Small businesses that lease their premises could be forced to renegotiate the terms of their bank loans because of an obscure change to the way commercial leases are treated in accounting, according to one accountancy firm.
Ralph Martin, audit technical director at Crowe Horwath, said the International Accounting Standards Board has issued an update that effectively abolishes the concept of operating leases. Instead, all leases will be treated as finance leases, meaning they will be recognised as liabilities on the balance sheet.
Mr Martin said one of the unintended consequences of the standard could be to force small business owners who lease their premises to renegotiate their loan agreements with their banks if this change in accounting standards puts them in breach of their loan covenants.
“Many loan agreements contain covenants based on ratios such as debt-to-equity or interest cover. The new standard could significantly affect those calculations,” he said.
“What was treated in the past as an operating lease will now sit in the balance sheet as a liability. The effect could be to trigger a breach of their loan covenants that could give the bank the right to demand repayment of the loan in full.
“Exceptions to this significant standard will be short-term leases [less than one year] and low-value assets such as office equipment and computers, but clearly won’t exclude long-term property leases.”
Mr Martin said that while the new standard accounting practice will not take effect until 1 January 2019, small businesses need to prepare for the change sooner rather than later.
“It’s easy to think that 2019 is nearly three years away, but our advice to small businesses is to start preparing for the change now,” he said.
“The new requirements can be complex, so it’s important to seek appropriate professional advice. Not all businesses will be affected equally. We expect the sectors to be most affected to include retailers and distributors, agribusiness, and the logistics and haulage industries.”
Patricia Stebbens, audit partner at KPMG Australia, said that all companies that lease major assets for use in their business will see an increase in reported assets and liabilities.
“This will affect a wide variety of sectors, from airlines that lease aircraft to retailers that lease stores. The larger the lease portfolio, the greater the impact on key reporting metrics,” Ms Stebbens said.
“Current lease accounting requires financial statement users to adjust for off-balance-sheet leases. The key change will be the increase in transparency and comparability. For the first time, analysts will be able to see a company’s own assessment of its lease liabilities, calculated using a prescribed methodology that all companies reporting under IFRS will be required to follow.”
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