The New Financial Reporting Standard

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Last week, the financial world witnessed the approval of a new financial reporting standard that will add, according to The Financial Times, around $3th of leases to balance sheets on a global level. The new IASB financial reporting standard targets the disclosure of leases and will affect at least one in two companies world-wide.

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Essentially, it will force companies, including airlines and retailers, to include leasing obligations in their annual statements of assets and liabilities (balance sheets) from 2019. This accounting standard is regarded as a result of the 2008 financial crisis which caused the previous two accounting reforms that focus on the revenue recognition and the valuation of financial instruments.

The combined impact of these changes, from an investor perspective, will depend from the industry to industry. However, generally speaking they will impact on lending arrangements, dividend policies and tax planning strategies. More importantly, this step ought to be seen as a move towards a more standardized cross-border accounting framework , the lack of which was one of the root causes of much financial turmoil in the past and of extraordinary gains in foreign markets.

Hans Hoogervorst, IASB Chairman, stated that the new standard (related to lease reporting) will provide ‘much-needed transparency on companies’ lease assets and liabilities, meaning that off-balance-sheet lease financing is no longer lurking in the shadows.’ Just to get a glance of its impact, take the case of supermarket chain, Tesco: its balance sheet will increase from GBP 8.6bn to GBP 17.6bn, according to estimates from Bernstein.

However, some argue that the impact of this standard on the companies’ debts will be neutralized by the fact that under a lease you have both an asset and a liability and the value of that asset can be bigger than the amount you pay for it under the lease agreement.

Nevertheless, the combined effect of the three accounting reforms will result in more transparent financial reports and consequently, in better decision making by investors. For example, the revenue recognition standard will require that from 2018 revenues have to match to costs and the financial instruments valuation standard will force banks to recognize not only credit losses that occurred but also the losses expected in the future. Adding to these two reforms, the lease reporting standard, which will bring assets out of the shadows: the leases that are now reported in the footnotes will be brought under the spotlight of the balance sheet as assets and liabilities, presents an welcomed effect by investors and regulators.

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