Content reviewed and verified by Graham Chee, with FCPA-led practice at Local Knowledge, Mascot NSW. Continuous CPA Australia member since 1986. Prior career at Goldman Sachs, BNP Investment Management and Merrill Lynch.. Last reviewed July 2026. Next review scheduled for October 2026.
TL;DR
Protect your Sydney SME's borrowing capacity and debt covenants from AASB 16's impact with expert FCPA guidance.
Introduction: The Impending Shift for Sydney SMEs
For many Sydney SMEs, the financial landscape is set to undergo a significant shift, particularly concerning how leases are reported. The Australian Accounting Standards Board (AASB) 16, effective for annual periods beginning on or after 1 January 2019, fundamentally changed lease accounting. However, its full implications, especially the 'balance sheet bloat' and its potential to impact debt covenants, are becoming acutely apparent for many owner-operated and founder-led businesses as financial year-ends approach in 2025 and beyond. This isn't merely an accounting exercise; it's a strategic financial imperative. As an FCPA-led practice, Local Knowledge brings institutional-grade compliance and financial structuring experience directly to SMEs. This article, penned by Graham Chee, FCPA, will dissect the core tenets of AASB 16, illuminate its direct impact on your balance sheet and borrowing capacity, and provide actionable strategies to navigate these changes proactively. We'll explore how right-of-use assets and lease liabilities are transforming financial ratios and what this means for your relationships with lenders. By the end, you'll have a clearer understanding of the challenges and the necessary steps to ensure your Sydney SME remains compliant and financially robust.
Understanding AASB 16: Beyond Off-Balance Sheet Financing
Before AASB 16, many operating leases were treated as off-balance sheet items, meaning lease payments were expensed as incurred, and the underlying assets and liabilities were not recognised on the balance sheet. This provided a seemingly cleaner financial picture, often enhancing key financial ratios. AASB 16 fundamentally alters this by requiring lessees to recognise nearly all leases on the balance sheet as a 'right-of-use' (ROU) asset and a corresponding 'lease liability'. This applies to virtually all leases with a term of more than 12 months, unless the underlying asset is of low value [AASB 16, paragraph 5]. The standard aims to provide a more transparent and faithful representation of a company's assets and liabilities, bringing consistency across industries and making financial statements more comparable. For Sydney SMEs, this means a significant shift from an expense-based approach to a capitalisation model, impacting everything from asset valuation to depreciation schedules. The change is not just about compliance; it's about re-evaluating business models that rely heavily on leased assets, from office spaces in the CBD to specialized equipment in manufacturing. The transition requires meticulous data collection, re-evaluation of lease contracts, and often, new accounting software functionalities to manage the complexities of lease accounting under the new standard. [AASB 16, Basis for Conclusions, BC01-BC07].
The 'Bloat' Explained: Right-of-Use Assets & Lease Liabilities
The term 'balance sheet bloat' directly refers to the increased asset and liability totals that result from implementing AASB 16. Under the new standard, a lessee recognises a 'right-of-use' (ROU) asset representing its right to use the leased item over the lease term. Concurrently, a 'lease liability' is recognised, representing the present value of future lease payments [AASB 16, paragraph 22]. This liability includes fixed payments, variable payments that depend on an index or a rate, residual value guarantees, and exercise prices of purchase options if reasonably certain to be exercised. The ROU asset is subsequently depreciated, and the lease liability is reduced by lease payments, with an interest expense recognised on the outstanding liability. This dual entry significantly inflates both sides of the balance sheet. For a Sydney SME leasing its premises, vehicles, or IT equipment, this means a substantial increase in reported assets and liabilities that were previously off-balance sheet. This 'bloat' is not a sign of financial distress but a reclassification, yet it has profound implications for how external stakeholders, particularly lenders, perceive the company's financial health and leverage. Understanding the calculation and presentation of these new line items is crucial for accurate financial reporting and communication. [AASB 16, Appendix B, application guidance].
AASB 16's Direct Impact on Sydney SME Debt Covenants
Safeguarding Your Borrowing Capacity Post-AASB 16
The shift under AASB 16 means that lenders will now see a more comprehensive picture of your SME's commitments. This transparency, while intended to be beneficial, can inadvertently reduce perceived borrowing capacity if not managed proactively. Lenders will assess your increased liabilities when evaluating new loan applications or reviewing existing facilities. To safeguard your borrowing capacity, open communication with your financiers is paramount. Early engagement allows you to explain the accounting impact of AASB 16 on your financial statements and negotiate adjustments to existing covenant terms, if necessary. Furthermore, demonstrating a robust understanding of your lease portfolio and its financial implications can build confidence with lenders. Consider providing pro-forma financial statements that illustrate the impact of AASB 16, alongside your statutory reports, to offer clarity. Businesses should also review their lease vs. buy strategies, as the accounting treatment for both is now more aligned, potentially making outright purchase or finance leases more attractive in certain scenarios. [ASIC Regulatory Guide 264, Paragraph RG 264.12].
Preparing for Your CPA Lease Audit: Key Considerations
As an FCPA, I understand the rigour involved in a CPA audit, especially with new accounting standards. For Sydney SMEs, ensuring your AASB 16 compliance is audit-ready is critical. Auditors will focus on the completeness and accuracy of your lease population, the correct identification of lease terms, the discount rate applied, and the subsequent measurement of ROU assets and lease liabilities. They will scrutinise your internal controls around lease data management and the valuation methodologies employed. Here's a numbered process to help prepare for your CPA lease audit:
Strategic Steps for Proactive Lease Accounting Compliance
Proactive management of AASB 16 is not just about avoiding non-compliance; it's about leveraging the standard to make informed strategic decisions. Sydney SMEs should consider these steps: Firstly, conduct a thorough inventory of all existing lease agreements. This includes property, vehicles, equipment, and any other assets used under a contractual right. Many businesses find hidden leases in service agreements. Secondly, invest in appropriate software or tools that can automate the calculation and management of ROU assets and lease liabilities. Manual tracking is prone to error and highly inefficient. Thirdly, educate key stakeholders, including management, sales teams, and procurement, on the implications of AASB 16. Their understanding is crucial for future contract negotiations. Fourthly, engage with your accounting professional early. An FCPA-led practice can provide tailored advice, assist with complex lease valuations, and help in communicating the impact to external parties like banks. Lastly, regularly review your lease portfolio. As your business evolves, so too will your leasing needs, and ongoing compliance requires continuous monitoring and adjustment. This strategic approach ensures that AASB 16 becomes a tool for better financial management, rather than a compliance burden. [APES 110, Code of Ethics for Professional Accountants, Section 100.5].
FCPA Insights: Managing SME Financial Health in 2025
In principal-led practice, we've seen firsthand that the transition to AASB 16 can be a significant undertaking for Sydney SMEs. It's more than just a technical accounting change; it demands a strategic re-evaluation of how businesses view and manage their leased assets and liabilities. The 'balance sheet bloat' is a reality that requires careful communication with lenders and proactive planning. Businesses that embrace this change by implementing robust systems and seeking expert guidance will not only ensure compliance but also gain a deeper, more transparent understanding of their true financial position, ultimately strengthening their borrowing capacity and long-term financial health. Our role is to translate these complex standards into practical, actionable strategies for owner-operated and founder-led businesses, ensuring they navigate these changes with confidence and clarity.
Frequently Asked Questions
Q.What is the primary impact of AASB 16 on an SME's balance sheet?
The primary impact of AASB 16 is the recognition of a 'right-of-use' (ROU) asset and a corresponding 'lease liability' on the balance sheet for most leases. Previously, many operating leases were off-balance sheet. This change increases both assets and liabilities, leading to what is often termed 'balance sheet bloat'. It provides a more comprehensive view of an entity's financial commitments but can alter key financial ratios. For example, a property lease in Sydney will now appear as a significant asset and liability on the books. [AASB 16, paragraph 22].
Q.How does AASB 16 affect debt covenants for Sydney SMEs?
AASB 16 can significantly impact debt covenants by increasing reported liabilities. Ratios such as debt-to-equity and gearing will likely increase, potentially pushing SMEs closer to or even breaching existing covenant thresholds. While EBITDA might improve due to the reclassification of operating lease expenses, the new interest expense on lease liabilities can affect interest cover ratios. Sydney SMEs should proactively engage with their lenders to explain the accounting changes and negotiate any necessary adjustments to covenant terms. [ASIC Regulatory Guide 264, Paragraph RG 264.12].
Q.Are there any exemptions under AASB 16 for SMEs?
Yes, AASB 16 provides two optional exemptions for lessees. SMEs can choose not to apply the recognition requirements for short-term leases (leases with a term of 12 months or less) and leases for which the underlying asset is of low value (e.g., office equipment like laptops or small furniture). If these exemptions are applied, payments are recognised as an expense on a straight-line basis over the lease term. The decision to apply these exemptions should be made consistently across similar leases. [AASB 16, paragraphs 5-8].
Q.What is a 'right-of-use' (ROU) asset?
A 'right-of-use' (ROU) asset is an asset recognised by a lessee under AASB 16, representing its right to use an underlying asset for the lease term. It is initially measured at the amount of the lease liability, plus any initial direct costs incurred by the lessee, lease payments made at or before the commencement date, and an estimate of costs to dismantle and remove the asset. This asset is subsequently depreciated over the shorter of the lease term or the useful life of the underlying asset. [AASB 16, paragraph 24].
Q.What steps should a Sydney SME take now to prepare for AASB 16?
Sydney SMEs should immediately start by identifying all their lease agreements and compiling a comprehensive lease register. Next, they should assess the financial impact on their balance sheet and key ratios, and engage proactively with their lenders to discuss potential covenant implications. Implementing appropriate lease accounting software or seeking expert advice from an FCPA-led practice can streamline the complex calculations and ensure compliance. Education of internal teams and a regular review of lease strategies are also crucial. [CPA Australia, AASB 16 Practical Guide].
Secure Your SME's Financial Future Post-AASB 16
The changes brought by AASB 16 are significant, but with proactive planning and expert guidance, your Sydney SME can navigate these complexities successfully. Don't let the 'balance sheet bloat' compromise your borrowing capacity or lead to unexpected covenant breaches. Our FCPA-led practice, Local Knowledge, is equipped with institutional-grade compliance and financial structuring experience to help owner-operated and founder-led businesses like yours. We provide tailored strategies to ensure your financial reporting is robust, compliant, and supports your growth objectives.
About the Author
Graham Chee, FCPA, CPA, GRCP, GRCA
Principal and Founder, Local Knowledge
Graham Chee is the principal and founder of Local Knowledge, an FCPA-led Australian practice that brings institutional-grade compliance, investment-structure and intellectual-property experience directly to owner-managed businesses. Graham is a Fellow of CPA Australia (FCPA since November 2005, continuous CPA member since 1986) and holds the OCEG Governance, Risk & Compliance Professional (GRCP) and Governance, Risk & Compliance Auditor (GRCA) designations. His prior career includes senior roles at Goldman Sachs, BNP Investment Management and Merrill Lynch. Graham was previously portfolio manager of the Asian Masters Fund (IPO December 2007 – 31 December 2009), which returned +29% in AUD terms versus the MSCI Asia Pacific (ex Japan) benchmark. He signs off on 100% of client files personally.
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This article provides general information only and does not constitute financial or accounting advice specific to your situation. For tailored advice, please speak with our principal. Every file is signed off by our principal under the CPA Code of Ethics.
Graham Chee FCPA, CPA, GRCP, GRCA · Principal, Local Knowledge · Mascot NSW · CPA-signed files