This article was originally published 29 April 2020.
The impact of COVID-19 is currently the first thing on everyone’s radar, but it is still important to consider the impact new accounting standards for the 2020 financial year will have on licensees’ Minimum Financial Requirements (MFRs).
The past 12 to 18 months have seen a wave of accounting standards changes, resulting in a considerable impact on a number of companies, including those in the real estate and construction industry.
The scene was set in FY19
During the 2019 financial year, two new accounting standards were introduced - Revenue from Contracts with Customers (AASB 15) and Financial Instruments (AASB 9).
The AASB 9 standard reintroduced the general provision against trade debtors by what is called the “expected credit loss model” on the prior year’s MFRs. This causes licensees to consider a general provision against their year-end debtor balance, even if there are minimal issues with recovery. Licensees now have to consider the risk of events happening in the future when determining the provision, which is relevant to the current COVID-19 situation.
The AASB 15 standard introduced the new revenue standard, which some argue was bought in to make accounting for revenue in construction as complicated as it possibly could be. This has resulted in many of our clients experiencing differing outcomes in terms of the impact on revenue recognition. Some clients had minimal to nil impact, while others experienced more considerable consequences, such as deferment of revenue when there were uninstalled materials at a site.
Ultimately, what both of these accounting standards did was reduce current assets and increase liabilities, resulting in detrimental impacts on MFRs.
More changes followed in FY20
As we moved to the 2020 financial year, the Australian Accounting Standards Board decided to throw another spanner in the works by introducing the new leases accounting standard (AASB 16). This standard requires those companies with operating leases (such as rental of premises, higher value printers and vehicles) to account for these items on the balance sheet which would previously have been expensed as the service was consumed. This is achieved by the inclusion of a “right to use asset” classified as a non-current asset (similar to plant and equipment) and a lease liability. How the asset is split between current and non-current is consistent with the repayment terms contained in the lease agreement.
Queenslanders take note
What makes this new accounting standard critical for licensees in the Queensland construction industry is its impact on the MFRs. While there will be some impact on net tangible assets, as the accounting for the asset and liability over the term of the lease is different, the Queensland Building and Construction Commission (QBCC) has been clear in its previous presentations to the industry by stating the main impact will be on the licensee’s current ratio. This is due to the requirement to recognise a current liability for the present value of the repayment expected to be made in the 12 months following balance date. While the connected “right to use asset” is recognised as a non-current asset, it reduces the licensee’s current ratio.
Due to the potential impact, and as we approach the end of the financial year, BDO recommends the preparation of financial modelling in advance, to assess the impact this new standard will have on the MFRs. This will give the licensee time to consider their position and, if possible, make relevant arrangements to ensure compliance by the end of the financial year.
If you require any assistance in relation to accounting for leases and compliance with the minimum financial requirements, please contact your local BDO Audit specialist.