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The impact of IFRS 16 for different retail audiences

IFRS 16 presents key challenges and considerations for management, boards and audit committees as well as external users of accounts. Here are the implications for each of these audiences.

Audience – management

Key challenges Key considerations
A clear understanding of the full portfolio of leases. Decide whether an arrangement is a lease, a service contract or a combination of both.
Potential requirements to augment IT systems and implement robust processes and  controls for initial implementation and ongoing compliance. Are existing IT systems and processes and controls robust enough to identify all leases and collate  complete and robust data?

Key complexities of implementing the new standard such as:

  • determining the discount rate to be applied to individual leases; and
  • treatment of lease breaks and lease renewals.
Keep up to speed with the latest thinking and practice as they evolve. Provide training for finance and  procurement teams and others who negotiate lease agreements.
 Ongoing compliance and monitoring to incorporate new leases and lease  modifications.  Ensure appropriate resources are in place to maintain up-to-date lease information and ensure that new  leases are structured in the best way. Can this be resourced internally? 
Review strategies on whether to buy or lease as well as ongoing lease terms. 

Is the property strategy still optimal? Consider the impact on capital expenditure and leasing strategies.

Find a balance between minimising the potential impact of IFRS 16 and the wider commercial benefits of lease arrangements. For example, turnover based agreements may reduce the impact on the balance sheet and reported earnings but at the same time could cause future volatility in rental payments.

The impact on current key performance indicators (KPIs).

What will be the pertinent KPIs in the future?

What discussions have taken place with lenders to understand the impact on existing covenants? Make a decision on the  accounting basis for covenants in existing and future financing arrangements.

HMRC’s treatment of the taxation of leases continues to be uncertain.

 

Audience – boards/audit committee 

Key challenges Key considerations
The impact of the new standard on strategic investment and capital structure decisions.

Reconsider key performance measures – both internal and external – that the board would like to see reported on a regular basis, such as those that are used to assess store performance.

Assess the impact on distributable reserves both during transition and ongoing, and on any resulting revisions required to dividend policies.

Assess the overall impact on a retailer’s balance sheet which may lead to alternative real estate investment decisions.

The impact on remuneration targets?
How will IFRS 16 affect bonuses and performance-related pay schemes, and will targets need to be adjusted or a new base level set?
Ensuring stakeholders have a clear understanding of the impact of IFRS 16.
How will retailers manage key stakeholder expectations through communication and investor strategies? Start communicating at an early stage, although there will be a trade-off between communicating early and waiting until the company has carried out sufficient analysis to provide robust guidance on the impact.

 

Audience – external users of accounts

Key challenges Key considerations
A clear understanding of the significant impact that IFRS 16 will have on performance measures including EBITDA, operating profit and profit before tax.

Have lenders and investors started to think about the differences that will be occurring? They should start to evaluate the impact of the changes now to avoid surprises.

Lenders should revisit the definitions used for covenants. These may need rewording as current definitions may be inadequate to cover the proposed changes.

Stakeholders should understand that while IFRS 16 will have a significant impact on performance measures, it will not reflect any changes in the underlying business.

The lack of comparability between retailers who:

  • apply IFRS 16 and those who adhere to the alternative UK GAAP reporting standards;
  • apply different transition options and exemptions available within IFRS 16; and
  • have different maturities of lease portfolio and different proportions of turnover-based versus fixed rental payments.

 

How will investors and analysts manage performance comparisons between various retailers given the divergence between IFRS 16, UK GAAP, and US GAAP and also within IFRS 16? This will require a detailed understanding of all relevant accounting standards and analyses of the impact of the different approaches, which will also have training and resourcing implications. 
How will the changes impact on the ratings and valuations produced on retailers?
Will the adoption of the standard cause a change in company valuations or will analysts continue to value retailers on the existing basis? 
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