IFRS 16: A Rare Chance to Strengthen Real Estate Governance

IFRS (International Financial Reporting Standard) 16 is effective for annual reporting periods beginning on or after January 1, 2019. The new standard applies to businesses using IFRS Standards. There is a need to establish new leasing standards and carefully examine all real estate lease agreements.

April 19, 2018

Effects on lease accounting

IFRS 16 requires that the assets and liabilities of all lease transactions be counted on balance sheets, and it is said that it will have a huge impact on real estate. Japanese companies who have adopted IFRS Standards (there are about 170) will have to comply with IFRS 16.

A major point of change is in regard to the accounting of real estate leases. Until now, if you rented an office space or a factory, you would count the costs of rent as expenses for that fiscal year, but under IFRS 16, the total expected payments, along with the rights to use, must be counted at their book values. If you don’t understand the details of your lease agreements now, be prepared to face trouble in the future. Many Japanese corporations establish local subsidiaries when they branch out overseas, and have many real estate leases that are under the jurisdiction of those foreign subsidiaries. Even if you can learn the yearly costs of rent through reports from on-site, it can be difficult to get details of the lease agreement, such as breakdowns of rental costs and common area charges, estimates for the term of the lease, and riders regarding future rent rates. You will need to carefully examine all the real estate leases that you have in Japan and abroad. “In Japanese real estate, general, everyday leases usually get renewed every two years, so it will be impossible, in practice, to estimate the term of the lease from the contract,” notes Toshimasa Sakaki of the JLL Japan Corporate Sales Headquarters. On top of that, when reporting asset retirement obligations, a specified period of time is set, but one can imagine cases in which, in order to report leased assets, the terms of the lease differ. In such cases, it will be necessary to re-calculate the asset retirement obligations. In addition, be aware that adopting IFRS 16 will make it impossible to temporarily report real estate sales profit, an advantage of sales and leaseback (S&LB). Sales profit will depreciate according to the leaseback period.

A chance to establish real estate governance

As you can see, compliance with IFRS 16 won’t go smoothly unless you know the leasing situations of all of your many branches, sales offices, foreign subsidiaries, and so on, both in and outside of Japan. However, underneath that, because IFRS 16 is compulsory, this could also be a golden opportunity to establish governance over real estate that you couldn’t handle until now. Takahiro Takahashi, head of the JLL Japan Integrated Portfolio Services Department, says, “There are more than a few Japanese companies who are aware that they aren’t managing their real estate properly, and that that’s a problem. I guess their head office, or the relevant departments, don’t have the authority, and they have been frustrated with the situation. If the head office manages all the overseas bases, they can re-think the real estate strategy of the entire group, inside and outside of Japan.” Not only that, he says, but optimizing the sizes of offices and the rent paid enables big cost reductions.

However, if compliance to IFRS 16 makes you want to reexamine real estate renting costs, you should do so within this fiscal year. The reason, warns Sakaki, is, “If you report in FY 2019 using amounts reported by local subsidiaries, and then use JLL Consulting Services starting next year, the amounts to be reported at book value might change, and the previous year's reports will need to be revised.”

Will this affect accounting standards in Japan?

To comply with IFRS 16, some Japanese companies are making management agreements with international accounting firms and large consulting companies. From such companies, you can expect advice on accounting regarding IFRS 16, but not insight relating to on-site real estate, or networking outside of Japan. They might not provide you with concrete real estate solutions. Having lost connections to pros who are well-informed on real estate in various countries on a global scale, dealing with this problem must be difficult. “Because JLL has a robust track record in global real estate market research, we get more questions about IFRS 16 from Japanese companies every day,” says Takahashi.

Currently, IFRS 16 only applies to about 170 Japanese companies, but Sakaki warns that “the fire is closer than you think.” That is because there are signs that accounting standards in Japan are also heading in the direction of the new lease standards in the IFRS 16. It is possible that, in the future, all Japanese companies listed on the stock market will have to comply with the new lease standards. “Thanks to IFRS16, a lot of companies must be realizing how important it is to have governance over real estate,” surmises Sakaki. Real estate has great potential for cost reduction, and because of that, could be considered an important infrastructure directly tied to improving revenue. Now is the time to re-think your system for managing it.