How to prepare your SMB for the new lease and rental regulations

Recent changes to the rules around the way businesses lease products could impact your SMB. The new ruling, known as IFRS16, is designed to increase balance sheet transparency by more accurately reflecting the use of leases and asset finance and comes into effect January 2019. Is your SMB ready?

According to research by Eclipx Commercial and East & Partners, the vast majority of Australian companies use leases and/or rentals in some form. Nearly 9 in 10 of the 646 SMEs surveyed who use equipment finance, said it helped them grow their business.

Leases are widely used not just because they give companies the ability to access property and equipment without paying large sums up front, but also because they can help offset obsolescence and residual value risk.

But with the new rules about how leases are treated in company financial statements coming into effect on January 2019, your SMB will need to understand how the changes impact.

What is IFRS16?

For the purposes of accounting standards, leases are currently categorised as either finance or operating leases – depending on complex rules and tests. Each classification is treated very differently, from an accounting standpoint. IFRS16 eliminates the distinction between operating and finance leases, instead applying a “right to use” test that looks at whether the business has the right to control the use of an identifiable asset for a period of time.

Because most leases will now be on-balance sheet, the companies most affected will be those with expensive assets – like real estate or manufacturing equipment. Smaller businesses, and/or those that lease less expensive items – like office furniture and computers – might not see a big difference in their financial statements, but will still need to factor in the effects.

What will it mean?

IFRS16 will impact your business processes; you’ll need more information about leases in order to properly account for them on your balance sheet.

The new standards will eliminate nearly all off-balance sheet accounting for lessees, with a considerable flow-on effect on several commonly-used financial metrics. Gearing ratios, current ratios, asset turnover, interest cost, EBIT, EBITDA, and even operating profit and net income, will all be affected by the change. Comparing company balance sheets will become easier as a result, but it will also potentially affect your company’s credit rating, the cost of borrowing, and how shareholders and other stakeholders assess your business.

How should you prepare?

Exactly how the change will affect your business will depend on a number of factors, and you should seek independent advice regarding your situation. There are two main areas to consider – one is financial reporting, which you should speak to your accountant, CFO or treasurer about. The other is the implications for any new lease or rental arrangements entered into – these should be discussed with a specialist asset financer that understands your business and its needs.

The earlier you start preparing, by fully understanding the impact for your business, the better prepared you will be (and the less compliance will cost). Depending on the value of the assets you lease, the impact may not be substantial, but investigation now will minimise potential surprises later.

Anthony Roberts, MD of Eclipx Commercial is a specialist asset and equipment finance expert.