CFO s Alert 01/2016 IFRS 16 Leases - A Briefing for CFO s Quick Links Introduction Transition About Nkonki Scope Determining whether a contract contains a lease from a lessee s perspective Separating components of a lease contract What changes in a company s balance sheet? What does IFRS 16 mean for a company s income statement? Are there any implications for cash flows? Impairment Lease commencement and inception date Determining the lease term Presentation of lease liabilities Presentation of lease assets Is there any impact on lessors? Click to register Contact details Also available on: Introduction On 13 January the IASB issued IFRS 16 Leases. The new standard will be effective from 1 January 2019. Early adoption is allowed provided that the new revenue standard IFRS 15 (Revenue from Contracts with Customers) is also applied. Transition As a practical expedient, an entity is not required to reassess whether a contract is, or contains, a lease at the date of initial application. The only determination that needs to be made is whether such a lease was previously classified as operating. The lessee shall either apply IFRS 16 with full retrospective effect (applying IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors ) or alternatively not restate comparative information but recognise the cumulative effect of initially applying IFRS 16 as an adjustment to opening equity at the date of initial application. Neither lessees nor lessors would change their accounting for finance leases existing at the date of initial application of the new standard. Experience Ingenuity.
IFRS 16 Leases - A Briefing for CFO s About Nkonki About Nkonki More than 40 Directors and Partners with more than 400 professional staff Global Connections A global network of independent accounting firms Global expertise, accessed through Kreston International from more than 20 000 professionals through186 firms spread across 100 countries Brand personality Ingenious Reliability - We always have to be reliable to our clients, from our level of knowledge and insights through to our ability to deliver on time and exceed expectations. Our brand promise is delivered across all levels to promote the reliability of our brand. 23years old (Established January 1993) Inspirational Responsiveness - We are always responsive to our clients needs as this is viewed as the core of client service. We understand the client s brief and the intended impact of our service. We are agile and capable of responding to unanticipated circumstances, additional client needs, or tighter deadlines. JSE Accredited to audit JSE Listed companies Insightful Impactful Assurance - We provide assurance in what we say, in what we do, and in the opinion we provide. Tangibles - Our people are trained to provide tangibles to ensure that all they bring to the clients attention are supported by tangible results. 51% Black women owned Integrity Empathy - We are always empathetic to our clients needs and are able to provide impact where it is intended the most and within the expected time. Our competencies Assurance and Advisory Assurance Advisory 100% Black owned External Audit Internal Audit Forensic Services IT Audit Risk Advisory IT Advisory Compliance Sustainability Curatorship Business Rescue Corporate Governance Process Engineering Secondments Integrated Reporting Fraud Risk Management Fraud Hotline Services Treasury Technical Services IFRS Taxation 2
Experience Ingenuity Scope IFRS 16 Leases applies to all leases, including subleases, except for: leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources; leases of biological assets held by a lessee (see IAS 41 Agriculture ); service concession arrangements (see IFRIC 12 Service Concession Arrangements ); licences of intellectual property granted by a lessor (see IFRS 15 Revenue from Contracts with Customers ); and rights held by a lessee under licensing agreements for items such as films, videos, plays, manuscripts, patents and copyrights within the scope of IAS 38 Intangible Assets. A lessee can elect to apply IFRS 16 to leases of intangible assets, other than those items listed above. What s the impact on lessees? The most significant impact on lessees is that almost all leases will be recognised on the balance sheet. The reason for this is that the balance sheet distinction between operating and finance leases has been removed. Instead, under the new standard; an asset (the right to use the leased item) and a financial liability to pay rentals are recognised. Leases where the lease term is 12 months or less and low-value leases do not have to be recognised on the balance sheet. - For example, leases of cars would not qualify as leases of lowvalue assets because a new car would typically not be of low value. IFRS 16 does not provide a monetary value that should be considered low, but does state that the assessment should be made based on the asset s value when new (even if a used asset is leased). The Basis for Conclusions notes that, at the time of reaching its decision to provide an exception, the IASB had in mind leases of underlying assets with a value, when new, in the order of magnitude of US$5,000 or less. Determining whether a contract contains a lease from a lessee s perspective All the following pre-requisites (PR) must exist prior to the determination whether a contract contains a lease as contemplated by IFRS 16: PR 1 - There must be an asset which can be identified as being leased. The asset must be explicitly specified in the contract. PR 2 - The lessee must have the right to obtain substantially all of the economic benefits from the use of the asset throughout the period of the lease? A lessee can obtain economic benefits from the use of an asset directly or indirectly by using, holding or sub-leasing the asset. PR 4 - The lessee must have the right to operate the asset throughout the period of use, without the lessor having the right to change the operating instructions. PR 3 - The lessee must have the right to direct to the use of the asset. The lessee must have the right to change how and for what purpose the asset is used. 3
IFRS 16 Leases - A Briefing for CFO s Experience Ingenuity A contract would not involve the use of an identified asset if a lessor has the substantive right to substitute the asset used to fulfil the contract. A substitution right would be substantive if both of the following conditions are met: - The lessor has the practical ability to substitute the asset. - The lessor can benefit from exercising the right to substitute the asset. A lessee would presume that the fulfilment of a contract depends on the use of an identified asset when it is impractical for the customer to evaluate either of these conditions. No presumption for lessors is necessary because they generally have sufficient information to make such a determination. Contract terms that allow or require a lessor to substitute other assets only when the underlying asset is not operating properly (e.g., a normal warranty provision) or when a technical upgrade becomes available would not create a substantive substitution right. Separating components of a lease contract In this context IFRS 16 makes provision for an entity to account for each lease obligation within a contract separately from non-lease obligations. For example maintenance services are often combined into a single lease contract. Such an obligation by the lessee to pay to the lessor for such services must be accounted for as a separate component of the lease contract: UNLESS - The service component is considered to be part of the total consideration and not a component that is divisible. Lessors would be required to apply IFRS 15 to allocate the contract consideration between the lease and non-lease components of a contract. What changes in a company s balance sheet? Leased Assets Lease Liabilities Companies with former operating leases will appear to be more asset-rich, but also more heavily indebted. IFRS 16 will bring all former operating leases recognised under IAS 17 Leases onto the balance sheet. This will have the effect of an increase in lease assets and financial liabilities. A lessee would measure lease assets, initially at the same amount as lease liabilities, and also include costs directly related to entering into the lease. Lease assets would then be amortised in a similar way to other assets such as property, plant and equipment, which would often be expected to result in straight-line amortisation over the lease term. The carrying amount of lease assets will typically reduce more quickly than the carrying amount of lease liabilities. This will result in a reduction in reported equity compared to IAS 17 for lessees with material former operating. 4
Experience Ingenuity Heading What does IFRS 16 mean for a company s income statement? EBITDA Operating profit Profit before tax NO CHANGE For an individual lease, the IFRS 16 model will result in a different total expense recognition pattern compared to IAS 17 for former operating leases. This is because interest expense is typically higher in the earlier years of a lease than in the later years. When combined with typically straight-line amortisation of lease assets, this results in a total expense related to a lease (interest plus amortisation) that is higher than a straight-line lease expense during the first half of the lease term. The opposite is true in the second half of the lease term. Over the lease term, the total amount of expense recognised is the same. Are there any implications for cash flows? Operating cash flow Financing cash flow Total cash flow DECREASE NO CHANGE To retain the link between the balance sheet, income statement and cash flow statement, the IASB decided that a lessee would classify cash payments for: a) the principal portion of lease liabilities within financing activities and b) the interest portion of lease liabilities in accordance with the requirements relating to other interest paid. The change in lease accounting does not cause a change in total cash flows because there is no economic change. Impairment Lessees right-of-use assets would be subject to IAS 36 Impairment of Assets. Lease commencement and inception date The lease commencement date would be the date on which the lessor makes an underlying asset available for use by the lessee. 5
IFRS 16 Leases - A Briefing for CFO s Section Experience TitleIngenuity Heading Determining the lease term The lease term would be determined at the lease commencement date based on the non-cancellable term of the lease, together with both of the following: - The periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option. - The periods after the exercise date of an option to terminate the lease if the lessee is reasonably certain not to exercise that option. Presentation of lease liabilities IFRS already specifies requirements for the presentation of financial liabilities in IAS 1 Presentation of Financial Statements. The IASB decided that a lessee would present lease liabilities on the balance sheet in accordance with those requirements as for other financial liabilities. A lessee would present lease liabilities as a separate line item, or would split total lease liabilities into more than one line item based on particular characteristics, if that were relevant to understanding the lessee s financial position. A lessee would also split lease liabilities into current and non-current portions, based on the timing of payments. Presentation of lease assets The IASB decided that a lessee would present lease assets on the balance sheet: a) together with owned property, plant and equipment (if not presented as a separate line item); or b) as their own line item(s) if that were relevant to understanding the lessee s financial position. This is because many lessees use owned assets and leased assets for the same purpose and derive similar economic benefits from their use. Is there any impact on lessors? The distinction between operating leases and finance leases remains for lessors, which means there is no fundamental change to lessor accounting from the IAS 17. 6
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IFRS 16 Leases - A Briefing for CFO s Contact details Section Title South Africa Johannesburg - Head Office Durban Office Stanger Pretoria Office Bloemfontein Nkonki House 1 1 Simba Road Sunninghill Johannesburg Heading Tel: +27 11 517 3000 P.O Box 1503 Saxonwold 2132 131 Jan Hofmeryer Road Westville 3629 Durban Tel: +27 31 2747 400 P.O Box 1427 Wandsbeck 3631 84 Balcomb Street Stanger 4449 Tel: +27 32 551 1111 P.O Box 501 Stanger 4450 638 Jacqueline Drive Garsfontein East Pretoria 0081 Tel: +27 12 993 9500 P.O Box 1569, Garsfontein East Pretoria, Gauteng 0060 95B Kellner Street Westdene Bloemfontein 9301 Tel : 051 430 9290 PO Box 11977 Universitas Bloemfontein 9321 Cape Town Office Alberton Office Northwest Port Elizabeth Jeffreys Bay 1st floor, Block A, Regent Square Kenilworth 7708 Tel: +27 21 797 4594 P.O Box 2926 Cape Town 8000 DVM Office Park, 1st Floor 16 Kingfisher Crescent Meyersdal Gauteng Tel: +27 11 867 1400 P.O Box 1363 Alberton 1450 48 Proctor Avenue Golf View Mafikeng 2745 Tel: +27 18 318 1660 3 Redheart Crescent WaveCrest Jeffreys Bay 6330 Tel: 082 788 3344 PO Box 11977 Universitas Bloemfontein 9321 3 Redheart Crescent WaveCrest Jeffreys Bay 6330 Tel: +27 42 296 1330 PO Box 930 Jeffreys Bay 6330 International footprint Nkonki Proprietary 2016 Also available on: A global network of independent accounting firms email:hello@nkonki.com www.nkonki.com 8