AASB 16 Leases A fundamental overhaul of lessee accounting effective 2019 kpmg.com.au
Understanding the impact to your company A new leasing standard AASB 16 Leases removes the concept of operating and finance leases for lessees which exists under AASB 117 Leases, replacing it with a single accounting model under which lessees must recognise all leases (including property and equipment) on the balance sheet as a new right of use asset and lease liability. Small value assets and short term leases are excluded. The rules for lessors have not significantly changed. The change to bring the majority of leases on balance sheet was driven by the IASB to improve transparency, comparability and disclosure of companies leasing activities. What is the impact of the new standard? The changes in accounting are not limited to the balance sheet. For example, the lease expense profile will be frontloaded for most leases, even when rental payments are constant yeartoyear. New information will also be required to support the determination of new judgments and estimates used in the calculation of the leased asset and liability on inception date and throughout the lease. These include lease term, discount rates, insubstance lease payments, rents linked to a rate or index, expected payments under residual value guarantees and inclusion of purchase options and termination payments. Although the economic benefits and risks of leasing does not change, the new lease accounting model will change key financial metrics and KPIs and introduce volatility to the balance sheet and profit or loss due to continual remeasurement requirements. As such, careful communication of this impact to key stakeholders such as investors, banks and credit rating agencies will be critical. Transition to AASB 16 On transition to AASB 16 an entity will have a number of interdependent options and practical expedients available. The different transition options will result in a different impact on transition and subsequently to the balance sheet and profit or loss. We therefore recommend companies model the various transition option results to their balance sheet and profit or loss going forward to assist in the determination of the most optimal transition method. Businesswide impacts As well as financial reporting changes, AASB 16 also has businesswide impacts, including, but not limited to, modifications and management of: New leasing systems to capture data and perform calculations; Debt covenants and credit rating, given new debt on balance sheet; Impairment tests and tax effect accounting, given increase in assets and liabilities; and Opex, capex approval processes and buy vs. lease strategies. These impacts should be managed and carefully communicated to stakeholders at both the transition date and on an ongoing basis. Impact on lessee balance sheet Expected impact to KPIs / ratios Profit or loss Balance sheet Ratios EBITDA EPS (in early years) Total asset Total liabilities Net assets (in early years) Gearing Asset turnover Asset Liability Companies with operating leases will appear to be more assetrich, but also more heavily indebted. Impact on lessee profit or loss Companies will see an increase in their EBIT / EBITDA profitability and ratios given the lease expense will be reported below the line. An increase in leverage ratios will reflect additional debt on the balance sheet from the lease liability. Depreciation Interest Cash rental payments Total lease expense will be frontloaded even when cash rentals are constant.
What are your next steps? One of the biggest hurdles your organisation may face is obtaining an understanding of your lease portfolio characteristics and setting up new systems, processes and controls to manage your lease portfolio going forward. Organisations should not underestimate the time required to collect lease data and assess the impact of the new standard. Below are suggested steps to ensure a successful transition to the new lease accounting standard. 1 Establish your project team Who is leading and supporting your implementation project? Which business areas should be involved? Are there any training requirements to raise awareness? 4 Select transition option Which transition method will you apply? Do you have all the data to be able to apply the full retrospective approach? Will you apply any optional exemptions? What will you say about AASB 16 in your 2017 annual report? 2 3 Understand your lease portfolio How many leases do you have? Where is your lease information stored? Do you have all the data required to calculate a right of use asset and a lease liability? Could there be any embedded leases in service contracts? What new leases will you sign by 2019? Where are accounting judgments and assumptions required? Investigate structural solutions to reduce impact Which terms can you negotiate to reduce your lease liability or eliminate volatility? Can alternative off balance sheet arrangements be structured? 5 6 7 Gap assessment of current systems, processes & controls Which processes and controls for affected business units will need to be modified or established? Can your existing systems cater for the new data and measurement requirements or will a new system be required? Which accounting policies will you need to update? Determine future state design How will you implement, test and embed new systems, processes and controls? What are your timing, cost and resource restraints? Implementation Will your company be set up to meet the requirements of AASB 16 by 2019? Can you deliver on your implementation plan? Implementation timeline Disclose impact in annual finance statements: 31 Dec. 2017 2015 & prior 2016 2017 2018 2019 2020 & beyond AASB 16 issued Jan. 2016 Comparative start: 1 Jan. 2018 (if full retrospective option is chosen) Effective Date: 1 Jan. 2019 KPMG provides a range of services and solutions that can help your organisation successfully implement AASB 16, please see next page to understand how we can assist you.
How KPMG can help with your implementation project Run or support your implementation project Provide our global tools and methodologies to support your project needs, including experienced project managers with proven methodologies and tools to assist you with gap analysis, transition option modelling, impact assessment for key financial metrics, analysis of changes required to processes and systems and project management support. Accounting advice Transition impact assessment Transformation & IT system change solutions KPMG Leasing Tool for IBM TRIRIGA Leasing strategy & valuation services Support the finance team with analysis of complex contracts and provide assistance with key judgments and assumptions. Develop solutions to minimise the impact of the new standard. KPMG Impact Analysis Tool can help you determine the most appropriate transition option by quantifying the impacts to the balance sheet profit, or loss and key metrics under the different transition options to assist you with communicating the change to key stakeholders. Perform systems assessment, strategy, design, configuration and implementation services. KPMG has worked with IBM to develop KPMG Leasing Tool for IBM TRIRIGA, a cloudbased, prepackaged KPMG solution that enables clients to centralise data and meet the new accounting requirements on a go forward basis, for both AASB 16 and US GAAP ASC 842. Support the company to determine the optimal procurement strategy and lease terms. Provide valuation services of KPMG s SGA and Real Estate Advisory Services teams. Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates. Contact us Michelle Gibbs National Leasing Lead Sydney +61 2 9455 9028 mfgibbs@kpmg.com.au Andras Berta Perth +61 8 9263 7556 andrasberta@kpmg.com.au Emma Pratt Brisbane +61 7 3233 9775 epratt1@kpmg.com.au Daina Klunder Melbourne +61 3 9838 4703 dklunder1@kpmg.com.au kpmg.com.au The information contained in this document is of a general nature and is not intended to address the objectives, financial situation or needs of any particular individual or entity. It is provided for information purposes only and does not constitute, nor should it be regarded in any manner whatsoever, as advice and is not intended to influence a person in making a decision, including, if applicable, in relation to any financial product or an interest in a financial product. 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. To the extent permissible by law, KPMG and its associated entities shall not be liable for any errors, omissions, defects or misrepresentations in the information or for any loss or damage suffered by persons who use or rely on such information (including for reasons of negligence, negligent misstatement or otherwise). March 2017. VICN15015AUD.
Quick reference guide Key requirements of AASB 16 Leases for lessees Which leases come onto balance sheet AASB 16 replaces AASB 117 and IFRIC 4 when determining whether a contract contains a lease. A reassessment of contracts to determine if lease arrangements exist under AASB 16 will be required unless the practical expedient not to reassess all contracts is applied. Many companies will also need to carefully assess whether there are leases embedded within other types of service contracts. For example, this may be the case when the entity is the only party using the asset. A lease arrangement exists if: Identified asset There is an identified asset explicitly or implicitly in a contract when the supplier does not have a substantive right to substitute the asset and the asset is physically distinct. Control over use + Control exists when the customer has the right to obtain substantially all the economic benefits from the use of the asset and direct how and for what purpose the asset is used. = Lease Companies may apply the practical expedients not to recognise an asset and liability for leased assets less than approximately USD $5,000 or with lease terms (including options to extend) of 12 months or less. Significant change to balance sheet and P&L profile From 1 January 2019 all lessees will recognise a rightofuse (ROU) asset and a corresponding lease liability for all leases. An example illustration is as follows: Balance Sheet PP&E ROU asset Other Total assets Borrowings Total liabilities Today 44,250 35,256 79,506 22,567 22,567 AASB 16 44,250 3,280 35,256 82,786 22,567 3,387 25,954 Net assets 56,939 56,832 Profit or loss Revenue Expenses: Operating lease Other EBITDA Amortisation Interest Net profit/loss Today 10,000 (1,000) (110) 8,890 8,890 AASB 16 10,000 (110) 9,890 (820) (287) 8,783 Transition options When applying the new standard, your company can adopt one of the following transition options: Full retrospective approach apply the standard as if it had always been in effect (i.e., from the onset of each lease) and restate comparatives, adjusting opening retained earnings in comparative year; or Modified retrospective approach apply the standard only at the date of application, do not restate comparatives and adjust opening retained earnings at date of application. Each option will have a different impact to the balance sheet and profit or loss on transition and therefore to future reporting. The options should be modelled out (see example right) to determine which option best meets your company s objectives, with consideration given to the cost of implementation. For instance, full retrospective approach may result in the lowest future expense going forward due to front loading of lease expense to retained earnings, however is likely to be the most expensive option to implement due to information requirements. ROU asset 1 As if AASB16 had always been applied 2 OR Full retrospective approach OR Modified retrospective approach Operating lease Present value of remaining lease payments 2 1 Choice on a lease by lease basis 2 Discounted at borrowing rate at application date Expense Years AASB 117 (st. line / cash) Modified (asset = retro) ROU asset Previous carrying amount of finance lease receivable Full retro Finance lease Example profile of total expense under different transition options Modified (asset = liability) Previous carrying amount of finance lease liability
New measurement requirements The ROU asset and lease liability are calculated using inputs which may not be captured in your company s systems, processes and controls. Furthermore, many of these inputs are subject to estimates which require reassessment and recalculation of the asset and liability each reporting period. The lease liability is measured as follows: Must be reassessed LEASE LIABILITY = Present value of lease payments which include consideration of the following: Service charges can be estimated and excluded from lease liability (report in P&L when incurred) Lease term Insubstance fixed lease payments Variable lease payments Residual Value Guarantees (RVG) Termination penalties Purchase options Discount rate Noncancellable term plus options to renew if economic incentive* Payments structured as variable payments however are unavoidable (i.e. fixed) Include variable lease payments when based on an index or rate (e.g., CPI) Expected payments (only shortfall on expected market value and RVG) Include if term reflects exercise of option to terminate if economic incentive* Include purchase price if economic incentive* Rate implicit in the lease or if not readily determinable, incremental borrowing rate * Examples of factors that should be considered when determining if the lessee has an economic incentive to exercise purchase or term varying options are: level of rents in secondary period vs market rates; nature of the asset and its location (and the availability of alternatives); significant leasehold improvements; and costs of termination or resigning. The lease liability is subsequently accreted for interest and reduced for principal payments. It is also adjusted for reassessments of RVG, changes to rental amounts linked to an index or rate, term reassessments, and changes in expectations around options to purchase. Discount rate changes are also required if the lease term changes or lease payments are based on a floating interest rate. The ROU asset is measured as follows: ROU ASSET Direct costs Prepaid amounts Make good provisions Lease incentives The ROU asset is subsequently amortised to profit or loss on a straight line basis (or pattern of use). It is adjusted for impairment and any measurements of the liability resulting from: reassessments of term, purchase options or RVG; or changes to variable lease payments linked to index or rate that relate to future periods. Note a fair value model may also be applied to the asset in some instances. Other changes The new leases standard also results in changes to accounting for subleases and sale and leaseback transactions and outlines increased disclosure requirements. For subleases, the intermediate lessor will recognise the head lease as a lease liability and ROU asset and make an assessment using the same criteria as that of AASB 117 to determine whether the sublease is an operating or finance lease. The intermediate lessor would account for the sublease as follows: If sublease is an operating lease: Record rental income; or If sublease is a finance lease: Recognise a finance lease receivable (and associated interest income) in place of the ROU asset and a gain or loss for the difference. For sale and leasebacks, the lessee will need to determine whether the asset can be derecognised under the new control criteria in AASB 15. A sale will be deemed to have occurred when the seller/lessee has transferred control of the asset. It is typically expected that control of the asset has transferred unless: the seller/lessee has a forward purchase call option; or the purchaser/lessor has a put option where the terms are such that there is a significant economic incentive to exercise the put option. If a sale occurs, the asset is derecognised and a new ROU asset and lease liability is recorded along with any associated gain or loss on disposal; however, any gain or loss can only be recognised by the seller/lessee to the extent that rights have been transferred to the purchaser/lessor. If a sale does not occur, then the seller/ lessee continues to recognise the asset and records a financial liability for the proceeds received. kpmg.com.au The information contained in this document is of a general nature and is not intended to address the objectives, financial situation or needs of any particular individual or entity. It is provided for information purposes only and does not constitute, nor should it be regarded in any manner whatsoever, as advice and is not intended to influence a person in making a decision, including, if applicable, in relation to any financial product or an interest in a financial product. 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. To the extent permissible by law, KPMG and its associated entities shall not be liable for any errors, omissions, defects or misrepresentations in the information or for any loss or damage suffered by persons who use or rely on such information (including for reasons of negligence, negligent misstatement or otherwise). March 2017. VICN15015AUD.