Whilst the world of corporate finance can sometimes feel a bit removed from that of financial reporting, those worlds do sometimes collide - the Financial Reporting Council (FRC) recently published proposed amendments to FRS102, which is a good example of how the two worlds can meet.
The headline grabbers are a change for companies currently reporting under FRS102 in respect of leases and revenue, who will in the future be expected to report on these areas in line with those large and listed companies currently reporting under the International Financial Reporting Standards (IFRS). The change in accounting for revenue involves the adoption of a five-step model which is likely to have the most pronounced effect on businesses with contracts for services with customers. That said, good practice for all businesses would be to anticipate at the earliest practical stage exactly how the amended standard will impact on when revenue is recognised.
The lease reporting changes are perhaps more dramatic in nature. The idea here is to harmonise the treatment of operating leases and finance leases. This necessitates the creation of an asset (known as a 'right of use' asset) and a liability in respect of future lease commitments, as well as accounting estimates in respect of the depreciation of the asset and the implied interest rate associated with the 'debt'.
What’s this got to do with corporate finance, you may ask?
Well, a couple of the more obvious impacts are:
- Many deals are done on the basis of an Earnings Before Interest, Tax, Depreciation & Amortisation (EBITDA) based Enterprise Value, and the implied multiples of EBITDA often form the basis for value expectations and negotiations of other deals. It is therefore highly relevant to understand which version of EBITDA you will be looking at when assessing value (one with operating lease expenditure (part of EBITDA), or one where that is effectively replaced by depreciation & interest (not part of EBITDA)). The same may also apply to changes in revenue recognition, which may shift revenue and profits up or down compared with earlier periods, although these effects are not likely to be as widely seen as those relating leases.
- There is speculation that lenders who have extant facility agreements, which include EBITDA based financial covenants (eg. Interest Cover), may seek to revise such agreements for companies who, for example, report significant operating lease expenditure currently. It is easy to see how gearing ratios may be affected too with a previously unreported debt type liability now popping up on the balance sheet.
The next step
So, whilst these changes may seem somewhat in the distant future, for all sorts of reasons it is advisable to start planning for them as soon as possible. Please get in touch with James Price on j.price@uhy-uk.com or your usual UHY adviser to find out more.
