Portfolio Management Association of Canada April 24, 2018 IFRS 16: Key impacts
Almost all leases on balance sheet right of use asset and lease liability, with significant impacts for gearing in certain sectors. Industry Median increase debt (*) Source: PwC Global Lease Capitalisation study of 3,199 listed IFRS reporters (2015). (*) Interest-bearing debt (**) Net debt / EBITDA (***) Equity less Intangibles / Total Assets Median increase EBITDA Median change leverage (**) Before standard After standard Median decrease in solvency (***) Before standard After standard All companies 22% 13% 2,03 2,14 35% 32% Retailers 98% 41% 1,17 2,47 41% 28% Airlines 47% 33% 3,26 3,63 25% 19% Professional services 42% 15% 0,53 0,96 40% 37% Health care 36% 24% 2,11 2,92 22% 19% Wholesale 28% 17% 2,04 2,31 31% 29% Transport & Infrastructure 24% 20% 2,21 2,52 36% 30% Entertainment 23% 15% 1,78 1,30 30% 25% Telecommunications 21% 8% 1,65 2,00 23% 21% 2
Lease Accounting What s Changing? New standards under IFRS & US GAAP (IFRS 16 and ASC 842) - no changes to ASPE Operating lease concept (off balance sheet) eliminated all leases to be accounted for as financings, with the following very narrow exceptions: o Small asset leases o Short-term leases o Contingent rentals Applies January 1, 2019 3
Comparability Operating Lease (IAS 17, ASC 840) IFRS 16 Lease payment 100,000 100,000 Assets Cash (100,000) (100,000) Right of Use Asset 303,263 Liabilities Lease Liability - Current 68,301 Lease Liability - Non-current 248,685 Income Statement Lease Expense (100,000) Amortization (75,816) Interest (37,908) EBITDA impact (100,000) - EBITDAR impact - - Operating Cash Flows Operating lease (100,000) Interest (? - policy) (37,908) Variable payments Financing Cash Flows Interest (? - policy) Principal portion (62,092) Net Cash Flows (100,000) (100,000) 4
Lease term and inclusions Term of lease Non-cancellable period of lease (commences when lessor makes underlying asset available for use by lessee) PLUS Periods covered by options to extend, if lessee is reasonably certain to exercise the option PLUS Periods covered by option to terminate, if lessee is reasonably certain not to exercise the option Inclusions Leases often contain both lease and non-lease elements (e.g. common area maintenance) Only the use of the underlying asset is considered a lease element. A lessee can elect, by class of assets, to separate lease and non-lease elements to account for all payments as lease payments. Separating non-lease elements can lower the total lease liability, but can also reduce EBIDA Most non-lease elements for office space though are variable in nature (e.g. heating and cooling costs passed onto lessee by landlord vary with weather conditions). Variable payments related to use are not included in the minimum lease payments to compute lease liability only fixed payments are included generally. Variable payments continue to be expensed as incurred. Note - variable payments indexed to interest rates or market rental rates are included in the minimum lease payments 5
Lease liability and Right of Use Asset Computation Total liability is computed as the present value of the minimum lease payments over term Right of use asset initial value starts with lease liability computed above, but can differ due to costs incurred or incentives received Discount rate is the rate implicit in the lease or the lessee s incremental borrowing rate (latter being more common) Lease payments reflect both repayment of principal and interest just like any conventional loan Current liability is the next year s principal repayments (the principal portion of the 12 months payments) The right of use asset is non-current and is amortized with a charge to depreciation expense Tip maintain an amortization schedule for the lease liability just like you would for a long-term loan to differentiate principal and interest components of lease payments 6
Transition Two options: Full retrospective approach under IAS 8 with comparative restatement Simplified approach OR Retrospective with cumulative effect as adjustment to opening retained earnings No restatement of comparative information Lease liability = remaining lease payments discounted at incremental borrowing rate at date of initial application of IFRS 16 (e.g. Jan 1, 2019) If remaining term of lease on Jan 1/19 is less than 12 months or meets low value threshold, no change needed 7
What IFRS 16 means for Firms? Changes - lessees: Will lessees look for their lenders to be more flexible in payment terms and if so, how will such accommodations be priced? Increase in current liabilities directly reduces working capital available to meet NI 31-103 requirements Processes will be needed to review and understand all potential lease agreements and conclude on treatment under IFRS 16 EBITDA increase for firms due to replacement of leasing expenses with interest and amortization May negatively impact debt covenants Opportunities? Portfolio managers may benefit from increased training on the implications of the new standard on portfolio company evaluation Competitive financing of large assets historically leased may result (e.g. fewer disincentives to buy)? 8
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