SMEs – Take-care the new NZ IFRS lease standard could have a big impact on you!

With the changes to the Companies Act 1993 and the introduction of the Financial Reporting Act 2013 (both effective for periods beginning on or after 1 April 2014) most for-profit SME companies no longer have a general purpose financial reporting requirement, as these entities do not have public accountability and are not “large” as defined.

“Large” is defined as being:

• For New Zealand owned entities - either $30m of revenue OR $60m of assets in preceding 2 reporting periods
• For overseas owned entities - either $10m of revenue OR $20m of assets in preceding 2 reporting periods.

The determination of the quantum of an entity’s revenues and assets is required to be carried out based on generally accepted accounting practice (GAAP).

GAAP for for-profit entities is either:

• New Zealand equivalents to International Financial Reporting Standards (NZ IFRS) – required for all Tier 1 entities; or
• New Zealand equivalents to International Financial Reporting Standards Reduced Disclosure Regime (NZ IFRS RDR) – available for entities that qualify to report as Tier 2 entities.

So how could a NZ IFRS standard impact an SME?

The new NZ IFRS standard on leases - NZ IFRS 16 Leases (NZ IFRS 16) (which comes into effect for periods beginning on or after 1 January 2019) requires entities to account for (in most instances) all leases on balance sheet.  

I.e. leases that are currently treated as operating leases (in most instance), will in future be required to be treated similar to the current accounting model for finance leases. This results in entities taking an uplift in asset values in respect of the “right-to-use” asset under the lease, as well as recognising a corresponding liability for the future lease payments.

For SMEs that are getting close to the size limit for assets as detailed above, NZ IFRS 16 could have a very real impact.

If an SME was required to account for current operating leases under NZ IFRS 16, and  bring the associated right-to-use assets onto its balance sheet, there is a very real risk that the SME may be considered “large” by definition; especially if the operating leases are long-term property leases.

If an SME is considered large, it is required to “step-up” into general purpose financial reporting and report under either NZ IFRS or NZ IFRS RDR – i.e. the SME will no longer be able to report using special purpose financial reporting (SPFR). If a SME is forced to report under NZ IFRS/ NZ IFRS RDR rather than SPFR, this could have a knock-on effect to items such as banking covenants, employee bonus plans, etc., as the accounting positions under SPFR will be very different to those under NZ IFRS/NZ IFRS RDR in a number of areas.

It is therefore important that all SMEs that could potentially breach the asset size criterion as a result of the advent of NZ IFRS 16, start looking at the consequences of this standard now, and if necessary, put a transition plan in place to transition to reporting under NZ IFRS/NZ IFRS RDR.

For more on the above, please contact your local BDO representative.