IFRS 16 Leases Breakfast Briefing
Deloitte Financial Reporting Advisory
Introduction & Agenda
Session # Topic Sub-Topic
1 Overview of IFRS 16
- Introduction
- Definition of a lease
- Measurement of asset and liability
- Transition
- Disclosure
2 Practical challenges
- Discount rates
- Data collation
3 Project Planning
- IFRS 16 Project Planning
4 U.S. GAAPversus IFRS 16
- U.S. GAAP versus IFRS 16
5 Plan update - How is your plan progressing?
Overview of IFRS 16 Leases
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Introduction
Highlights
IAS 17
Risk and rewards model
IFRS 16
Control model
The finance lease/operating lease distinction under IAS 17 is no longer relevant under IFRS 16 for lessees. Instead, most leases will have to be recognised as “right-of-use” asset with a related liability, with subsequent accounting similar to the finance lease model under IAS 17.
IFRS 16 key changefor lessees
Shift in leasing principles
Effective for periods commencing on or after 1 January 2019
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Key Highlights
Majority of operating leases on balance sheet
Significant impact on income statement & KPIs
Assets: Right-of-Use Asset
Liabilities: Financing
Finance costs
Operating costs
EBITDA
Example KPIs Impacted:
Gearing Ratio
Asset turnover
Current ratio
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Definition of a lease
Definition of a lease - overview
Lease and non-lease
components
Control:Right to
obtain benefit
Control:Right to
direct use
Identifiedasset
Leases vs.service
contracts
Definition of a lease
Control: Right to obtain benefit
Lessee has the right to obtain substantially all the economic
benefits from that use over the life of the lease (rather than over the
life of the asset).
Control: Right to direct use
Does the customer have the right to direct how and for what purpose the
asset is used throughout the period of use?
Relevant decisions may be type, when, where, whether output is
produced. Decisions may be predetermined.
Identified asset
May be implicitly or explicitly specified.
Is the asset physically distinct?
If a capacity portion is it substantially all of the capacity?
Supplier’s substitution rights may mean no identified asset.
No identified asset if supplier has both:
• The practical ability to substitute alternative assets throughout the period of use; and
• They would economically benefit from substitution.
Leases vs. service contracts
Now matters more whether something is a lease or a
service contract.
Lease and non-lease components
Expect to separate on basis of standalone prices – but can
choose not to.
On transition can make policy choice whether to ‘grandfather’ previous conclusions as to whether existing contracts are leases.
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Illustrative examples
Question: Is it a lease or a service contract?
Background
A manufacturing company, ProduceCo (the “Hirer”), enters into a contract with a freight carrier, Transport Solutions (the “Owner”), to transport goods on its behalf. Transport Solutions provides the truck and the driver to deliver the goods.
• This agreement is for a period of five years and the truck shall remain the exclusive property of Transport Solutions.
• The Hirer shall be entitled to make all relevant decisions regarding the use of the truck, including when the truck is in use, where it is used, and what goods it is used to transport.
• When not in use the truck may be kept at either the Hirer or the Owners premises.
• The Owner shall not be entitled to substitute the truck for a similar asset during the Lease Term. The Owner shall not be entitled to take possession of the truck during the Lease Term, unless the Hirer defaults on at least two consecutive payments.
• At the expiration of the Lease Term, the Hirer shall surrender the truck to the Owner by delivering the truck to the Owner or the Owner’s agent in good condition and working order, (ordinary wear and tear is expected), as it was at the commencement of the Agreement.
• The Hirer shall pay €50,000 quarterly to the Owner, commencing on July 1, 2019 for the period of the Lease Term.
1. EQUIPMENT
The Owner leases to the Hirer the following equipment
Qty Manufacturer Model Description Unique ID number
New Not new Retained
1 SteelWorks RC-08 Rail car RC-081978 Y
1 SteelWorks RC-08 Rail car RC-081979 Y
1 SteelWorks RC-08 Rail car RC-081980 Y
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Truck
Truck
Truck
Illustrative examples
Solution: Is it a lease or a service contract?
ProductCo has the right to control the truck identified in the contract, because:
• It has exclusive use of the truck, which gives it the right to obtain substantially all of the
economic benefits from use of the identified assets.
• It has the right to determine how the truck is used at all points during the lease term
meaning it has the right to direct the use of the identified asset.
It is a lease!
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Illustrative examples
Question: Is it a lease or a service contract?
Background
Lets look at a different contract, for the use of the truck between Transport Solutions and another customer, ManuCo Inc.
• The contract between ManuCo and Transport Solutions requires Transport Solutions to transport a specified quantity of goods by using a specified type of truck in accordance with a stated timetable for a period of five years.
• The timetable and quantity of goods specified are equivalent to ManuCo having the use of the truck for five years. • Transport Solutions provides the truck, drivers and engine as part of the contract. • The contract states the nature and quantity of the goods to be transported and the type of truck to be used to
transport the goods.• Transport Solutions has a large pool of similar trucks that can be used to fulfil the requirements of the contract. • Similarly, Transport Solutions can choose to use any one of a number of engines to fulfill each of ManuCo’s requests
and each engine could be used to transport not only ManuCo’s but also the goods of other customers.• The trucks and engines are stored at Transport Solutions’ premises when not being used to transport goods.
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Illustrative examples
Solution: Is it a lease or a service contract?
There is no identified asset in this contract. As a result Solutions is only providing freight
capacity to ManuCo’s. This contract is a service contract and IFRS 16 does not apply.
It is not a lease!
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Lessee accountingRecognition exemptions and practical expedients
Optional lessee recognition exemptions:
Can straight-line expense and keep off-balance sheet:
i) leases with a lease term of 12 months or less and no purchase options – election made by class of underlying asset; and
ii) leases where underlying asset has a low value when new (e.g. personal computers or small items of office furniture) – election made on lease-by-lease basis
May be of particular relevance to leases of low value items of equipment, or short-term
property leases.
May be of particular relevance for multi-occupancy properties such as office blocks, industrial estates, and shopping centres.
Accounting for leases on a portfolio basis:
• Where an entity has portfolios of leases with similar lease characteristics the standard permits the accounting to be on a portfolio basis, using estimates and assumptions for the portfolio, if it is not expected to result in materially different accounting.
Likely to apply to leases for items such as cars where they
are all part of a master agreement.
Treating an entire contract that contains a lease, as a lease:
• IFRS 16 only requires lessees to bring the lease component of a contract on-balance sheet. Payments for non-lease services such as maintenance or security are expensed as incurred.
• Allocation of contract payments between lease and service components made on basis of relative standalone prices: considerable judgement may be required to estimate.
• Lessee can elect, as practical expedient, to treat entire contracts that contain a lease as a single lease, removing the need for an unbundling exercise but increasing the liability and asset recorded.
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Initial recognition
Lessee accounting
The balance sheet
Asset
• Initially measured at amount of liability plus initial direct costs
• Adjusted for lease incentives, payments at or prior to commencement and restoration obligations
• Subsequently measured at cost less depreciation and impairment (unless investment property that is fair valued or belongs to class of PPE that is revalued)
• Test for impairment under IAS 36 (instead of onerous lease provisions)
Right-of-use asset and liability recognised on lease commencement under single model
Liability
• Initially measured at present value of lease payments
• Lease term similar to IAS 17 (‘reasonably certain’)
• Variable lease payments that depend on index or rate included in initial measurement using rate at commencement
• Subsequently remeasured (and asset adjusted) for changes in:
‒ lease term and purchase option assessments, using revised discount rate; and
‒ residual value guarantees and future lease payments resulting from index/rate changes, using original discount rate
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Illustrative examples
Question: Can you calculate the Right of Use Asset and the lease liability?
Background
A Landlord leases to a Tenant, and the Tenant rents from the Landlord the following premises:1 Meadow Lane, Dublin (the “Premises”).
• This agreement is for a period of ten years, commencing on March 1, 2020 (‘the Lease Term’). • The tenant has the option to extend the lease agreement for an additional five years, which is to be exercised before the end of the
Lease Term.• The Tenant shall pay €200,000 annually to the Landlord, with the first payment due for payment on March 1, 2020. • The non-cancellable period of the Lease Term is two years. Should the Tenant terminate the lease after two years, a penalty fee will be
payable to the Landlord. The penalty fee will comprise of the remaining payments + 15%.• The contract signing date is 1 February 2020.
Additional facts about the contact:
• It is reasonably certain that tenant will exercise the option to extend the lease for an additional five years.• Initial direct costs have been incurred of €3,000. These fees related to professional fees including real estate commission fees and legal
review of the lease agreement.• The tentant’s incremental borrowing rate has been assessed to be 8%, as the interest rate implicit in the contract cannot be readily
determined.
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Illustrative examplesSolution: Can you calculate the initial Right of Use Asset and the lease liability?
At the commencement date, the tenant shall measure the lease liability at the PV of the lease payments that are not paid at that date. As the first payment was due on the commencement date (i.e. 1 march) this was excluded from the calculation of the PV of the lease payment.
Discount rate 8.00%
The interest rate implicit in the contract is not readily determinable so the tenant should use the incremental borrowing rate of 8% as the discount rate to calculate the PV of the lease payments.
The lease term used for computation is fifteen years (i.e. 10 years plus the option to extend the contract for another 5 years) as it is reasonably certain that tenant will exercise the option.
The right of use assets is measured at the present value of the expected lease payments at the commencement of the lease.
Year Date Discount rate Payment Liability Right of use
asset
0 01-Mar-20 1.00 200,000 200,000
1 01-Mar-21 1.08 200,000 185,185 185,185
2 01-Mar-22 1.17 200,000 171,468 171,468
3 01-Mar-23 1.26 200,000 158,766 158,766
4 01-Mar-24 1.36 200,000 147,006 147,006
5 01-Mar-25 1.47 200,000 136,117 136,117
6 01-Mar-26 1.59 200,000 126,034 126,034
7 01-Mar-27 1.71 200,000 116,698 116,698
8 01-Mar-28 1.85 200,000 108,054 108,054
9 01-Mar-29 2.00 200,000 100,050 100,050
10 01-Mar-30 2.16 200,000 92,639 92,639
11 01-Mar-31 2.33 200,000 85,777 85,777
12 01-Mar-32 2.52 200,000 79,423 79,423
13 01-Mar-33 2.72 200,000 73,540 73,540
14 01-Mar-34 2.94 200,000 68,092 68,092
15 01-Mar-35 2.94 - -
1,648,847 1,848,847
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Illustrative examples
Solution: Can you calculate the Right of Use Asset and the lease liability?
Dr Right of use asset €1,848,847
Cr Lease liability €1,648,847
Cr Cash €200,000
Being the recording of the right of use asset and lease liability at inception at the present value of the lease payments over the lease term
Dr Right of use asset €3,000
Cr Cash (Initial direct costs) €3,000
Being recording of the payment of initial direct costs.
The right of use asset should include the initial direct costs of €3,000.
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Other key considerations
Subleases
Impact onKPIs/ratios
IFRS 16disclosure
requirements
Disclosingexpectedimpact
Impairmentreview
Wider considerations
Sale and leaseback
Profit on disposal is restricted to right of use asset transferred
IFRS 16 disclosure requirements
Disclosure is more extensive than under IAS 17; judgement required to determine what to disclose and how.
Disclosing expected impact
FRC and ESMA require expected impact of forthcoming standards to
be disclosed.Impairment review
Onerous lease provisions are a thing of the past; reviewing right-of-use asset for impairment may
present new challenges.
Subleases
Sublease is classified as operating or finance. If a finance lease it is derecognized from the balance
sheet.
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Transition
Lessee accounting
Transition
Effective for periods
beginning on or after 1 Jan 2019
Earlier application permitted if IFRS 15 has also
been applied
Not required to reassess whether a contract is, or contains, a lease
at the date of initial application
Challenge for systems to
capture all data?
A lessee must make a single
choice on how to transition
Transition choice will impact net
assets, distributable reserves and future P&L
Choice of transition approach determines impact on
transition date balance sheet and future P&L
Retrospective application or cumulative catch-up approach?
This is a single choice that must be applied to all leases
Options for transitioning to IFRS 16
Option 1 – retrospective
• Restate comparatives as if IFRS 16 always applied
Option 2 – cumulative catch-up
• Leave comparatives as previously reported
• Any difference between asset and liability recognised in opening
retained earnings at transition
• Carry forward existing finance lease liabilities
• Calculate outstanding liability for existing operating leases using
incremental borrowing rate at date of transition
• Choose how to measure asset on lease-by-lease basis
Option 2A
Measure asset as if IFRS 16
had been applied from lease
commencement (but using
incremental borrowing rate at
date of transition.
Option 2B
Measure asset at amount equal
to liability (adjusted for
accruals and prepayments)
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TransitionLessee accounting
Application of transition options – example
Example facts:
• 5-year lease, entered into on 1 Jan 2017; €100k payable on second day of each year.
• 8% discount rate at lease commencement; 12% discount rate at date of transition.
• Right-of-use asset is depreciated straight-line.
Option 1 Option 2A Option 2B
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Disclosure
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The objective of the disclosures is for lessees to disclose information in the notes that, together with the information provided in the statement of financial position, statement of profit or loss and statement of cash flows, gives a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance and cash flows of the lessee.
Lessee accounting
Key disclosures
A lessee shall disclose information:• In a single note or separate
section in its financial statements.
• In a tabular format, unless another format is more appropriate.
• Depreciation by class of underlying asset;• income from sub-leases of right-of-use assets;• interest expense;• gains and losses on sale and leaseback transactions; and• variable lease payments expensed.
Disclosure is required of the expense recognised for short-term leases and leases of low value assets when eitherpractical expedient is used.
Additional qualitative and quantitative information about its leasing activities is necessary.
• Detail on sale and leaseback transactions
• Restrictions or covenants imposed by leases.
An explanation of any difference between: • operating lease commitments
disclosed applying IAS 17 at the end of the annual reporting period immediately preceding the date of initial application, discounted using the incremental borrowing rate at the date of initial application; and
• lease liabilities recognised in the statement of financial position at the date of initial application.
If a lessee uses one or more of the specified practical expedients in paragraph, it shall disclose that fact.
Must maintain a record of low value leases.
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Consider:1. The flexibility provided by leases.2. Restrictions imposed by leases.3. Sensitivity of reported information to key variables.4. Exposure to other risks arising from leases.5. Deviations from industry practice.
Meeting the disclosure objective
Additional information relating to extension options or termination options
Additional information relating to variable lease payments
Additional information relating to residual value guarantees
Key disclosuresLessee accounting
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Practical challenges
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Discount rates
Lessee accounting
The discount rate
Determining appropriate discount rates
• The interest rate implicit in the lease should be used if it can be readily determined; otherwise, use the incremental borrowing rate.
• Determining the rate implicit in the lease requires knowledge of the underlying asset’s residual value and its fair value; information unlikely to be readily available to lessees.
Interest rate implicit in the lease
The rate of interest that causes the present value of
(a) the lease payments and
(b) the unguaranteed residual value to equal the sum of
(i) the fair value of the underlying asset and
(ii) Any initial direct costs of the lessor.
Incremental borrowing rate
The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.
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The discount rate
Lessee accounting
Why does it matter?
Example fact pattern:
• On 1 Jan 2020, a company enters into
700 new 10-year leases with rentals of
€48,000 each per year paid in arrears.
• Under IAS 17 it would have recognised a
straight-line expense of €33.6m per year.
Discount rate 5% 7% 10%
Initial liability €259m €236m €206m
Year 1 expense
€39m €40m €41m
Year 5 expense
€34m €35m €35m
Year 9 expense
€29m €28m €26m
Total payable €336m €336m €336m
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Discount rate
How to calculate an incremental borrowing rate
Risk free rate
• Align weighted average payment term of the lease with the term for the source of the risk free
rate
• Adjust risk free rates for unusual items such as hyperinflationary economies, currency unions
and countries which use a currency that is not their own
• Ensure credit spread data points are relevant at the lease inception date
• Use credit spreads from debt that best matches the weighted average payment term of the lease,
otherwise estimate
• Be aware that group funding policies may not be relevant considerations for determining the IBR
• Make an adjustment if there is benefit to the lender in the form of a secured asset
• Get data from banks or lenders as unlikely to have secured borrowing rates
The IFRS 16 IBR is not:
IAS 23 Borrowing Rate
IAS 36 impairment discount rate
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The challenge doesn’t end once you have some rates
Some final thoughts
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Data Collation
Data Points
Lease Information Collation
Termination Purchase, Extension Clauses
Start & End Date
Service Element
Payments
Initial Direct Costs
Frequency of Lease
Payments
Asset Identifiers
Frequency of Rent
Increases
Future Restoration
Costs
Variable Lease
Payment & Index
Lease incentives
Collars & Caps
Asset value at new
Is asset sublet
Monthly/ Annual Rent
Charge
Fixed Rate Increase
Percentage
Renewal Terms
IRIILGuaranteed
Residual Value
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U.S. GAAP versus IFRS 16
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U.S. GAAP and Dual reporters
Leases
recognised
on the
balance
sheet
Effective date
Transition approach
Remeasurement assessment for leases tied to an index or rate
Day 1 versus Day 2
There is no exemption for leases of low-value assets
IASB’s and the FASB’s new leases standards
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Project Management
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Interim FS
IFRS 16 is much more than just an accounting change. Companies need to give consideration to the impact on data, systems, processes and controls and broader impacts including tax, remuneration, treasury and regulatory requirements.
Illustrative IFRS 16 Timelines
Project governance
Assess, analyse and prepare
Implement
Embed
Mitigate and strategise
• Train all staff• Develop project
plan, timeline of activities, resources (including structure) & budget
• Identify & engage key stakeholders
• Perform readiness assessment
• Establish scope of IFRS 16
• Develop accounting policy including transition
• Define data requirements
• Define technology strategy
• Collect and analyse lease data
• Build lease calculator/ lease models
• Implement required system changes
• Prepare draft IFRS 16 disclosures
• Define ‘business-as-usual’ state objectives and implement changes
• Update financial reporting processesand controls
• Define test strategy• Perform dry runs &
UAT (as appropriate)
• Share learnings and educate stakeholders
• Consider impacts on treasury, remuneration, performance measurement, and regulatory requirements
• Scrutinise significant contractual arrangements and future contract governance
Readiness and resources
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Additional resources
IAS Plus https://www.iasplus.com/en/standards/ifrs/ifrs-16IFRS 16 website www.deloitte.com/ie/ifrs16-10-questionsDeloitte e-learning — IFRS 16 (basic) https://www.iasplus.com/en/publications/e-learning/ifrs-16-basicDeloitte e-learning — IFRS 16 (advanced) https://www.iasplus.com/en/publications/e-learning/ifrs-16-advancedDeloitte Accounting Research Tool “DART” https://dart.deloitte.com/USDART
Alternatively please refer to your Deloitte contact.
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Questions
The Deloitte Team
Kevin Butler
Partner
Audit & Assurance
T: +353 (0)21 4907047
John Kelly
Director
Audit & Assurance
T: +353 (0)21 4207867
Oliver Holt
Director
Audit & Assurance
T: +353 (0)1 4175731
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