New accounting rules focusing on leases will make tough demands of real estate – make sure your property management technology is up to the job.

It might be wise for real estate professionals to think of 1 January 2019 as D-Day for their departments. This is the date on which the International Accounting Standards Board’s new IFRS 16 standard becomes effective; thereafter, all publicly-listed companies will be required to ensure the value of their leases, including their property leases, are accounted for on their balance sheets and other financial statements.

The reforms will apply in the US too, under the Financial Accounting Standards Board’s Topic 842 regulation, so many companies will be dealing with two separate major new accounting standards – albeit similar – from 2019 onwards. Real estate will find itself front and centre of the considerable effort required to transition to the new rulebook – and to manage its impacts on an ongoing basis thereafter.

The IASB itself concedes there will be substantial costs for companies making the switch, as well as challenges and difficulties managing the impacts, but it believes the benefits of greater visibility of businesses’ leasing obligations more than justify the downsides. In other words, businesses now have no choice but to get on with the job of preparing for IFRS 16 and Topic 842 – and find the most efficient and effective way of doing so.

For real estate functions, it will be crucial to have property management technology that is fit for purpose. Indeed, the imperative is so strong that the reforms should prompt real estate to modernise their IT infrastructure, replacing legacy systems that will not deliver what is needed. Accountancy advisers argue that assessing the capabilities of existing technology is one of the first steps businesses will need to take as they plan for IFRS 16. And given that the new reforms make considerable demands on the finance function – which will require collaboration and support from real estate – now may be the perfect time to push for the resources needed for renewal.

Your property management technology needs to be capable of delivering a range of outputs. For transition, it should be able to organise and access all relevant property leases; it should also be able to extract the key data required from those leases for IFRS 16 purposes; and it should be able to deliver that data to finance in a format that can be easily integrated by its IT systems. In addition, on an ongoing basis, property management technology will need to be able to model the impact of new leases on the balance sheet, to inform real estate and finance about the implications of new property transactions and how best to structure them.

Systems that don’t provide accurate tracking and monitoring of key data will put your business at a real disadvantage, requiring resource-intensive manual interventions to make corrections and add missing information. In turn, that will inhibit the real estate function’s capacity to offer strategic advice on leasing in the context of the new standards, preventing it capitalising on an opportunity to add significant value.

Practically speaking, this is real estate’s opportunity to replace cumbersome on-site server based applications with a web-based alternative that provides the required functionality on day one and can be upgraded through automatic upgrades as new modules are required or new tools become available. For example, artificial intelligence and deep learning technologies may provide a real head start for real estate functions working to comply with the new standards.

Working in tandem with the finance department’s enterprise resource planning systems, modern property management technology will generate “one version of the truth” across the company – and enable real estate to meet its responsibilities and to add value as the new standards become effective. That will be crucial as real estate seeks to work in partnership with finance to respond to and manage these reforms.

Takeaways:

• New accounting standards that come into force in 2019 will require companies to record the value of real estate leases on their balance sheets
• Property management technology that cannot cope with the new standards will force companies to make time-consuming and expensive manual interventions
• To respond both tactically and strategically to the new rules on leases, real estate will need to move away from inflexible and limited legacy technologies

With new lease accounting standards coming into effect, businesses must decide how to manage the transition and ensure their property management technology is up to the job

The impact of the IFRS 16 accounting standard will be huge for many publicly-listed companies. For the first time, almost all lease obligations will have to be accounted for on the balance sheet – that will see the average company’s debt increase by 22% according to analysis by PwC, and by significantly more in sectors where businesses have big portfolios of property leases, such as retail and leisure.

The new rules are likely to have profound effects on how businesses think about leases for many years to come, but the first challenge is to manage the transition to IFRS 16; that will require companies to look at the capabilities of their current property management technology and to consider the pros and cons of different adoption methods.

In drafting IFRS 16, the International Accounting Standards Board (slightly different rules apply in the US under the Financial Accounting Standards Board’s Topic 842 equivalent standard) has given companies two options for making the transition:

• Fully retrospective accounting – under this option, for reporting periods that end after the effective date of the new standard, companies report on all their leases on an IFRS 16 basis as if the standard had always been in place; they must also provide a comparison of how their reporting would have looked under the previous rules, so that the effect of the new standard is transparent and visible

• Modified retrospective accounting – this is a more straightforward approach that requires companies simply to apply IFRS 16 on their leases from the effective date onwards, with an adjustment of retained earnings made on the balance sheets, but no comparison with the old method

Both approaches have advantages and disadvantages. The fully retrospective method provides a much more detailed overview of the figures and how they’ve changed under IFRS 16, and is likely to be more accurate; but it requires businesses to produce two reports simultaneously, will almost certainly be more expensive and time-consuming to deliver, and will need a large amount of historic lease data.

By contrast, the modified retrospective option will not depend on so much data and is likely to be considerably less burdensome; but it will depend on estimates rather than definitive information and could be less accurate, which may have knock-on effects on other key financial metrics.

The basic capability of the company’s property management technology is going to be one consideration in this choice. For example, is your system capable of generating the data required for the fully retrospective accounting? Can it even cope with the data requirements under the modified approach, which will still be demanding? Are you thinking about investing in new technology as part of the shift to IFRS 16 and should this capability be part of that decision-making process?

It will also be valuable to model the effects on the balance sheet and broader company finances of the two different options before you make a definitive decision. This will require collaboration with the finance function – and property management technology that is capable of producing the outputs finance will require to carry out this work.

Making the effort now, ahead of time, will pay dividends, particularly for businesses with large lease exposures. The selected transition approach will potentially have an impact on company profitability for years after transition – until the final lease in place at the moment of transition expires – so it’s crucial to get it right.

Takeaways:

• New accounting standards that come into force in 2019 will require companies to record the value of real estate leases on their balance sheets
• The new standards give two interim options for compliance: full retrospection and partial or modified retrospections
• Both approaches have pros and cons, so real estate will need to consider the business’s individual circumstances to choose the right way forward
• The transition approach you choose could have an impact on your company’s profitability
• Plan ahead now to identify the best way to proceed before the new standards become operative

For more information on our lease accounting solution, please visit the IFRS 16 page.

New accounting standards requiring businesses to bring leasing obligations onto their balance sheets will require many companies to get to grips with two different sets of rules – will your property management technology cope?

It has been billed as the biggest shake-up in accounting standards for 30 years, but many businesses are not yet ready for the introduction of new rules on leases. While the rules are due to come into effect in 2019 throughout the world, their property management processes and technology may not be fit for purpose.

The rules will for the first time require businesses to include on their balance sheets the value of all their obligations on leases that are longer than 12 months. But while they are expected to hit one in two publicly-listed companies and add $2.8 trillion to company balance sheets, many firms are not prepared. In one survey published last year 43% of respondents said they were not very well informed about the changes or that it was too early to tell what the impacts would be.

That’s worrying given that many businesses are actually facing two sets of changes they will need to prepare for. Not only does the International Accounting Standards Board’s IFRS 16 set out the process for bringing leases on to the balance sheet, but the Financial Accounting Standards Board’s Topic 842 in the US does the same thing. Many businesses with international operations are therefore going to have to cope with both.

The good news is that the IASB and the FASB worked together in drafting their standards with the aim of delivering a converged standard that would be consistent globally. Nevertheless, while the two organisations were united by a common purpose – to tackle the fact that 85% of lease agreements and commitments do not appear on the balance sheet – there are some clear differences between the processes they have put in place.

These differences begin with the effective dates of the two standards. While IFRS 16 isn’t due to take effect until 1 January 2019, Topic 842’s effective date is 18 December 2018, a couple of weeks earlier. More significantly, however, the IASB takes the single model approach while the FASB has opted for a dual model:

• The single model requires companies to account for all leases as “Type A” financing leases. The balance sheet therefore shows the acquisition of a right-of-use asset and a corresponding liability, with interest and amortisation expense recognised separately in the income statement.

• The dual model classifies leases as either “Type A” or “Type B” (operating leases with a generally straight-line lease expense pattern); both must be on the balance sheet, but the expense recognition and presentation are different.

Several other technical variations flow from this distinction. In the US in particular, the distinction between financing and operating leases will require additional work when compiling balance sheets and income statements.

Another issue, meanwhile, is adoption. Under IFRS 16, businesses are able to choose between fully retrospective reporting when accounting for existing leases, or a modified version; Topic 842 offers only the latter.

The question now for many real estate professionals – for property leases are likely to form the burden of most companies’ compliance work – is whether their property management technology is capable of coping with both sets of rules. Does it offer the functionality to identify and extract the key data under both IFRS 16 and Topic 842, and to feed that information into the finance department’s IT systems?

If not, the transition to the new standards is likely to be a painful one, requiring doubling up of effort and manual interventions to ensure compliance with both regimes, both at the transition stage and on an ongoing basis thereafter.

That will suck in resources that could be put to far better use elsewhere – and risk pitching the real estate function against finance as both grow increasingly frustrated about the unnecessary workload.

Takeaways:

• New accounting standards that come into force in 2019 will require companies to record the value of real estate leases on their balance sheets
• The new standards are being introduced by both the IASB and the FASB, with subtle differences between the two authorities’ approach
• Companies covered by both sets of standards must get to grips with the requirements of each one
• The IASB takes the single model approach while the FASB has opted for a dual model

For more information on our lease accounting solution, please visit the IFRS 16 page.