lear picture of the financial position of businesses, but changes were deferred after Woolworths and Coles objected to the proposal. The changes to accounting standards would require rent and other financial obligations over the term of a lease to be included on balance sheets as debt. The leases would also be included on balance sheets as assets. The requirement would be expected to trigger reviews of banking covenants and debt exposure levels by banks and financiers and lead to demands for some retailers to reduce their debt. While the actual financial position of retailers would be effectively unchanged by the new accounting standard, bringing future financial obligations under retail leases onto balance sheets is likely to have a material effect and lead to higher disclosure requirements by banks and financiers. The requirement would create a greater focus on the quality of leases, with the change expected to particularly impact on retail chains carrying loss making stores. Banks would be expected to adjust their risk on debt exposure to retailers, with many financial collapses linked to chains that have been unable to exit unprofitable stores. The change to accounting rules could also spook investors with some listed retailers with long term leases potentially facing some impact on profits. The change would have a variable impact on retailers depending on the number and age of leases, but industry wide, it is estimated that the value of leases that will be brought onto balance sheets will exceed $40 billion. Leases are one of the major cost centres for retailers, sometimes accounting for 20 per cent or more of sales, and rent and outgoings costs have previously been included as recurrent costs in accounts. Under the latest changes to accounting regulations, retailers would have to calculate the net present value of future lease commitments and include the total exposure as debt on their balance sheets. According to accountants, the requirement will increase earnings before interest, tax, depreciation, but will generally reduce pre-tax and net profits, particularly for expanding retailers and those with newer leases with higher rental commitments. The standard could also force changes to leasing incentives, which often retain high headline rents in the lease document that are offset with discount periods or other concessions such as contributions towards fitouts. Under the new standard, a retailer would be forced to overstate its debt liability on a lease on the headline rent figure, but would face a complicated process to then account for the incentives and any discount period that was part of a side contract. An adverse impact on bottom line profits would affect retailers who had higher amortisation and financing costs associated with leases than the rent and occupancy costs that were previously a recurrent cost centre in the accounts. There is also a likelihood of reduced shareholder equity because of the change to a retailer’s debt profile and gearing. Landlords not immune Industry observers believe the new accounting standards could also have implications for retail landlords, with retailers likely to opt for shorter term leases to minimise the debt drag on their balance sheets. Retailers would also be under increased pressure to quit loss making stores. The new accounting standard will force retailers to renegotiate debt covenants with their bankers as gearing levels will jump significantly and would be expected to see most, if not all, retailers breach their existing debt ratios. The renegotiation process is likely to be problematic for some chains who continue to suffer poor sales and declining profitability and, some accounting firms expect that a number of retailers could face the prospect of administration with banks taking a cautious approach to debt gearing as retail sales continue to underwhelm. The proposed change to accounting standards would increase the debt liability on the balance sheet for Woolworths by an estimated $15 billion, while Wesfarmers would have to incorporate around $12 billion in debt obligations on its retail leases. The struggling Myer department store would see its current debt of around $340 million blow out to more than $2 billion based on its leases. The major chains would be expected to be more heavily impacted by the change to regulations as they are generally locked in to longer term leases. The International Accounting Standards Board plans to finalise its proposed changes this year with the new requirements likely to be implemented in the 2018 financial year. This story first appeared in Inside Retail PREMIUM issue 2042. To subscribe, click here.