How does IFRS 16 impact retail financial statements?

IFRS 16 significantly impacts retailers by: (1) Increasing total assets by 20-30% on average due to ROU assets, (2) Increasing total liabilities similarly with lease liabilities, (3) Improving EBITDA by 15-25% as lease expense becomes depreciation + interest, (4) Worsening debt-to-equity ratios by 25-40%, (5) Changing expense patterns with front-loaded interest expense. Store-intensive retailers like fashion, grocery, and department stores see the most dramatic impacts.

How should retailers account for turnover rent (sales-based rent)?

Turnover rent (percentage of sales) should be excluded from the initial lease liability measurement under IFRS 16. Only include: (1) Fixed base rent in the lease liability, (2) CPI-linked adjustments at commencement date rates. Exclude: (1) Percentage of sales rent (recognize as expense when incurred), (2) Performance-based variable rent. Many retail leases have structures like 'greater of $X or Y% of sales'—capitalize the minimum $X, expense any excess based on actual sales.

Can retailers use the portfolio approach for similar leases?

Yes, IFRS 16 permits a portfolio approach when the effect would not differ materially from individual lease accounting. Retailers commonly group: (1) Small format stores in similar locations (kiosks, pop-up shops), (2) Leases with similar terms and characteristics, (3) Franchisee subleases. However, large flagship stores, different geographies with different IBRs, and materially different lease terms should be accounted for individually. Document your portfolio grouping criteria and test for material differences.

What happens to retail lease accounting when stores close or downsize?

Store closures and downsizing trigger lease modifications or impairments: (1) Partial termination (downsizing space): Account as lease modification, reduce ROU asset and liability proportionately, recognize gain/loss in P&L, (2) Full termination: Derecognize ROU asset and liability, recognize termination costs and any gain/loss, (3) Impairment (store operating losses): Test ROU asset for impairment under IAS 36, recognize impairment loss if recoverable amount < carrying amount. Restructuring provisions may also be required for onerous lease obligations.

How do retailers determine lease term for renewal options?

Retailers must assess if renewal options are 'reasonably certain' to be exercised based on: (1) Store performance and strategic importance, (2) Leasehold improvements value (fit-out costs of $500K+ create strong incentive), (3) Location quality (prime mall locations typically renewed), (4) Market rent trends (options below market = likely to renew), (5) Relocation costs and business disruption. Document the assessment for each material lease. Reassess when facts change (e.g., poor store performance may mean renewal becomes unlikely).

IFRS 16 for Retailers: Complete Implementation Guide

Q: How do retailers determine lease term for renewal options?

Retailers must assess if renewal options are 'reasonably certain' to be exercised based on: (1) Store performance and strategic importance, (2) Leasehold improvements value (fit-out costs of $500K+ create strong incentive), (3) Location quality (prime mall locations typically renewed), (4) Market rent trends (options below market = likely to renew), (5) Relocation costs and business disruption. Document the assessment for each material lease. Reassess when facts change (e.g., poor store performance may mean renewal becomes unlikely).

Published: January 8, 2025 | Reading Time: 11 minutes

The retail sector faces unique IFRS 16 challenges. With hundreds or thousands of store leases, complex variable rent structures, frequent modifications, and industry-specific metrics, retailers experienced the most dramatic financial statement impact of any industry when IFRS 16 became effective.

This comprehensive guide addresses retail-specific IFRS 16 implementation challenges, from store lease accounting and turnover rent treatment to portfolio management strategies and impact on key retail performance metrics.

IFRS 16 Impact on Retail Financial Statements

Balance Sheet Transformation

Retailers saw dramatic balance sheet changes at IFRS 16 adoption:

Typical Retail Impact (Industry Averages)

Total Assets: +20% to +35% (ROU assets from store leases)
Total Liabilities: +25% to +40% (lease liabilities)
Debt-to-Equity Ratio: +30% to +50% (new lease debt)
Current Ratio: -10% to -20% (current portion of lease liability)

Example: Mid-Size Fashion Retailer

100 stores leased (average 5-year terms)
Pre-IFRS 16 Total Assets: $500M
New ROU Assets: $150M (store leases capitalized)
Post-IFRS 16 Total Assets: $650M (+30%)
Debt-to-Equity increased from 0.8 to 1.2

Income Statement Effects

Key P&L changes for retailers:

EBITDA Improvement: +15% to +25% (lease expense removed from operating costs)
Operating Profit: Slight decrease (depreciation > previous lease expense in early years)
Interest Expense: Significantly higher (lease interest expense added)
Net Profit: Front-loaded expense pattern (higher interest early, lower later)
Variable Rent: Separated and more visible in financial statements

Example: Store Lease Expense Pattern (5-Year Lease, $100K Annual Rent, 5% IBR)

Year	Old IAS 17 (Operating Expense)	New IFRS 16 (Dep + Int)
1	$100,000	$106,180
2	$100,000	$103,127
3	$100,000	$99,921
4	$100,000	$96,548
5	$100,000	$92,995

Front-loaded impact: Years 1-2 show higher expense; Years 4-5 show lower expense.

Impact on Key Retail Metrics

EBITDA and EBITDAR

EBITDA: Increases 15-25% (lease rent removed)
EBITDAR: Less commonly used post-IFRS 16
Comparability: Historical trends broken at transition

Same-Store Sales (SSS)

Metric: Not directly impacted (revenue-based)
Store-level profitability: Appears higher (rent expense reduced)
Analysis: Need to adjust for IFRS 16 in comparisons

Return on Assets (ROA)

Denominator: Assets increase 20-35%
Numerator: Net income relatively unchanged over full lease term
Result: ROA decreases significantly

Leverage Ratios

Debt/EBITDA: Better (EBITDA higher, debt includes leases that were always obligations)
Debt/Equity: Worse (lease liabilities on balance sheet)
Covenant Impact: May trigger renegotiation

Store Lease Accounting Challenges

Challenge #1: Variable Rent (Turnover Rent)

Many retail leases include variable rent based on sales performance:

Common Structures

Base + Percentage: Fixed base rent + % of sales above threshold
Greater of: Greater of fixed amount OR % of sales
Pure Percentage: Only % of sales (rare in modern leases)

IFRS 16 Treatment

Include in Lease Liability:

Fixed base rent (or minimum guaranteed rent)
CPI-linked adjustments (at commencement date index)

Exclude from Lease Liability (Recognize as Expense When Incurred):

Percentage of sales rent
Performance-based variable payments

Practical Example: Shopping Mall Lease

Lease Terms:

5-year lease for retail unit
Rent: Greater of (a) $150,000/year OR (b) 8% of annual sales
Expected sales: $2.5M/year (8% = $200,000)

IFRS 16 Accounting:

Lease Liability: Based on $150,000/year minimum (PV ~$649,000 at 5% IBR)
Variable Rent: If actual sales = $2.5M, pay $200K total, recognize $50K as variable lease expense
If sales drop: If sales = $1.5M (8% = $120K), pay minimum $150K, no variable expense

Key Point: Cannot anticipate high sales and capitalize $200K—only capitalize the minimum guaranteed amount.

Challenge #2: Lease Term Assessment for Stores

Determining "reasonably certain" renewal for retail locations:

Factors Indicating Renewal Likely

Strong Store Performance: High sales, profitability, strategic location
Significant Fit-Out Costs: Custom build-outs of $500K+ create economic penalty to relocate
Prime Location: Flagship stores, high-traffic malls, limited alternative sites
Favorable Option Terms: Renewal rate 15-20%+ below market
Brand Strategy: Store critical to market presence (e.g., only store in major city)

Factors Indicating Renewal Unlikely

Poor Performance: Underperforming stores in closure review
Mall Decline: Shopping center losing anchor tenants, declining traffic
Format Change: Retailer shifting to e-commerce, reducing physical footprint
Overexpansion: Overlapping trade areas with other company stores

Example Decision Framework:

Store A (Flagship CBD Location):

5-year non-cancellable + two 5-year options
$2M fit-out investment
20% of company revenue from this location
Option rent 10% below current market
Conclusion: Include first option (10-year lease term) - renewal reasonably certain

Store B (Suburban Mall):

3-year non-cancellable + one 3-year option
Minimal fit-out ($50K)
Below-average sales performance
Mall losing foot traffic, anchor tenant left
Conclusion: Exclude option (3-year lease term) - renewal not reasonably certain

Challenge #3: Frequent Lease Modifications

Retailers frequently modify leases due to:

Space Expansion: Adding adjacent units as business grows
Downsizing: Returning portion of space to reduce costs
Rent Concessions: Negotiating temporary rent reductions during downturns
Term Extensions: Exercising options or negotiating new terms
Format Changes: Converting stores to different concepts

See our detailed guide: Lease Modification Examples

Portfolio Approach for Lease Management

When Portfolio Approach is Appropriate

IFRS 16 permits applying accounting to a portfolio of leases with similar characteristics if results wouldn't materially differ from individual treatment.

Good Candidates for Portfolio Approach

Small Format Stores: Kiosks, pop-ups, small boutiques with similar lease terms
Franchisee Subleases: Standardized sublease agreements
Similar Geography/Term: Stores in same country, same lease duration, same currency
Equipment Leases: POS systems, fixtures with similar characteristics

Should Be Accounted for Individually

Flagship Stores: Large, material lease commitments
Different Geographies: Leases in different countries with different IBRs
Materially Different Terms: 3-year vs. 10-year leases
Unique Features: Complex variable rent, unusual modification clauses

Example Portfolio Grouping: Fashion Retailer

Portfolio 1: Small Mall Kiosks (Treated Together)

50 kiosks in Singapore shopping malls
Standardized 3-year leases
SGD 30,000-40,000 annual rent range
Similar renewal likelihood (low)
Average IBR: 4.5%
Approach: Calculate average lease parameters, apply to portfolio

Individual Treatment: Flagship Stores

5 flagship stores (Orchard Road, Raffles Place, etc.)
SGD 500,000-1,500,000 annual rent
Different lease terms (5-10 years)
Unique characteristics (renewal options, expansion rights)
Approach: Individual calculations for each store

Portfolio Management Best Practices

Document Grouping Criteria: Define portfolio categories with clear inclusion rules
Test for Materiality: Verify portfolio approach doesn't differ materially from individual approach
Consistent Application: Apply same methodology each period
Review Annually: Reassess whether portfolios remain appropriate
Technology: Use lease accounting software to manage large portfolios efficiently

Store Closures and Restructuring

Accounting for Store Closures

Scenario 1: Partial Space Reduction (Modification)

Example: Department store reduces leased space from 20,000 sqft to 12,000 sqft

Accounting:

Modification that decreases scope (40% reduction)
Reduce lease liability proportionately (remeasure at revised discount rate)
Reduce ROU asset by 40% of carrying amount
Recognize gain/loss = difference between ROU reduction and liability reduction

Example Numbers:

ROU asset carrying amount: $500,000
Lease liability before modification: $480,000
New liability (60% of remeasured amount): $260,000
ROU asset reduction: $500,000 × 40% = $200,000
Liability reduction: $480,000 - $260,000 = $220,000
Gain recognized: $20,000

Scenario 2: Full Store Closure with Early Termination

Accounting Steps:

Derecognize ROU Asset and Lease Liability: Remove both from balance sheet
Recognize Termination Payment: Record payment to landlord to exit lease
Calculate Gain/Loss: (ROU asset carrying amount) - (Lease liability) - (Termination payment)
Additional Costs: May include restoration costs, employee severance, inventory write-downs