New lease standards add burden to tenants, landlords

By Yeow Chee Keong and Chen Voon Hoe

AFTER nearly five years of deliberation, the International Accounting standards Board (IASB) issued the revised leasing standard IFRS 16 in January 2016. IFRS 16 will replace the current IAS 17 for companies with annual reporting periods beginning on or after Jan 1, 2019. Before the new standard becomes effective, tenants, landlords and stakeholders should take the time to understand the implications that the new standard might have on them and for Singapore's real estate industry.

Tenant's perspective

Currently under IAS 17, property lease contracts are classified as either operating leases (where they are not part of assets and liabilities - commonly referred to as "off balance sheet") or finance leases (where they are included in assets and liabilities - commonly referred to as "on balance sheet"), with the majority classified under the former.

When IFRS 16 comes into effect, almost all leases will have to be recognised as "right of use" assets with corresponding lease liabilities. This will have an impact on the tenant's key financial metrics, including increased leverage ratios and potentially lower return on assets.
In addition, tenants will need to split the lease and non-lease (such as service charge) components in the contract and recognise only the lease components on the balance sheet. In a recent PwC study on the impact of the new lease standard on tenants across all industries and sectors, it was found that 53 per cent of entities surveyed will see an increase in their debt of over 25 per cent.
Zooming into the retail sector, the survey found that the median increase in debt for retail companies is 98 percent, effectively almost doubling their debt. In addition, the new standard's additional requirements on disclosures, contract and data management may incur significant costs for tenants - in terms of finances and other resources. Retailers in Singapore are already facing pressures on their operating models, and this clearly is something retailers need to prepare for.

QUESTION

Explain how the new accounting treatment for leases under IFRS 16 would affect tenants who have entered into debt covenants with creditors. Also, explain from the perspective of the debt hypothesis of Positive Accounting Theory (PAT) what actions such tenants might take.