Advisers and other small business owners need to act now to avoid falling foul of their debt-covenants due to changes in accounting practices due to come into effect from 1 January 2019.
Crowe Howarth audit technical director, Ralph Martin, warned that International Accounting Standards Board’s International Financial Report Standard (IFRS) 16 Leases, which effectively abolishes the concept of the operating lease, could significantly affect debt-to-equity or interest cover ratios.
“It’s easy to think that 2019 is nearly three years away, but our advice to small businesses is to start preparing for the change now,” he said.
“Many loan agreements contain covenants based on ratios such as debt-to-equity or interest cover. The new standard could significantly affect those calculations.
“What was treated in the past as an operating lease will now sit in the balance sheet as a liability. The effect could be to trigger a breach of their loan covenants that could give the bank the right to demand repayment of the loan in full.
“Exceptions to this significant standard will be short-term leases (less than one year) and low-value assets such as office equipment and computers, but clearly won’t exclude long-term property leases.”
Martin added that the new standard could require some businesses to adjust their accounting systems to capture the required data, while the reclassification of rent into a mixture of ‘depreciation’ and ‘interest’ could have an impact on earn-out arrangements based on earnings before interest, taxes, depreciation and amortisation (EBITDA) multiples.
He also noted that the replacement of the current straight-line expenses approach of operating leases with front-loaded recognition of interest expense could affect the timing of earnings associated with major projects and asset groups.
