The long-term financial prospects of multi-site and large commercial and industrial property tenants are to become more transparent under a new bookkeeping reporting standard which has come into effect during the current financial year.
The changes are contained in an internationally-recognised practice known as International Financial Reporting Standard 16 (IFRS16) - the technical name created by the global International Accounting Standards Board (IASB).
Standard 16 will now see property leaseholders required to reflect the future commitment of the entire lease term on their balance sheets – expanding out from the current practice of only recording monthly lease payments. For most applicable New Zealand companies, the 2019/2020 period will be the first full financial year the new format will be recorded.
Head of corporate and occupier services at Bayleys Property Services, Chris Menzies, said the new format would improve the ability for a tenant to account for their leased portfolio in the most transparent way.
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He said the new IFRS16 practice would only be of real relevance for medium to large companies operating from multiple individual sites, or for companies with substantial revenue or assets.
“It’s not something relevant for the smaller tenant/business owner operating from a neighbourhood retail premises or for a small light industrial firm running its operations out of a suburban warehouse,” Mr Menzies said.
“We’re talking about trading entities with either upwards of $30million in revenues or $60million in assets.
“The initial data input required and the subsequent calculations forecasting over future years literally has to be generated through technical property management software and be interpreted by either a qualified accountant or a commercial property manager with the appropriate understanding of how the IFRS16 standard works.”
Explaining the new protocol, Mr Menzies said that for a tenant with a monthly rent roll of $100,000 on a new 10-year lease, or multiple 10-year leases on individual sites, the IFRS16 accounting procedures would calculate the tenant’s total liability at $12million, being the total lease payments not paid, which is then discounted by the interest rate implicit in the lease or the incremental borrowing rate.
Under the old bookkeeping practice, a tenant’s liability was assessed and accounted for on a month to month basis as an operating expense – thereby keeping the on-going lease commitments off the books. The IFRS protocol not only encompasses property occupancy payments, but all leasing commitments a business is responsible for – ranging from photocopiers through to vehicles.
“Property will be 90 percent of the focus though,” said Mr Menzies, “because it is such a different entity from leasing a piece of office equipment or machinery - which are usually written down in value or upgraded and replaced every three years. Tenants simply don’t do that with their premises.”
“For example, under IFRS16 - and here’s why the numbers must be crunched by a software programme - the debt risk of the lease diminishes over the term of the rental period – factoring in any rights of renewal, until it reaches a potential zero level at the end of the lease. The figure created for establishing that line is deemed be what is known as the ‘right of use’, or the rights of the tenant to occupy their premises.”
Mr Menzies said accounting for upfront rental incentives received by tenants for long-term or high value tenancies also changed under IFRS16.
“While a landlord’s tenancy incentive – whether as a one-off cash payment or as fit-out contribution – was previously accounted for in the year in which it was received, the new protocol now factors in the dollar-worth of the incentive across the entire length of the lease,” he said.
“And here’s where the expertise of a property manager or accountant comes into the frame when crunching the numbers…. There are a large amount of assumptions which need to be made throughout the lifespan of a lease, including potential increases in rent, and possible length of tenure beyond subsequent expiries.
Mr Menzies said that as the new IFRS 16 methodology only related to property occupiers, it would have only minimal implications for property owners – specifically large companies which owner.