Audit insights: retail – are you ready for a radical change?
The balance sheets of retailers will be radically transformed by the new international accounting standard IFRS 16 Leases, but its impact will be felt commercially by all retail stakeholders.
This Audit insights publication aims to help retailers and external users of their accounts understand some of the key challenges that will arise and the important issues that they need to address as the new standard is implemented.
Under IFRS 16 nearly all leases will have to be reported on a company’s balance sheet for accounting periods beginning on or after 1 January 2019. Retailers, who normally hold large numbers of leased properties and other operational assets, will experience significant changes to their reporting, and it will shine a further spotlight in the boardroom on the challenges around real estate strategy. The new standard will also have a fundamental impact on performance comparability because there will be significant differences between retailers using IFRS 16 and those who continue to report using UK GAAP (Generally Accepted Accounting Principles), in addition to a number of judgements, options and exemptions that will be allowed within IFRS 16.
Areas of key impact on the financial statements
Under IFRS 16 operating leases will be recognised on the balance sheet as a liability with a corresponding right-of-use asset. In addition the income statement profile will change with higher charges in the earlier years of a lease.
IFRS 16 will have a significant impact on financial ratios and traditional performance measures, including:
- EBITDA (earnings before interest, taxes, depreciation and amortisation);
- operating profit before tax*;
- operating cash flows and net debt; and
- net assets.
* (rental expense is replaced by depreciation and finance charge.)
Retailers need to start preparing for IFRS 16 now because it will require substantial work. But before they begin they should consider these key questions:
- Do they have the relevant and sufficient resources in place to ensure full and proper implementation?
- Have boards and executive management identified the financial and commercial impacts of the forthcoming changes, and the options available, so that all decisions are fully informed?
- Has the impact on the interests of key stakeholders, such as banks, investors, landlords and contractual partners, been fully considered and have they been consulted?
- How will stakeholders deal with the lack of comparability that will result from IFRS 16 and any implications for company valuations where lease obligations are significantly different to those currently assumed?