In January 2016, The International Accounting Standards Board [IASB] issued an International Financial Reporting Standard [IFRS 16] which will come into effect for most companies from 1 January 2019. IFRS 16 specifies how an IFRS report will recognise, measure, present and disclose leases. The standard provides a single lessee accounting model, requiring lessees to recognise assets and liabilities for all leases unless the lease term is 12 months or less or the underlying asset has a low value.

The new rules will be particularly difficult for struggling retailers and may have a significant impact on their profits and valuations. The reason is the cost of leases was historically recorded as an operating cost in the profit and loss account. Under IFRS 16 leases have to be brought on to the balance sheet as assets and corresponding liabilities.

In 2016, the IASB estimated that retailers had $571bn of future payment obligations that were not recorded on their balance sheets. Many investors have not yet appreciated the effect this change will have on retailers’ future earnings.

Because rent will no longer be treated as an operating cost, operating profit or ebitda will rise while finance and depreciation charges will eat into net income. This will lower earnings per share enough to affect valuations. There could be tax problems if adjustments have to be made to accounts, which will have most effect on companies with lots of leases.

Many companies, particularly those with long and inflexible leases, may be forced to renegotiate their leases and other debt agreements. We may begin to see a trend towards shorter term leases.

Turnover rents have become more commonplace in the Irish market and as they are less affected by IFRS 16, will most likely continue to be popular in future.

A turnover lease is a lease where the rent payable by the tenant is calculated either wholly, or partly, by the actual turnover achieved by the tenant’s business operated out of the premises.

Alternative forms of rent might be a rent based solely on the tenant’s turnover but with the tenant guaranteeing a minimum amount of turnover.