AASB 16 Leases. Modifications and implementation. 23 October 2018

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1 AASB 16 Leases Modifications and implementation 23 October 2018

2 Your facilitators are Patricia Stebbens Hayley Pang Michael Voogt Daina Klunder 2

3 Setting the scene Date of initial application is almost upon us 1 January Overview (2016) Transition options (2017) Have you got its measure? (2017) More to consider On transition to the new standard and on an ongoing basis. 3

4 Transition for lessees - modifications Full retrospective Modified retrospective reconstruct ROUA Modified retrospective ROUA = lease liability Reconstruct modifications Reconstruct modifications Ignore prior modifications 4

5 Agenda Accounting for lease modifications, both lessees and lessors Disclosure requirements, on transition and ongoing Implementation insights 5

6 Modifications

7 Lease modification - definition Change in the: scope of a lease, or consideration for a lease that was not part of the original terms and conditions. 7

8 Lease modification examples Negotiate to reduce floor space from 4 floors to 3 floors. Receive a rent rebate for 2 years due to downturn in economy. Negotiate to increase lease term. Negotiate to increase the number of vehicles rented. 8

9 Lessee: modifications overview Decrease in scope Quantity of assets Increase in scope Change in consideration Lease term 9

10 Understanding modifications Reduce rent due to downturn in economy. Add to lease an extra floor of office space. Reduce the lease term for office space. Lease an additional 2 trucks as part of a master leasing arrangement that does not take a minimum quantity of trucks to be leased. Neither increase nor decrease in scope change in consideration Increase in scope increase in quantity of assets Decrease in scope Account for as a new lease 10

11 Examples Increase in scope: Lease term Increase in scope: Additional vessel Decrease in scope: Reduction in floor space 11

12 Example: Increase in scope lease term Scenario 20 year lease of an industrial area commences, no extension options Lease payments are $150,000 p.a. Incremental borrowing rate is X% End of Year 18 an extension is agreed for an additional 10 years No change in annual lease payments Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 Y12 Y14 Y16 Y18 Y20 Y22 Y24 Y26 Y28 Y30 12

13 Example: Increase in scope lease term Scenario 20 year lease of an industrial area commences, no extension options Lease payments are $150,000 p.a. Incremental borrowing rate is X% End of Year 18 an extension is agreed for an additional 10 years No change in annual lease payments Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 Y12 Y14 Y16 Y18 Y20 Y22 Y24 Y26 Y28 Y30 Effective date of modification Accounting for the modification: At end of Year 18 Revised term Y% Difference Lease liability $300, years $1,100,000 $800,000 ROUA $200,000 Remeasure lease liability: $1,100,000 Adjust ROU asset: $1,000,000 13

14 Example: Increase in scope quantity of assets Scenario 10 year lease of a vessel (vessel 1) Lease payments are $1,000,000 p.a. Incremental borrowing rate is X% End of Year 4 lessee signs an amendment to lease an additional vessel (vessel 2) for an $1,000,000 p.a. for 6 years Market rent for vessel 2 is $1,200,000 Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 Effective date of modification Increase in lease payment is not commensurate with standalone price 14

15 Example: Increase in scope quantity of assets Scenario 10 year lease of a vessel (vessel 1) Lease payments are $1,000,000 p.a. Incremental borrowing rate is X% End of Year 4 lessee signs an amendment to lease an additional vessel (vessel 2) for an $1,000,000 p.a. for 6 years Market rent for vessel 2 is $1,200,000 Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 Effective date of modification Increase in lease payment is not commensurate with standalone price Remeasurement: Remeasure lease liability (present value $2m for remaining 6 years at revised discount rate) 15

16 Example: Increase in scope quantity of assets Scenario 10 year lease of a vessel (vessel 1) Lease payments are $1,000,000 p.a. Incremental borrowing rate is X% End of Year 4 lessee signs an amendment to lease an additional vessel (vessel 2) for $1,200,000 p.a. for 6 years Market rent for vessel 2 is $1,200,000 Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 Increase in lease payment is commensurate with standalone price 16

17 Example: Increase in scope quantity of assets Scenario 10 year lease of a vessel (vessel 1) Lease payments are $1,000,000 p.a. Incremental borrowing rate is X% End of Year 4 lessee signs an amendment to lease an additional vessel (vessel 2) for $1,200,000 p.a. for 6 years Market rent for vessel 2 is $1,200,000 Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 Increase in lease payment is commensurate with standalone price Separate lease: Recognise new lease liability (present value $1.2m for 6 years at revised discount rate) Vessel 1: No change 17

18 Additional considerations discount rates Estimate requires judgement Process in place? May require use of specialists 18

19 Example: Increase in scope forward starting Scenario 8 year lease of a building Lease payments are $400,000 p.a. Incremental borrowing rate is X% End of Y2 lease amended to include the rental of the underground car park from Y5 for $30,000 p.a. Relative stand alone prices are $375,000 for building rental and $75,000 for the car park Incremental borrowing rate is Y% Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Effective date of modification Car park available for use 19

20 Example: Increase in scope forward starting Scenario 8 year lease of a building Lease payments are $400,000 p.a. Incremental borrowing rate is X% End of Y2 lease amended to include the rental of the underground car park from Y5 for $30,000 p.a. Relative stand alone prices are $375,000 for building rental and $75,000 for the car park Incremental borrowing rate is Y% Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Effective date of modification Car park available for use Poll question: When is the car park component recognised? a) At the effective date of the modification, the end of year 2 b) At the effective date of the modification, the start of year 5 c) When the car park is made available for use, 20 the start of year 5

21 Example: Increase in scope forward starting Allocation of consideration: Observable stand-alone price: building A $375,000 Observable stand-alone price: car park B $75,000 Total C = A+B $450,000 Building component as % of total observable prices D = A/C 83% Car park component as % of total observable prices E = B/C 17% Allocation of consideration to building lease D x $430,000 $357,000 Allocation of consideration to car park lease E x $430,000 $73,000 21

22 Example: Increase in scope forward starting Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Remeasure building lease: Recognise car park lease: Lease liability: $1,700,000 - $200,000 = $1,500,000 ROU asset: $1,600,000 - $200,000 = $1,400,000 Lease liability: $300,000 ROU asset: $300,000 22

23 Example: Decrease in scope Scenario 10 year lease for right to use 10,000m 2 warehouse space Lease payments are $100,000 p.a. Incremental borrowing rate is X% Contract modified to lease 7,500m 2 for last 4 years Lease payments are $85,000 p.a. Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 10,000m 2 7,500m 2 Lease payments $100,000 Lease payments $85,000 23

24 Example: Decrease in scope Scenario 10 year lease for right to use 10,000m 2 warehouse space Lease payments are $100,000 p.a. Incremental borrowing rate is X% Contract modified to lease 7,500m 2 for last 4 years Lease payments are $85,000 p.a. Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 10,000m 2 7,500m 2 Lease payments $100,000 Lease payments $85,000 Step 1: Remeasure lease liability and ROUA. Recognise gain or loss: P&L impact Step 2: Remeasure lease liability and ROUA for revised lease payments 24

25 Example: Decrease in scope Scenario 10 year lease for right to use 10,000m 2 warehouse space Lease payments are $100,000 p.a. Incremental borrowing rate is X% Contract modified to lease 7,500m 2 for last 4 years Lease payments are $85,000 p.a. Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 10,000m 2 7,500m 2 Lease payments $100,000 Step 1: Remeasure lease liability and ROUA. Recognise gain or loss: P&L impact Step 2: Remeasure lease liability and ROUA for revised lease payments Step 1 At end of Year 6 Lease payments $85,000 75% (25% partial termination) ROUA $280,000 $210,000 Difference $70,000 (Cr) Lease liability $340,000 $255,000 $85,000 (Dr) $15,000 (CR P&L) 25

26 Example: Decrease in scope Scenario 10 year lease for right to use 10,000m 2 warehouse space Lease payments are $100,000 p.a. Incremental borrowing rate is X% Contract modified to lease 7,500m 2 for last 4 years Lease payments are $85,000 p.a. Incremental borrowing rate is Y% Y0 Y2 Y4 Y6 Y8 Y10 10,000m 2 7,500m 2 Lease payments $100,000 Step 1: Remeasure lease liability and ROUA. Recognise gain or loss: P&L impact Step 2: Remeasure lease liability and ROUA for revised lease payments Step 2 At end of Year 6 Lease payments $85,000 Revised lease payments ROUA $210,000 $230,000 Difference $20,000 (Dr) Lease liability $255,000 $275,000 $20,000 (Cr) 26

27 Lessee: modification accounting complexities Multiple elements Modification Y0 Y1 Y2 Y3 Y4 Y5 Y6 Car 1 5 year lease term Car 1 Car 2 1 year lease term 3 year lease term 27

28 Lessee: modification accounting complexities Multiple elements Modification Y0 Y1 Y2 Y3 Y4 Y5 Y6 Car 1 5 year lease term Car 1 Car 2 1 year lease term 3 year lease term Poll question: Is there a gain or loss to be recognised? a) Yes, there is a decrease in lease term for car 1 b) No, there is an overall increase in lease term 28

29 Lessor: modifications to an operating lease Account for as a new lease taking into account prepaid/accrued lease payments. Classify new lease as operating or finance, depending on terms. Amortise prepaid/accrued lease payments over new lease term 29

30 Lessor: modifications to a finance lease Increase in scope is at the standalone price, account for a separate lease 30

31 Lessor: modifications to a finance lease Increase in scope is at the standalone price, account for a separate lease OR If not a separate lease reassess lease classification Operating lease Finance lease Terminate original lease, create a new lease Carrying amount of underlying asset = net investment of original lease immediately before modification effective date Apply AASB 9: Consider is the modification to the lease receivable substantial? Apply modification of financial asset accounting 31

32 Implementation insights

33 Lease term assessment - penalties Lessee and the lessor each have the right to terminate the lease without permission from the other party with no more than an insignificant penalty Lease is no longer enforceable 33

34 Example: Lease term assessment - penalties 5 year lease of a warehouse Lessee uses the warehouse as a furniture showroom Fit-out costs are incurred Lessee and lessor each have the right to terminate the lease after 6 months Penalty should be applied broadly, and includes economic disincentives to exercise a termination option 34

35 Poll question: Example: Lease term assessment - penalties applied? Can the short-term lease exemption be a) Yes b) No c) Further information is required 5 year lease of a warehouse Lessee uses the warehouse as a furniture showroom Fit-out costs are incurred Lessee and lessor each have the right to terminate the lease after 6 months Penalty should be applied broadly, and includes economic disincentives to exercise a termination option 35

36 Lease term assessment - penalties Economic disincentives that may create a penalty : Economic value of leasehold improvements Cost to dismantle leasehold improvements Cost to restore the warehouse to its original condition Potential impact of early termination on customer relationships 36

37 Transition disclosures 1 2 Retrospective approach Early adoption Practical expedients for lease definition Modified retrospective approach Early adoption Practical expedient for lease definition Practical expedients relating to operating leases Weighted-average incremental borrowing rate Differences between operating lease commitments and lease liabilities 37

38 Go forward disclosures 1 Mandatory quantitative information specific disclosures Lease costs and sub-lease income Maturity analysis of lease commitments Reconciliation of ROU assets by major class of underlying assets Total cash outflows for leases Lease expense for low value leases Lease expense for short term leases 2 Additional entity-specific information Extension and termination options Variable lease payments Residual value guarantees Sale & leaseback transactions 38

39 Overview of Key Operating Decisions Procurement and approval process Budgeting and forecasting process Changes to KPIs Impact on debt covenants New leasing systems to capture data and perform calculations for statutory reporting purposes Go forward processes and controls 39

40 Key points to remember The lease liability and ROUA are required to be remeasured when there is a lease modification. There may be a gain or loss if there is a decrease in scope. For a multiple element modification, each element is separately addressed. Disclosures are required for leases not on balance sheet. There could be significant impacts on the business on transition to AASB

41 KPMG Resources IFRS 16 Leases standard core concepts Leases Transition to AASB 16 AASB 16 Leases Do you have its measure? 41

42 Thank you

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