IFRS 16 Leases. An overview. March 9, kpmg.com/ca/leases
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1 IFRS 16 Leases An overview March 9, 2016 kpmg.com/ca/leases
2 Today s presenters Mag Stewart Jason Bower Jeff King Andy Brown Partner Professional Practice magstewart@kpmg.ca Partner Audit jgbower@kpmg.ca Partner Accounting Advisory jgking@kpmg.ca Senior Manager Professional Practice ajbrown@kpmg.ca 2
3 Agenda Major impacts for lessees New definition New accounting Multiple transition options IFRS US GAAP Next steps 3
4 Why a new leasing standard? Currently analysts adjust financial statements for off-balance sheet leases Under IFRS 16, companies will bring these leases onbalance sheet, using a common methodology 4
5 Major impacts for lessees
6 Lessees face major changes All major leases on-balance sheet Balance sheet Asset = Right-of-use of underlying asset Liability = Obligation to make lease payments P&L Lease expense Depreciation + Interest = Front-loaded total lease expense 6
7 Impact on balance sheet Companies who currently have operating leases will appear to be more assetrich, but also more heavily indebted Asset Liability 7
8 Impact on the income statement Total lease expense will be front-loaded even when cash rentals are constant Depreciation Interest Cash rental payments 8
9 Impact on cash flow statement Operating Variable lease ON payments Short-term and low value leases Financing Cash paid for principal ON portion of lease liability Cash paid for interest portion of lease liability will be classified in accordance with other interest paid i.e., either operating or financing 9
10 Impact on financial ratios Profit/loss Balance sheet Ratios EBITDA Total assets Debt/equity EPS (in early years) Net assets Interest coverage Asset turnover 10
11 New definition
12 Lease definition The new on/off-balance sheet test for lessees a key judgement area Lease classification test ON OFF New standard Old standard Lease ON Finance lease Service Operating lease 12
13 Lease definition Control The new definition increases focus on who controls the asset and may change which contracts are leases Lease Not a lease? 13
14 Lease definition Example Said Co. enters into a two year contract with Fred Co. to transport cargo from Milan to New York and Japan on the SS Catwalk Fred Co. must use the SS Catwalk to transport Said Co. s goods during the term of the contract (i.e., it has no substitution rights) Said Co. s cargo will occupy substantially all of the capacity The contract specifies the cargo to be transported and dates of pickup and delivery Fred Co. operates and maintains the ship, is responsible for safe passage of cargo on board Said Co. is prohibited from hiring another operator for the ship or operating the ship itself Is there a lease? 14
15 Lease definition Exemptions Two optional exemptions make the standard significantly easier to apply Short term leases Leases of low value items 12 months USD 5,000 for example 15
16 New accounting
17 Measuring the lease liability Lease liability = Present value of lease rentals + Present value of expected payments at end of lease 17
18 Measuring the right-of-use asset ROU asset = Initial direct costs + Prepaid lease rentals + Lease liability + Estimated costs to dismantle - Lease incentives received 18
19 New accounting - Example Lease of equipment Lease does not contain any renewal or purchase options No residual value guarantees No variable lease payments or contingent rent Lease term Useful life of leased asset 5 years 10 years Annual lease payments in arrears $155 Rate implicit in the lease 6% PV of future lease payments $655 19
20 New accounting - Example (cont d) Balance Sheet Income Statement Period Cash ROU asset Lease liability Depreciation Interest expense Total expense Total Depreciation year 1: 655/5 years = 131 Interest expense: 655 * 6% = 39 22
21 Variable lease payments Which variable lease payments are included in the lease liability? Payments based on an index or rate Payments based on turnover or usage 21
22 Reassessment of key judgements Variable lease payments (index or rate) Lease term Lease liability Residual value guarantee Purchase option 22
23 Lessor accounting Lessor accounting remains similar to current practice Lease classification test Finance leases and operating leases but lacks consistency with new lessee accounting model Consistent accounting model for lessors and lessees 23
24 Sale-and-leaseback IFRS 16 essentially kills sale-and-leaseback as an off-balance sheet financing structure Yes On-balance sheet lease at cost Is there a sale? No On-balance sheet financing, potentially at fair value 24
25 Multiple transition options
26 Applying the new lease definition Cost Comparability Apply the new definition to all contracts OR Grandfather existing contracts and apply the new definition only to new contracts 28
27 Applying the new standard A lessee can choose to apply the standard Cost Comparability Retrospectively to all accounting periods OR As a big bang at the date of initial application 27
28 Effective date Effective date January 1, 2019 Annual report December 31, Mar June Sep Dec Early adoption permitted if IFRS 15 is adopted Interim f/s *Timeline is based on requirements applicable to a public entity with December 31 year-end and assumes company will transition on the effective date of the standard, January 1, A company may elect to early adopt (beginning in 2016) if IFRS 15 is adopted 30
29 IFRS US GAAP
30 IFRS vs US GAAP The FASB published ASC Topic 842, Leases, on February 25, 2016 IFRS and US GAAP standards converged? Lease definition Leases on-balance sheet for lessees Lessor accounting Lessee accounting model Detailed measurement and transition requirements Exemption for low value items 30
31 IFRS vs US GAAP (cont d) Key financial metrics as compared to previous lease accounting Balance Sheet Assets Liabilities IFRS 16 US GAAP (Topic 842) Income Statement Depreciation Interest expense Cash flow Statement Cash flow from operating Cash flow from financing Financial ratios EBITDA Interest coverage 31
32 Next steps
33 Things to think about now Some questions to assess the impact on your company s financial statements Which contracts are leases? Which transition options to choose? Database of all leases? Systems and processes in place? What about ratios and covenants? 33
34 Broader business impacts Treasury Covenants Credit rating Regulatory capital (banks) Systems Leasing database System solution ERP integration Finance Transition options Data collection Tax KPIs Strategy Lease vs buy Lease structuring Sale-andleaseback IFRS 16 Accounting change Employee benefits Management remuneration KPI s Investor relations Analyst queries KPI s (e.g., EPS) Comparability 34
35 Questions
36 Resources: kpmg.com/ca/leases 36
37 Thank you kpmg.ca 2016 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 39
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