability will also be included, split between the current and non-current portion. The term of the lease will have a significant impact on the value of the lease asset and lease liability.
Rental expense in the profit and loss will be replaced by a depreciation charge on the right-of-use asset and a finance charge on the lease liability.
Impact on your Ratios
On initial recognition, the new lease accounting standard will impact key financial ratios. The benchmarks you use will need to be adjusted to account for the changes, particularly if they have been set covenants by external parties like banks and financiers.
Impact on Reporting Obligations
It is important to note that the changes to the leases standard has the potential to turn a small company into a large company under the Corporations Act 2001. This in turn would trigger auditing and reporting obligations for companies that previously had no ASIC obligations.
Act Now and Be Prepared
Businesses should not underestimate the effort, time and costs required to implement these changes.
It is important to be prepared and understand what impact the new standard will have on your business to reduce any potential issues and minimise implementation and compliance risk.
If you would like to find out how the new leases accounting standard will affect your business, contact your Pilot advisor or Chris King on 07 3023 1300.