Can a Licence to Occupy can stay off-balance sheet?
The answer to this FAQ will ultimately be a question for your Accountant
Before you brainstorm the bricks n' mortar portion of your business plan, we strongly recommend you read + consider this FAQ to learn how adopting a more nimble business model which includes the use of a short-term Licence to Occupy (might be used to provide your business with a strategic advantage).
Other business benefits could also accrue, such as the opportunity to combine multiple + adaptive physical store presence with online eCommerce sales.
Why is this important?
If an agreement does not meet the definition of a "Lease" under AASB 16 Leases, then it is not accounted for on-balance sheet.
Why is this especially important for Commercial + Retail Property tenants?
The following observations have been extracted (emphasis added) from the PWC report entitled: Why the new standard matters to the Retail and consumer industry
The retail industry is likely to be one of the most affected by the new standard, given the significant use of rented premises for their stores. The PwC Global Lease Capitalisation study indicated that there would be a median debt increase of 98% for retailers, and 41% median increase in EBITDA.
Most of such leases are in the form of medium term leases (generally 3-5/9 years),whether in premium locations (flagship stores), shopping centres or ordinary outlets …
Historically such leases have been considered as operating leases, and have not therefore had any impact on the balance sheet.
The amount recorded in the income statement was typically on a straight line basis and entirely included in operating expenses. The new lease standard will not only have an impact on the balance sheet, but also on the operating costs, with a split of the expense between operating and finance costs.
The exemption for short-term leases and small assets is unlikely to provide any significant relief to retailers.
A Licence to Occupy is prima facie caught by the definition of "Lease" under AASB 16?
Under AASB 16, a "Lease" is defined as an agreement, or part of an agreement, that conveys the right to control the use of an identified asset.
The definition does not refer to an agreement labelled as a Lease.
Agreements not labelled as a Lease may meet the definition of a lease under AASB 16; conversely, an agreement labelled as a Lease may not meet the accounting definition of a Lease.
In assessing whether an arrangement is, or contains, a Lease, 3 key assessments need to be made.
These are presented diagrammatically below …
Where the lawyer's role becomes clear ➲ The exemption for short-term leases!
In the majority of cases, the use of a Licence to Occupy (typically being a short-term arrangement) will qualify for the short-term lease exemption, meaning that it represents an alternative method to circumvent the application of AASB 16 which means that such arrangements can potentially (subject to confirmation from your accountant!) remain off-balance sheet.
The use of a Licence to Occupy is therefore an increasingly important proactive strategic legal tool to consider when your business plans for the control or use of any property.
The technical details of the exemption
The following summary (in technical speak) has been extracted (emphasis added) from the KPMG article AASB 16 Check: Short-term and low value exemptions
The low value and short-term lease exemptions are available to lessees (tenants) only.
*A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less.
A lease that contains a purchase option is not a short-term lease.
The election for short-term leases shall be made by class of underlying asset to which the right of use relates [AASB 16: 8].
***The following lease expenses are not required to be disclosed:
Expenses relating to leases with a term of one month or less; and
Expenses relating to leases which are both low-value and short-term [AASB 16:53(c-d)].
Accounting Humour
I stumbled upon the following quote in conducting research for this FAQ and thought it worthy of further dissemination.
Extracted (emphasis added) from the article by David H. from the Queensland Audit Office: Do you have any ‘lease agreements’ that are not leases, or any hidden leases?
When discussing leases, it is useful to refer to the quote by Sir David Tweedie, the then Chairman of the International Accounting Standards Board (IASB) on April 25, 2008 when he said:
"One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet."
Credits:
This FAQ was written by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.
Important Notice:
This FAQ is intended for general interest + information only.
It is not legal advice, nor should it be relied upon or used as such.
We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.