© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Accounting Advisory Services
KPMG in the Lower Gulf
Accounting Frontline Issue: 03
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
ContentsIFRS 9 for non-financial entities
or corporate entities
4
Accounting for nonrefundable
up-front fees under IFRS 15
7
Accounting potpourri –
a mixture of accounting issues
9
Hedging for dummies 11
IFRS 16 – Leases 14
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The landscape of international accounting is evolving increasingly quickly. The IASB
has issued new standards on revenue, leases and financial instruments with
implementation due over the next few years. The IASB has also been issuing
amendments and exposure drafts to update existing standards.
Many of the changes that were planned as a response to the economic crisis have
now been issued and entities are busy gearing themselves up to implement the
changes. Change is, perhaps, the only constant in a swiftly changing accounting
universe. It is indeed an exciting time for both accountants and auditors alike.
In this newsletter, we evaluate the significant aspects of these changes and explain
how they are expected to impact the financial statements of entities in the United
Arab Emirates and beyond:
– Most banks have by now taken tangible steps to implement IFRS 9 - Financial
instruments. However, IFRS 9 has an impact beyond just banks. Our article on
IFRS 9 for non-banking clients explores some of these changes.
– IFRS 15 - Revenue from contracts with customers is expected to have a wide
impact across different sectors. Our article on IFRS 15 evaluates the
accounting for nonrefundable fees under the new standard and compares it
with the current requirements.
– Hedging has traditionally been seen as complex and difficult. In our article, we
focus on the non- financial services sector and explain some of the more
challenging concepts.
– Accounting Potpourri, our new section, clarifies some upcoming IFRS changes.
– IFRS 16 - Leases is expected to grow the balance sheets of lessees with
significant operating leases. We highlight some of the key requirements of the
new standard.
As always, we would be delighted to receive feedback from you on topics that we
should cover in forthcoming issues of Accounting Frontline.
Yusuf Hassan
Partner
Accounting Advisory Services
KPMG Lower Gulf
Foreword
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
IFRS 9 for non-financial entities
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
I Accounting Frontline – Issue: 03
IFRS 9 - effective from 1 January 2018 - revamps
accounting for financial instruments (such as
loans, investments, receivables and deposits)
through its impact on classification, hedging,
measurement and disclosures. Obviously, banks
and financial institutions are the most impacted.
However, IFRS 9 has a significant impact on
non-financial entities as well.
Classification
Classification is how financial assets are
classified on an entity’s balance sheet. It is
important because it determines the basis of
measurement, as well as how changes are
accounted for. The basis of measurement is
important since it affects volatility. For instance,
fair value changes in an equity share classified
as fair value through profit or loss (FVTPL) is
recognized in an entity’s P&L. However, fair
value changes in a non-trading equity share
classified as fair value through other
comprehensive income (FVOCI) can’t be
recognized in a profit or loss account. Any such
movements, including that arising on sales, are
recognized in OCI.
The first step in the classification process is to
establish that the cash flows from assets are
solely payments of principal and interest (SPPI).
This ensures only plain vanilla lending
arrangements are classified and measured at
amortized cost.
or corporate entitiesThe next step is to assess the business model in
which the financial assets are managed. Non-
financial entities need to classify their financial
assets into amortized cost, fair value through
profit or loss account or fair value through OCI
business models, based on, for example, how
the portfolios are managed as shown through
the portfolio’s KPIs, the way portfolio managers
are compensated, or the basis of measurement
for internal reporting. Appropriate documentation
is required to support any conclusions reached.
Debt instruments that meet the SPPI criteria
may also be held in a business model for
liquidity purposes – that is, some of the portfolio
may be sold to meet cash flow needs (perhaps
for acquisitions). Sales should be more than
infrequent and of significant value. For these
portfolios, interest income, foreign exchange
revaluations and impairment losses or reversals
are recognized in the profit or loss and
computed in the same manner as financial
assets measured at amortized cost. The
remaining fair value changes are recognized in
OCI. Upon derecognition, the cumulative fair
value change recognized in OCI is recycled to
the profit or loss account.
Impairment losses must be recognized for all
investments in debt securities not classified as
FVTPL. These reflect probability-weighted
estimates of expected credit losses (ECLs)
based on historical experience and forward
looking information: 12 month ECLs for assets
where credit risk has not significantly increased
and lifetime ECLs where it has.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Special exemption: Trade and lease receivables and contract assets
Accounting Frontline – Issue: 03 I
The accounting treatment of trade receivables is of
immense importance to non-financial entities as these
are one of the most significant financial assets. In
most cases, trade receivables should meet the criteria
to be classified as amortized costs.
From an impairment perspective, IFRS 9 allows non-
financial entities with trade receivables that do not
have a significant financing component to record
lifetime ECLs without applying the general impairment
model. For receivables and contract assets that do
have a significant financing component, IFRS 9 gives a
choice: either recognize lifetime ECLs or apply the
general impairment model.
Currently, most non-financial entities use a matrix
approach to estimate incurred losses based on the
number of days past due. This can still be used for
trade receivables under IFRS 9 – although with certain
changes to reflect ECLs against incurred losses. As a
result, bad debt provisions are expected to both
increase and become more volatile.
ABC LLC develops a provision matrix:
Practical example - adapted from example 12 of the
implementation guidance to IFRS 9
ABC LLC, a manufacturer, has a portfolio of trade
receivables of AED30m in 2017. It operates in one
geographical region. Its customer base is a large
number of small clients. Trade receivables are
categorized by common risk characteristics that reflect
customers’ abilities to pay amounts due. The trade
receivables do not have a significant financing
component in accordance with IFRS 15 - Revenue
from contracts with customers. Paragraph 5.5.15 of
IFRS 9 states that the loss allowance for such trade
receivables is always equal to lifetime expected credit
losses.
To determine the portfolio’s expected credit losses,
ABC LLC uses a provision matrix based on historical
observed default rates over the expected life of the
trade receivables, adjusted for forward-looking
estimates. At every reporting date, the default rates
are updated and changes in forward-looking estimates
are analyzed. In this example, economic conditions are
forecast to deteriorate.
Current 1-30 days past
due
31-60 days
past due
61-90 days
past due
More than 90
days past due
Default rate 0.3% 1.6% 3.6% 6.6% 10.6%
Trade receivables are measured using the provision matrix, with lifetime expected credit loss allowances calculated
by multiplying gross carrying amounts by the lifetime expected credit loss rate:
Gross carrying amount Lifetime expected credit loss allowance
Current AED15,000,000 AED45,000
1-30 days past due AED7,500,000 AED120,000
31-60 days past due AED4,000,000 AED144,000
61-90 days past due AED2,500,000 AED165,000
More than 90 days past due AED1,000,000 AED106,000
AED 30,000,000 AED 580,000
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
I Accounting Frontline – Issue: 03
Disclosures
IFRS 9 moves away from a rule-based approach
towards a judgmental approach and increases
flexibility. However, it requires extensive disclosures
to explain how judgment has been exercised, as well
as quantitative disclosures about financial assets.
Extensive disclosures are also needed where a non-
financial entity applies hedge accounting.
Mindset change is welcome – but will require extra
judgment
IFRS 9 simplifies the complex accounting
requirements of IAS 39 and aligns accounting with the
way in which risk is managed. The responsibility for
some accounting decisions, judgments and
disclosures has moved from the finance department
to a joint decision between risk management and
finance. While the mindset change is welcome, it is
likely to result in significant effort and investments.
Hedging
IFRS 9 allows entities to switch to a new hedge
accounting model that is aligned more closely with risk
management. Under the new model, more risk
management strategies (such as those related to
commodity price risks) are likely to qualify for hedge
accounting.
The new model is principle based and permits hedge
accounting to be applied even if there is
ineffectiveness in excess of 80 to120 percent of the
hedged item. The ‘bright line’ no longer exists and has
been replaced by a requirement to demonstrate that
an economic relationship exists and the hedge ratio
between the hedging instrument and the hedged item
is still appropriate.
The approach is judgmental and is expected to result
in more hedges qualifying for hedge accounting.
However, ensure an appropriate governance process
is in place for significant decisions and judgments.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Accounting Frontline – Issue: 03 I
Accounting for nonrefundable
Non-refundable fees under IFRS 15
Under IAS 18, many entities argued for upfront
recognition of refundable fees. The new IFRS 15
- Revenue from contracts with customers
modifies how revenue is recognized in an
entity’s profit or loss statement and is expected
to significantly impact entities across sectors.
IFRS 15 is mandatory for accounting periods
commencing on or after 1 January 2018.
Some contracts include nonrefundable up-front
fees that are paid at or near inception – such as
joining fees for health clubs, activation fees for
telecommunication contracts, and setup fees for
outsourcing contracts. IFRS 15 helps determine
the timing of recognition for such fees. In a
local example, the guidance could impact the
way local free zone authorities recognize their
annual subscription fees.
up-front fees under IFRS 15 Relevant requirements
An entity must assess whether the
nonrefundable up-front fee relates to the
transfer of a promised good or service to the
customer. In many cases, that activity does not
result in the transfer of a promised good or
service to the customer – that is, it’s not a
separate performance obligation but is an
administrative task. If the up-front fee is in
effect an advance payment for performance
obligations to be satisfied in the future, revenue
must be recognized when those goods or
services are provided. The revenue recognition
period extends beyond the initial contractual
period if the entity grants the customer the
option to renew the contract and that option
provides the customer with a material right.
Flowchart summarizing the accounting treatment:
Does the fee relate
to specific goods or
services transferred
to customers?
Promised good or
service
Advanced payment for
future goods or services
Recognize as revenue upon
transfer of promised good or
service
Recognize as revenue when control
of good or service is transferred
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
I Accounting Frontline – Issue: 03
Practical example
Cable company X enters into a one-year contract to
provide cable television to Mrs Z. In addition to a
monthly service fee of AED100, Company X charges a
one-time up-front installation fee of AED10. Company
X has determined that its installation services do not
transfer a promised good or service to the customer,
but are instead a set-up activity and an administrative
task. Mrs Z can renew the contract annually for an
additional one-year period at the monthly service fee
rate. Does the contract renewal grant Mrs Z a material
right? After comparing the installation fee with the
total one-year service fees of AED1,200, Company X
concludes that the nonrefundable up-front fee does
not grant Customer Z a material right as it is not
deemed significant enough to influence Customer Z’s
decision to renew or extend the services beyond the
initial one year term. The installation fee is therefore
treated as an advance payment on the contracted one
year cable service and is recognized as revenue over
the one year contract term.
What has changed?
Under IAS 18 - Revenue, any initial or entrance fee
is recognized as revenue when there is no
significant uncertainty over its collection and the
entity has no further obligation to perform any
continuing services. It is recognized on a basis that
reflects the timing, nature, and value of the
benefits provided. Such fees may be recognized
totally or partially up-front or over the contractual
or customer relationship period, depending on
facts and circumstances. Under IFRS 15, the entity
needs to assess whether a nonrefundable, up-front
fee relates to a specific good or service transferred
to the customer – and, if not, whether it gives rise
to a material right to determine the timing of
revenue recognition.
What should you do?
IFRS 15 is an important change to how revenue is
recognized and will affect systems and processes
as well as accounting. Entities are encouraged to
evaluate the changes and to gear themselves to
comply with the requirements of the standard.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Accounting Frontline – Issue: 03 I
Accounting potpourri –
What’s new?
a mixture of accounting issues
We consulted our Accounting Advisory
Services professionals to identify some
emerging accounting issues. We hope these
generate discussion and clarity in your day-
to-day work.
Narrow scope
amendment to IAS 12
Deferred tax assets on unrealized losses were
being recognized in different ways so the IASB has
issued a narrow scope amendment to increase
clarity by clarifying the general underlying
principles. These amendments are effective for
annual periods beginning on or after 1 January
2017.
The clarifications:
A temporary difference must now be calculated by
comparing the carrying amount of an asset against its
tax base at the reporting date. When an entity is
determining whether or not a temporary difference
exists, it should not consider:
— The expected manner of recovery of the related
assets (for instance, by sale or by use)
— Whether any deferred tax asset is likely to be
recoverable.
— Estimation of future taxable profit
The IASB clarified that determining the existence and
amount of the temporary differences and estimating
the future taxable profit against which deferred tax
assets can be utilized are two different steps.
Estimating any future taxable profit inherently includes
the expectation that an entity will recover more than
the carrying amount of the asset. Therefore, if an
entity believes that is likely to realize more than the
carrying amount of an asset at the end of a reporting
period, it should incorporate this assumption into its
estimate of future taxable profits.
How do deferred tax assets affect
future taxable profits?
The tax deduction resulting from the reversal of
deferred tax assets is excluded from the estimated
future taxable profit used to evaluate the
recoverability of those assets.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
I Accounting Frontline – Issue: 03
— Other assets and liabilities if they meet the
disclosure objective (for example, cash and cash
equivalents and interest payments that are
classified as operating activities).
— The amendment does not prescribe a specific
format but encourages management to consider
the disclosure that best meets the objective based
on the individual circumstances of the entity.
The amendment suggests a reconciliation between
opening and closing balances should meet the
disclosure requirement. One possible way of providing
the disclosures required by the amendment could be:
IAS 7 - Net debt amendment
For some time, investors have been calling for more
disclosures on net debt, a term not defined in IFRS.
The IASB has responded by requiring disclosures that
enable users of financial statements to evaluate
changes in liabilities arising from financing activities,
including both changes arising from cash flow and
non-cash changes. This amendment is mandatory for
accounting periods commencing on or after 1 January
2017. This should help users evaluate changes in
borrowings. The disclosure requirements also apply to:
— Financial assets arising from financing activities
(such as derivative assets that hedge long-term
borrowings)
20X1Cash
flowsNon- cash changes 20X2
Acquisition Foreign
exchange
movements
Fair value
changes
Long-term
borrowings
22,000 (1,000) - - - 21,000
Short-term
borrowings
10,000 (500) - 200 - 9,700
Lease liabilities 4,000 (800) 300 - - 3,500
Assets held to hedge
long term
borrowings
(675) 150 - - (25) (550)
----------- -------------- --------------- ---------------- --------------- --------------
Total liabilities from
financing activities
35,325 (2,150) 300 200 (25) 33,650
===== ======= ======= ======== ======== =======
Note that this example only shows current period amounts. Corresponding amounts for the preceding
periods must be presented in accordance with IAS 1 - Presentation of financial statements
Help us to help you!
Accounting potpourri is an interactive feature where we interact with you and
comment where we can. Send in your queries, comments and questions and we
will try to answer them in future editions.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Hedging for dummiesHow does IFRS 9 help?
Under IAS 39, hedging is a complex area of
judgment. Many companies avoid hedge
accounting, even if they hedge. IFRS 9 attempts
to simplify the accounting for financial
instruments and to align hedging with risk
management. Hedging, previously largely the
prerogative of banks and financial institutions, is
now more accessible and simplified for
corporates.
This indicates some of the issues associated with
forecasting - because the past never tells us which
way the future is heading. Treasurers might – with
hindsight - have analyzed the number of oil
platforms in the Gulf of Mexico, tracked China’s
automotive market, or Ali al-Naimi’s body
language. If an entity wants to remain focused on
its core business, it should consider hedging –
despite the fact that in a years’ time it is quite
likely that somebody will ask: “Why did we buy an
umbrella when it didn’t rain?” To understand why
this is the wrong question, we must understand
the basic concepts of risk management.Explaining the concept
An airline CFO and a treasurer are reviewing
their P&L in 2012. As ticket surcharges tested
demand elasticity and fuel became an ever
larger portion of cost, locking the price of fuel at
US$100/bbl might have looked like a good
strategy. Only one quarter later, everybody had
become an oil and gas analyst, smarting about
an overdue correction. Two human biases are
often part of hedging strategies - the risk
avoidance bias and the hindsight bias:
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
Accounting Frontline – Issue: 03 I
Sea hedges
In Miyako, Japan, seawall defenses were 10m
above sea level - the watermark of a tsunami 50
years earlier. When the 2011 earthquake struck,
causing the Fukushima disaster, the wave that hit
Miyako was 17 meters high.
If we decide a 20m wall is too expensive, we have
two options:
— If our processes are strong enough to recover,
we might decide to let the once-in-a-lifetime
“black swan” loss hit us, and then continue
with operations.
— If the wave repeats a bit too often, then maybe
we can take our village somewhere else – in
other words, consider tweaking or pivoting the
business model.
In either case, the sea walls (our hedges), built
even at 10m and viewed by some as ineffective,
saved lives.
In risk analytics, hedging is often linked to cash
flow at risk (CFaR) methodology. CFaR models try
to build worst case scenarios by coinciding
revenue reductions (and delays) with increases in
expenses. Nevertheless, these worst case
scenarios allow correlations to cancel out some
effects - if your revenues are falling, the chances
are that your cost base will also diminish a bit. The
focus is on cash flow because, from an operational
perspective, cash is often the scarcest and most
valuable element. While hedging strategies try to
address cash setbacks, accounting for it is usually
only an afterthought.
Risk avoidance bias – where certainty is preferred
over a gamble – is based on the logic of locking in
US$100/bbl before things get even worse.
Hindsight bias – where things appear to be more
predictable after the fact – makes it seem more
obvious that oil prices were going to fall.
Trend to continue
Price plateaus
Price reverts to mean
Actual price
Source: KPMG analysis of OPEC data
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Risk is a probability of an occurrence (frequency) of
an unwanted event multiplied by the consequence
(severity) of the event. For example, for an
individual taking a decision whether or not to buy
an umbrella, one may feel that one soaked suit
won’t hurt. However, dividing it over one’s
capacity to withstand helps decide whether or not
hedging would be appropriate. Maybe the
individual is prone to pneumonia?
If done properly, hedging increases an entity’s
capacity to withstand risk. Yet, from an operational
perspective, hedging should be viewed only as a
temporary solution because hedging really just
buys time. Ideally, treasury, risk and operations
departments should work together to minimize the
underlying reasons that give rise to the exposures.
From 2018, with IFRS 9, accounting rules are
finally better aligned with risk and treasury ways of
reasoning:
For a fair value hedge you can use…
IFRS 9 non-derivatives
IAS 39 derivatives only
Invest in a fund with overweight exposure to the
silica mining industry, whose performance
fashions a 0.8 correlation to an input glass price.
Under IAS 39, we could only do this through a
derivative - although this at least offered a cheap
exposure through leverage. Required derivatives
often didn’t exist and structuring them was
prohibitively priced. Assuming creativity and cash
are available, IFRS 9 might allow it.
Non-financial items can be hedged…
IFRS 9 through risk components
IAS 39 only in its entirely
Because the final price of the glass also includes
transport, production and administrative expenses
and profit margins, we are actually addressing only
one source of risk, or decomposing the risk into
pieces, when investing in the silica mining
industry. Under IAS 39, this was impossible. Under
IFRS 9, it can be done.
Basis risk change might involve…
IFRS 9 hedge ratio rebalancing
IAS 39 hedge discontinuation
We realize that glass producers are repeating
elevator producers’ trick and keeping a larger share
of the value for themselves. The correlation
between a basket of silica mining companies and
the price of glass falls to 0.6, making our hedge
less effective. In an IAS 39 world, we would have
to discontinue the hedge and create a new one
(assuming we still want to continue the
relationship at 0.6 correlation).
In our bright and shiny IFRS 9 world, according to
paragraph basis risk (another name for a situation
where a change in the underlying instrument does
not fully offset the instrument we are hedging), the
change might involve simply rebalancing the hedge
ratio to restore its effectiveness. Of course, an
economic relationship should exist between the
variables in the first instance.
IFRS 9 makes hedging easier – but
it still isn’t for everyone
CFaR models help you think about risk
management, Start by identifying and eliminating
operational risk - and only then think about hedging
to reduce finance and treasury risk. CFaR models
enable you to identify and leverage correlations
between asset classes and their differing
volatilities to formulate actionable hedging
strategies that can be translate into significant
savings. Hedging is not for everyone – but with the
changes to IFRS 9, hedge accounting is now more
straightforward.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
I Accounting Frontline – Issue: 03
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
IFRS 16 – LeasesTechnical overview
In January 2016, IASB issued IFRS 16 - Leases,
redefining how leases are accounted for by the
lessee. Under IAS 17 - Leases, a lessee had to
make a distinction between a finance lease (on
balance sheet) and an operating lease (off
balance sheet). IFRS 16 requires the lessee to
recognize almost all lease contracts on the
balance sheet, with an optional exemption for
certain short-term leases and leases of low-value
assets. IFRS 16 will significant impact on
lessees that have entered into contracts
classified as operating leases under IAS 17.
Scope
IFRS 16 applies to all lease contracts except for:
— Leases to explore for or use minerals, oil,
natural gas and similar non-regenerative
resources
— Leases of biological assets within the scope
of IAS 41 - Agriculture
— Service concession arrangements within the
scope of IFRIC 12 - Service concession
arrangements
— Licenses of intellectual property granted by a
lessor within the scope of IFRS 15 - Revenue
from contracts with customers
— Rights held by lessees under licensing
agreements within the scope of IAS 38 -
Intangible assets for items such as films,
video recordings, plays, manuscripts, patents
and copyrights.
— A lessee may choose to apply IFRS 16 to
leases of intangible assets other than those
mentioned above.
What is a lease?
IFRS 16 defines a lease as a contract, or part of
a contract, that conveys the right to use an asset
for a period of time in exchange for a
consideration. In practice, it can be challenging
to distinguish between a contract that conveys
the right to use an asset and a contract for a
service that is provided using the asset.
Under IFRS 16, a contract contains a lease if
there is an identified asset and the contract
gives the right to control the use of that asset
for a period of time in exchange for a
consideration. An asset can be explicitly or
implicitly identified, but is not identified if the
supplier has a substantive right to substitute it.
Substitution rights are substantive if the supplier
can substitute an alternative asset and benefits
economically from doing so.
If a customer cannot readily determine whether
the supplier has a substantive substitution right,
it is presumed that the right is not substantive.
Separating contract components
Contracts often combine different kinds of
obligations, such as lease components or a
combination of lease and non-lease components.
For example, leasing an office could include the
lease of equipment and maintenance. In this
situation, IFRS 16 requires each lease
component to be identified and accounted for
separately. Bundled contracts need to be
carefully separated.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
Accounting Frontline – Issue: 03 I
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
This grosses up balance sheets by substantially
increasing recognized financial liabilities and assets
for entities with significant lease contracts – and
that are currently classified as operating leases.
The lease liability is initially recognized on the
commencement day and measured at an amount
equal to the present value of the lease payments
during the lease term that are not yet paid. Right-
of-use assets are initially recognized on the
commencement day and measured at cost, as the
amount of the initial measurement of the lease
liability, plus any lease payments made to the
lessor at or before the commencement date less
any lease incentives received, the initial estimate
of restoration costs and any initial direct costs
incurred by the lessee. The provision for the
restoration costs is recognized as a separate
liability.
Discount rate
The lessee uses the interest rate implicit in the
lease as the discount rate. This is the rate that
causes the present value of lease payments and
the unguaranteed residual value to equal the sum
of the fair value of the underlying asset and any
initial direct costs of the lessor. If this rate cannot
be readily determined, the lessee should instead
use its incremental borrowing rate.
Lease terms
As with IAS 17, IFRS 16 defines the lease term as
the non-cancellable period of the lease plus
periods covered by an option to extend or
terminate - if the lessee is reasonably certain to
exercise the extension option or not exercise the
termination option.
Recognition and measurement
exemptions
IFRS 16 contains two recognition and
measurement exemptions:
1. Short-term leases (12 months or less)
2. Leases for low value underlying assets
If either of the exemptions is applied, the leases
are accounted for in the same way as current
operating leases - on a straight-line or another
systematic basis that better represents the pattern
of the lessee’s benefit). Election can be made on a
lease-by-lease basis.
Initial recognition and
measurement
The new lessee accounting model within IFRS 16
is the most important change. Under IFRS 16,
lessees no longer distinguish between finance
lease contracts (on balance sheet) and operating
lease contracts (off balance sheet), but they are
required to recognize a right-of-use asset and a
corresponding lease liability for almost all lease
contracts. This is based on the principle that, in
economic terms, a lease contract is the acquisition
of a right to use an underlying asset with the
purchase price paid in instalments.
Initial direct costs
IFRS 16 defines initial direct costs as incremental
costs that would not have been incurred if a lease
had not been obtained. This includes commissions
or other payments made to existing tenants to
obtain a lease. All initial direct costs are included in
the initial measurement of the right-of-use asset.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
I Accounting Frontline – Issue: 03
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Lessor accounting
IFRS 16 does not substantially change IAS 17
lessor accounting. The lessor still has to classify
leases as either finance or operating, depending on
whether the risk and rewards of the underlying
asset have been transferred. For a finance lease,
the lessor recognizes a receivable at an amount
equal to the net investment in the lease (the
present value of the aggregate of lease payments
receivable by the lessor and any unguaranteed
residual value). If an operating lease, the lessor
continues to present the underlying assets.
Subsequent measurement
The lease liability is measured in subsequent
periods using the effective interest rate method.
The right-of-use asset must be depreciated in
accordance with IAS 16 - Property, plant and
equipment. The lessee must also apply the
impairment requirements in IAS 36 - Impairment.
Other measurement models
IFRS 16 also permits lessees to use the fair value
model under IAS 40 - Investment property or the
revaluation model in IAS 16 if it relates to a class
of property, plant and equipment and the lessee
applies the revaluation model to all assets in that
class.
Transition
IFRS 16 is effective for reporting periods beginning
on or after 1 January 2019. Earlier application is
permitted, but only alongside IFRS 15.
What does it all mean?
Balance sheets of lessees with major operating leases are likely to be significantly
impacted. Both the asset and liability sides are expected to increase – and the impact
on balance sheet ratios could be considerable. Impacted entities should already be
assessing the new standard and considering its impact.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms 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.
Accounting Frontline – Issue: 03 I
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the UAE, member firms of the KPMG network of independent member firms affiliated with KPMG
International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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.
© 2017 KPMG Lower Gulf Limited and KPMG LLP, operating in the United Arab Emirates, member firms of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights
reserved. Printed in the UAE.
The KPMG name and logo are registered trademarks or trademarks of KPMG International.
Yusuf Hassan
Partner – Head of Accounting
Advisory Services
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Partner – Head of Risk
Consulting
+971 2 401 4839
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Director
Accounting Advisory Services
+971 4 424 8914
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