Although you might think of them as set in stone, accounting standards are actually updated regularly. The International Accounting Standards Board (IASB) is the organization responsible for developing and implementing changes to accounting practices, and it announced a new accounting standard that requires lease obligations to be reported on the corporate balance sheet on Wednesday, January 13th. The new IASB standard revising the policy for leases was developed together with the U.S. Financial Accounting Standards Board.
This means that on January 1st, 2019, businesses around the globe will have to add around $3.3 trillion of leasing commitments to their balance sheets because of new regulations, significantly increasing the debt that must be reported by many industries, in particular the airline and retail sectors.
This new accounting standard including leases comes following many years of discussions regarding “off-balance sheet” financing, and is estimated to impact over half of global businesses.
IASB and U.S. FASB implement new accounting standard for the reporting of leases
Wall Street analysts highlight that retail, hotel and airline firms that lease property, planes and other expensive equipment will see the biggest hits to their balance sheets, as prior accounting standards do not require that leases be accounted for.
The Wednesday IASB statement noted that future payments of off-balance sheet leases is close to 30% of total assets on average for firms in these sectors.
As an example of the impact of the new accounting standard, the net debt reported by UK food retailer Tesco would jump from £8.6 bn on August 30th to £17.6 bn, estimated Richard Clarke, an analyst from Bernstein. Clarke also pointed out that while the new standard may make Tesco (and many other firms) look more indebted to the untrained eye, but the assets associated with the leases also impact the balance sheet, so “the net effect would be neutral.” The caveat emptor here is that not all firms have significant assets associated with their leases like Tesco does.
The new standards may also impact some firm’s banking covenants and debt-based contracts with lenders, but it will make it much more straightforward to compare firms that use leases as part of their operational model and businesses that tend to borrow and buy.
Vincent Papa, the director of financial reporting policy at the Chartered Financial Analysts Institute, which has been lobbying for leases to be included on balance sheets for decades, noted: “Putting obligations on balance sheets enables better risk assessment. It is a big improvement to financial reporting.”
Statement from IASB chairman
IASB chairman Hans Hoogervorst noted that: “The new Standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off-balance-sheet lease financing is no longer lurking in the shadows”.