World Financial Symposium 27 28 September 2017 Convention Center Dublin (CCD) Ireland World Financial Symposium 2014
IFRS World Financial Symposium 2014
Addressing the FX Mismatch Issue Niall Naughton Partner, KPMG World Financial Symposium 2014
What is the FX mismatch issue? Large part of lease commitments are in USD For non-usd functional currency airlines with USD leases the ROU asset will be recorded at the rate at the lease start date but the lease liability will revalue under IAS 21 Results in significant volatility in financial result Entities where functional currency pegged to USD not impacted Economic risk always existed!
KPMG IFRS 16 benchmarking - 9 airlines from EMA, ASPAC, America area Are you impacted by foreign exchange on USD lease debt? 22% If yes : have you considered a solution to reduce USD volatility exposition? 78% 14% 29% 57% World Financial Symposium 2014
Possible solutions How are airlines dealing with the issue? Cash flow hedge Derivatives Structuring options Other alternatives
Cash flow hedge? A cash flow hedge where the lease liability is the hedging instrument for highly probable future receipts of USD revenue This is an appropriate solution but is dependent upon having sufficient highly probable USD inflows. Most non-usd functional currency airlines do not have sufficient USD inflows to offset the lease payments.
Use of derivative products Can achieve hedge accounting result Cost implications to solution IFRS 16 doesn t change the actual economic risk Why would it change hedging strategy? Hedge designations would need to be documented at beginning of comparative period if using a full retrospective approach.
Structuring options? Creation of SPE External aircraft leases are in the books of a USD functional currency special purpose entity On-leases in the local currency to the parent company. This structure could cause lease liability revaluation to be recorded in FCTR in the consolidated financial statements. Does this pass the test of having commercial substance?
Other alternatives? Local currency leases Shorter duration leases Live with the volatility the economic risk has not changed!
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Accounting for Contracts at Airport Hubs Severine Guffroy Director of Accounting, Air France KLM World Financial Symposium 2014
Definition of a lease contract under IFRS 16 Existence of an identified asset Explicitly or implicitly Without true right of substitution Physically distinct Lease contract Control of the asset use Right to obtain substantially all the economic benefits from its use and Right to decide how and for what purpose the asset is used
Arrangements at airports Customized lounges Hangars Buildings Lands Offices Counters, bridges, etc Common areas
Does an identified asset exist? Buildings, hangars, lands, customized lounges, etc. Common areas, offices, counters, bridges, etc. Explicitly or implicitly No substantive right to substitute Physically distinct
Does an identified asset exist? Common areas, offices, counters, bridges, etc. Some questions are depending on the way the use of the airport is organized Is there a contract with the airport concerning the use of common areas? Is the area / asset being used physically distinct? Are there any other parties using a significant portion of the asset? E.g. retailers, taxi/bus companies, parking facilities, advertisers? security etc. Does the airport authority have a practical and enforceable right of substitution? Is the airline using the majority of the hub / terminal?
Is there a right to control the use of an asset? Buildings, hangars, lands, customized lounges, etc. Common areas, offices, counters, bridges, etc. Right to obtain substantially all the economic benefits from its use Right to decide how and for what purpose the asset is used
Is there a right to control the use of an asset? Common areas, offices, counters, bridges, etc. Some questions are depending on the way the use of the airport is organized Is there a contract with the airport concerning the use of common areas? What are the significant decisions that are relevant to the asset? Who operates the asset and who was involved in the design of the asset? In the common area, are there other sources of benefits (shops, billboards, etc.)? Can the airline decide to change the customization of the common area? Who obtains substantially all of the economic benefits? Are there other users of the asset E.g. retailers, taxi/bus companies, parking facilities, advertisers? security etc.
Point for attention Does the arrangement meet the definition of a lease? Yes No Is the lease based on use (ex: fee per passenger)? Service contract (Expense as incurred) Yes No Variable leases are not included in the lease liability expense as incurred IFRS 16 accounting with a Right-of-Use asset and a lease liability Disclosure on variable leases Partly IFRS 16 accounting for the fixed part / expense as incurred for the variable part Disclosure on variable leases
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Accounting for Restoration and Maintenance Costs under IFRS Thomas Egan IAWG Accounting Technical Expert, IATA World Financial Symposium 2014
How are Maintenance Costs treated currently? There are several observed practices including: Observed Practice 1 - Accrue provision for major overhauls and inspections with usage, maintenance costs booked against provision when incurred. Observed Practice 2 - Provision for contractual obligation for cash settlement on return of aircraft is recognised during the lease term, and maintenance is expensed as incurred. Observed Practice 3 - Provision raised for contractual obligation during the last maintenance cycle only, and major maintenance events within the lease are capitalised as leasehold improvements. Source: KPMG Global Aviation Group, 2013 Airline Disclosures Handbook
How are Maintenance Costs treated under IFRS 16? There are several Standards to consider: IFRS 16 requires restoration costs to be included in the ROU asset and amortised from the date they become an obligation IFRS 16 requires depreciation to be applied using IAS 16 that requires a component approach when appropriate IAS 37 requires a provision for maintenance obligations that cannot be avoided Challenge will be balancing these requirements?
What maintenance costs are part of the ROU Asset? The costs of restoring the underlying asset to the condition required by the terms and conditions of the lease (IFRS 16.24 (d)) This could be seen as the costs to return the aircraft removal of paint and C-check Or more widely to include items such as the last engine overhaul, D-check, LLPs or payments in lieu For items included a provision is made at the same time as the unavoidable obligation is added to the ROU asset and depreciated. Overhauls, D-checks and LLPs are not unavoidable on day one, so if these are included in that definition they would backload these costs as they are depreciated over their remaining useful lives.
What maintenance liabilities require a provision? Lease contracts generally require the lessee to maintain the aircraft during the period of the lease and these costs are not avoidable in relation to used potential That is the criteria in IAS 37 for a provision to be taken For owned aircraft IAS 16 indicates that a provision is not appropriate as the owner could sell or take the asset out of use and thereby avoid the cost, so there is no obligation A lessee cannot do that. They must either perform or compensate the lessor for the overhauls, major repairs or inspections.
Should the overhauls and inspections be capitalized? Some airlines capitalize overhauls and inspections of leased aircraft consistent with how owned aircraft are accounted for under IFRS. If the overhauls, inspections and other major components are capitalised, they would be depreciated separately. Clearly a ROU Asset contains components (eg, overhauls and inspections) that have useful lives that vary from those of the overall ROU Asset. Concern is that unlike owned aircraft where maintenance provisions are forbidden by IAS 16, a lease creates unavoidable obligations. Challenge is how to balance these requirements.
An Illustrative Approach Treat the cost of removing paint and the final check as restoration costs forming part of the ROU asset and amortise from day one Provide for obligations for engine overhauls and D checks over time and release them when the work is performed Expense all other maintenance as incurred and treat the ROU asset as a single asset The result of this approach is that the depreciation is relatively level throughout the life of the lease, but routine maintenance and repair costs are likely back-loaded as is normally the case for new aircraft. That is partially offset by the financing element under IFRS 16 as that is front loaded.
IAS 16 IAS 37 IFRS 16 Whatever approach is used will need to mesh the relevant IFRS standards and should reflect the economic reality if the transaction that combines the lease payments and the maintenance obligation. World Financial Symposium 2014
Transition Options Severine Guffroy Director of Accounting, Air France KLM World Financial Symposium 2014
What are the transitional provisions of IFRS 16? IFRS 16 is mandatory for annual periods beginning on or after January 1, 2019 Two options can be used Retrospective method: Accounting as if IFRS 16 has always been applied The first adjustment is made as of January 1, 2018 when 2019 financial accounts are closed Y-1 figures are then fully comparable Difficulty: magnitude of the work to be done (see illustration to follow)
What are the transitional provisions of IFRS 16? Simplified retrospective method: The First Time Adjustments impact is recorded on January 1, 2019 Important simplifications are proposed, as to consider that : No restatement of comparative figures Lease liability calculated using the lessee s incremental borrowing rate at the date of initial application right-of-use asset = its carrying amount (calculated as if IFRS 16 applied since the commencement date but using the lessee s incremental borrowing rate at the date of initial application) or = lease liability at the transition date Initial direct costs can be excluded No change for leases previously classified as finance leases Difficulty: no comparative figures at least in the front of the financial statements (P&L, CFS)
Which transitional provision to use? The simplified retrospective method seems difficult to be used because of the lack of comparative figures at the transition date French organizations had written to IASB to request a change in Standard allowing to present comparative figures IASB answered on May 31, 2016 it will not change the Standard The other main differences between the two methods are the following: Use of the implicit rate of the contract (retrospective method) versus lessee s incremental borrowing rate Value of the right-of-use asset for aircraft can be highly different which is linked also to the $ rate (for non $ airlines)
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