New accounting norms likely to hit finances of retail companies

IndAS 116 rules will lead to rise in notional assets & liabilities, say companies

IndAS 116, the new accounting standard for leases, which will be visible from the June quarter, may significantly affect the financials of retail companies. This is because firms, which depend on the lease model when setting up stores, will now have to account for it in their balance sheet, something that they did not do when using the previous accounting standard, namely, IndAS 17.
 
Executives from retail firms told Business Standard that this was likely to bloat balance sheets with notional assets and liabilities. “As IndAS 116 requires that a lessee bring all leases into the balance sheet in the form of a ‘right-to-use’ asset as well as a lease liability, balance sheets will now expand,” said Anand Agarwal, chief financial officer, V-Mart Retail.
 
In the case of V-Mart, for instance, its balance sheet, said experts, would grow by Rs 300 crore, which is the estimated value of its lease for all its 226 stores. The duration of these leases is between 9 and 15 years, they said. As on March 31, 2019, V-Mart’s total assets were nearly Rs 632 crore, while cash and bank balance was about Rs 17 crore.
 

An increase in balance sheet size is expected to impact key financial ratios such as return on capital employed (ROCE) and return on equity (ROE) for companies. ROCE measures a firm’s profitability and the efficiency with which its capital is used. ROE, on the other hand, measures a firm’s profitability in relation to shareholders’ equity. In the case of V-Mart, both are expected to decline, experts said.
 
While balance sheet size of a retailer would grow because of the new accounting standard, earnings before interest tax depreciation and amortisation (Ebitda) would be higher. This is because lease expenses will no longer be reported as operating expenses in the profit and loss account (P&L). It will instead appear as depreciation and interest costs within the P&L statement, hitting profitability.  
 
Executives from Future Retail said they saw a 3-4 per cent rise in Ebitda because of the shift in reporting lease expenses in the P&L account. Profit before tax, they said, would reduce by a proportionate amount in the initial years though the impact would wane in later years as depreciation and interest costs would decrease.
 
In a recent report on the IndAS 116 impact on retail firms, Edelweiss analysts Ankit Dangayach, Nilesh Aiya and Raj Koradia had said they saw debt rising for most companies, hitting their deleveraging plans. “Indebtedness would grow,” they said. “Which is hardly good for the health of a company.” Estimates by analysts Sandeep Gupta, Mohit Baheti and Umesh Jain of Motilal Oswal said the debt-equity ratio of a few retail companies (such as Aditya Birla Fashion and Retail) would double from 0.7 to 1.5, implying a significant increase in overall debt due to the new accounting standard.
 
However, some experts argue that the pain would be temporary. “Since the initiative (with IndAS 116) is to bring about transparency in lease accounting and align Indian standards with global norms, companies will gain in the long run. They will, however, have to develop the accounting and reporting framework for applying the new standard and will require to have proper controls to monitor outcomes,” said Sandip Khetan, national leader and partner, financial accounting advisory services, EY India.