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IFRS 16 Leases :Nelson Muhumuza Senior Audit Technical Deloitte
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IFRS 16 Effective 2019
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Background
Project history
Joint document: IASB and FASB
JointIASB and FASB
786comment
letters
Introduce a right-of-use concept
Major concernCost and
complexity, measurement,
lessor accounting and scope
March 2009 Discussion
paper
August 2010 1st Exposure draft
May 2013 2nd Exposure
“One of my great ambitions before I die is to fly in an aircraft that is on an airline's balance sheet.” Sir David Tweedie, Chairman, International Accounting Standards Board
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Joint document: IASB and FASB
IASB and FASB reach differentdecisions on
expense recognition and other areas…
643comment letters
concern:
measurement, lessor accounting
Major concern:
lessor accounting
Carry forward of previous
lessor accounting
May 2013 Exposure draft
January 2016 IFRS 16 issued
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In a nutshell What is changing
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The changesIn a nutshell
Lessee accounting
IAS 17 IFRS 16
Operating lease vs
Finance lease
Right-of-use assetand
Lease liability
Effective date: 1 January 2019 Limited changes to scope of IAS 17
Enhanced guidance on identifying a lease
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IAS 17 IFRS 16
Lessor accounting
~Operating lease
vsFinance lease
Effective date: 1 January 2019 Limited changes to scope of IAS 17
Enhanced guidance on identifying a lease
~
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ScopeTo what leases does IFRS 16 apply?
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To what leases does IFRS 16 apply?
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IFRS 16 applies to all leases, except….Scope
… leases of (or rights to):
…subsequent measurement of:
Right-measured at a revalued amount
Licenses of intellectual property by lessorsLessees choice: Intangible assets
licensing agreements for motion picture films, patents etc.
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IFRS 16 applies to all leases, except….
Investment property held by lessees under fair value model
-of-use assets of PPE measured at a revalued amount
Licenses of intellectual property
choice: Intangible
explore for (or use) minerals, oil, natural gas, etc.
biological assets held by lessees
licensing agreements for motion
Service Concession arrangements
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Portfolio applicationScope
Lease
Lease Lease
Lease
Lease
Lease
Lease
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Lease
Practical expedient for leases with similar
characteristics
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Identifying a leaseWhen do I have a lease
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When do I have a lease
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When does a contract contain a lease Definition of a lease
The right to direct the use of the identified
asset
Use of an identified
asset
A contract is, or contains a lease if it meets
• Fulfilment of the lease depends on the use of an
• The contract conveys the right to controlfor a period of time in exchange for consideration.
CONTROLPresentation title
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When does a contract contain a lease
The right to obtain
substantially all of the
economic benefits
A contract is, or contains a lease if it meets both of the following criteria:
Fulfilment of the lease depends on the use of an identified asset; and
control the use of the identified asset for a period of time in exchange for consideration.
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New lease accounting standardA synopsis of IFRS 16
Your impact
Company A 2015 R m* Balance sheet Old New Total existing assets 48 511 48 511 Lease assets excl shipping Lease assets for shipping
83 7 508
Total existing liabilities (23 344) (23 344) Lease liabilities excl shipping Lease liabilities for shipping
(83) (7 508)
Income statement Old New Lease payments (232) Low-value/short-term xxx EBITDA (xxx) (xxx) Depreciation xxx Finance cost excl shipping Finance cost for shipping
(8) (751)
Profit before tax xxx xxx *Note we have assumed a discount rate of 10% to estimate the present value of the lease liability and the finance cost in the year of adoption.
Key ratios
EBITDA Net Debt: EBITDAInterest cover Debt:Equity
New disclosures
Flexibility leases provide Sensitivity & risks analysisDeviations from industry practice Increased impact analysis
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New lease accounting standard
Lessee impact All leases come on balance sheet, except
Lessor impact Mainly unchanged – operating & finance leases
Net Debt: EBITDA
Head lease (FL)
Sublease (FL/OL)
Potential mismatch for subleases
Lessee may require new information around non-lease components
Low-value leases
risks analysis Increased impact analysis
Effective date: 1 January 2019
Discussions to have now Investors & Analysts
Impact on financial report, key ratios and disclosures
Impact on business valuation and free cash multiples
Ability to access desired information Cost of implementation
Lenders Impact of covenants and debt renegotiations
Short-term leases (12 months or less)
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The requirements Identifying a lease
Is it a lease?
Identified asset and
A contract that conveys the right to use an asset for a period of time in exchange for consideration
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Right to control the use of an identified
asset
Right to obtain substantially all
economic benefits from use
Right to direct the use
Assessment at inceptionRe-assess only if terms and
conditions of contract changed
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A decision treeIdentifying a lease
‘How and for what purpose’ predetermined
Identified asset
Substantially all economic benefits
Lease
Customer can operate the asset without the supplier having the
right to change operating instructions?
OrCustomer designed asset to
predetermine how and for what purpose the asset is used?
Not a lease
NoYes
Fulfilment of the contract depends on the use of an identified asset
The contract conveys the right to control the use of the identified asset
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‘How and for what purpose’ predetermined?
Identified asset?
Substantially all economic benefits?
Customer has right to direct how and for what purpose the
asset is used throughout the period of use?
Not a leaseLease
Yes
No
No
No
No
Yes
Yes
Yes
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What to consider…Identified asset
Is it an identified asset?
Portions of assets
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Is it an identified asset?
Substantive substitutions
rights
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Portions of assetsIdentified asset
Is it an identified asset?
Physically distinct portion
e.g. a floor of a building
Example: fibre
optic cable
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identified asset?
Capacity portion
Substantially all of the capacity?
e.g. 100% capacity of 3 specified dark
fibres in a fibre optic cable
e.g. 20% capacity of a fibre optic cable
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Substitution rights of supplierIdentified asset
• Does the supplier have the ability to substitute alternative assets?
and• Would the supplier
benefit from exercise of right to substitute?
If customer cannot readily
determine, presume that
supplier does have substantive substitution right
Supplier has a substantive
substitution right
It is not an identified asset
It is
identified asset
Substantive substitution rights
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Substitution rights of supplier
Does the supplier have the practical to substitute alternative assets?
andWould the supplier economically
from exercise of right to
If customer cannot readily
determine, presume that
supplier does nothave substantive substitution right
Supplier does not have a
substantive substitution right
It is an identified asset
an
identified asset
substitution rights
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Right to obtain economic benefits
Control the use of the identified asset
Economic benefits within the scope of
rights to useNot the economic benefits
from ownership
Economic benefits over the life of the asset
Substantially all
EXAMPLES:
• Primary output and by• Using asset in commercial
transactions with third parties
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Right to obtain economic benefits
Control the use of the identified asset
Economic benefits within the scope of
rights to useNot the economic benefits
from ownership
Economic benefits over the life of the asset
Substantially all
EXAMPLES:
Primary output and by-productsUsing asset in commercial transactions with third parties
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Right to direct the useControl the use of the identified asset
Are decisions predetermined?
Does the customer have
the right to direct how and for
what purpose the asset is used throughout the period of use?
Does customer have right to
operate the asset without the
supplier having the right to change
operating instructions?
OrDid the customer design the asset to predetermine
how and for what purpose?
NoYes
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Control the use of the identified asset
customer have the right to direct
what purpose the asset is used throughout the
• Relevant decisions?
• Type, when, where, whether output is produced?
• Decisions determined during and before the period of use?
(this is not about rights to operate and maintain
the asset)
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Lease contracts When do I combine contracts or separate components?
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When do I combine contracts or separate
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Combining or separating contractsLease contracts
Account for as a single contract
Account for each component separately
Combine two or more contracts
Identify separate lease components
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Combining or separating contracts
Non-lease
Account for each component separately
Account for separately from non-lease
components of a contract
or Elect not to separate
(by class)
Identify separate lease components
Identify separate lease components
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Allocation of considerationLease contracts
Contract consideration
Lessee:
Lessor: allocate consideration in accordance with IFRS 15
Component
Component
Lease component: Relative stand-alone priceNon-lease component: Aggregate standIf no observable data, estimate maximising the use of observable information
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allocate consideration in accordance with IFRS 15
Component
Component
Component
alone priceAggregate stand-alone price
If no observable data, estimate maximising the use of observable information
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Lease termHow long is the lease for?
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How long is the lease for?
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Extension and termination optionsLease term
Option to terminate Non-cancellable period
Reassess significant event or change in circumstances that lessee controls and affects whether exercise ‘reasonably certain’ . Revise: change in non-cancellable period.
Consider all facts and circumstances that create an expected changes:••••
•
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Extension and termination options
Option to extend
Option to terminate
significant event or change in circumstances that lessee controls and affects
‘reasonably certain’
Consider all facts and circumstances that create an economic incentive, including expected changes:
Contractual terms for optional periodsSignificant leasehold improvements Costs of termination and returnImportance to operations (specialised, location, alternatives)Conditionality associated with option
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Measurement Lessees: How do I measure the rightuse asset and lease liability?
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Lessees: How do I measure the right- of use asset and lease liability?
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Initial measurementMeasurement
At commencement date: recognise rightasset and lease liability
Lease liability
Present value of lease payments
Rate implicit in the lease or Incremental
borrowing rate
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At commencement date: recognise right-of-use asset and lease liability
Right-of-use asset
Cost
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Initial measurementMeasurement
Payments made less incentives receivable commencement date
Commencement date
Payments made less incentives received beforecommencement date
Measurement of lease liability
Cost of right-of-
Rate implicit in the lease
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Payments made less incentives receivable aftercommencement date
Measurement of lease liability
-use asset
Discounted at:Rate implicit in the lease or Incremental borrowing rate
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Initial measurementMeasurement
Lease liability
Exercise price of
purchase option
(reasonably certain)
Fixed payments
less incentives
Variable payments
(e.g. CPI/rate)
Expected residual value
guarantee
Penalty for terminating
(if reasonably
certain)
NPV =
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Right-of-use asset
Initial direct costs
Payments less
incentives before
commence-ment date
lease liability
Estimated cost for
dismantling restoring
asset
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Initial measurement exampleMeasurement
Initial direct costs T1 T2
100 250 300
Lease term:Discount rate:
Present value =Lease liability Right-of-use asset
Lease commenceme
nt date
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T3 T4 T5
350 400 450
5 years5%
Present value 1 494
Lease liability 1 494asset 1 594 (1 494 + 100)
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Subsequent measurementMeasurement
YearLease liabilities
Amortisation tablePrincipal Interest Rental
T1 1,494 75 250.00T2 1,319 66 300.00T3 1,085 54 350.00T4 789 39 400.00T5 429 21 450.00
IFRS 16:
Year
AssetsDepreciation table
Openingbalance Amortisation Closing
balanceT1 1,594 319 1,275T2 1,275 319 956T3 956 319 638T4 637 319 319T5 319 319 0.00
IAS 17:(250+300+350+400+450)/5 = 350 p.a.
Lease term:
Discount rate:
Present value =
Lease liability
Right
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Lease term: 5 years
Discount rate: 5%
Present value = 1 494
Lease liability 1 494
Right-of-use asset 1 594 (1 494 + 100)
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Subsequent measurement: lease liabilityMeasurement
Time
Expe
nse
prof
ile
Constant periodic rate of interest (P&L- finance cost)
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Subsequent measurement: lease liability
Increase the lease liability to reflect the interest
Decrease the lease liability to reflect payments made
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Subsequent measurement: rightMeasurement
Time
Expe
nse
prof
ile (P&L - depreciation)
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Subsequent measurement: right-of-use asset
Apply depreciation requirements in IAS 16
Depreciate over the useful life (taking extension options into consideration)
Impairment under IAS 36
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Old standard vs new standard
Measurement
Time
Expe
nse
prof
ile
Interest and depreciation under IFRS 16
Straight-line payments under old standard
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Old standard vs new standard
IFRS 16 results in front-loading of expense
Old standard ‘smoothed’ the impact on P&L
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Subsequent measurement (alt): right
Measurement
Time
Sub
sequ
ent
mea
sure
men
t
Fair value
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Subsequent measurement (alt): right-of-use asset
…if right-of-use asset meet the definition of investment property
or
…if right-of-use asset relates to a class of PPE that is measured using the revaluation method
Subsequent measurement is at fair value…
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Subsequent measurement: reMeasurement
Original discount rate (unless changes result from floating interest rates) • Residual value guarantees expectation• Payments due to changes in an index or rate (when they take effect)
Revised discount rate if:• Change in the lease term• Significant change in circumstances within the control of the lessee regarding an option to
purchase
Re-measurement of lease liability
Any change in lease liability
leads to an adjustment to the right-of-use asset
Lease liability
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Subsequent measurement: re-assessments
Original discount rate (unless changes result from floating interest rates) if changes in:
Payments due to changes in an index or rate (when they take effect)
Significant change in circumstances within the control of the lessee regarding an option to
If right-of-use asset is reduced to zero, any remaining re-measurement goes to
P&L
Right of use asset
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Recognition What exemptions are available
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What exemptions are available
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ExemptionsRecognition
Short-term leases (12 months or less)
Accounting policy choice: Apply IFRS 16 or straight
(if applying the exemption: Apply IAS 37 to assess onerous contracts)
Election by class of underlying asset
A lease that contains a purchase option is not a short-term lease
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Accounting policy choice: Apply IFRS 16 or straight-line the expense
(if applying the exemption: Apply IAS 37 to assess onerous contracts)
Election on a lease-by-lease basis
Low-value leases
Assessment on an absolute basis
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MeasurementHow will lessees deal with modifications?
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How will lessees deal with modifications?
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Lessee modifications Measurement
Has the modification been agreed to by both
parties?
Scope increased by adding the right to use of underlying assets
andIncrease in consideration
is commensurate with stand-alone price for the
increase in scope
Yes
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Do not account for the modification
until it is agreed to
Account for modification as a separate lease
Re-measure the lease liability
(based on increase or decrease in
scope)
No
Yes
No
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Lessee modifications Measurement
Account for lease modification by remeasuring the lease liability using the discount rate at
Account for lease modification as a separate lease
Original lease Modification
Only when:• Modification increases scope; and• Consideration is commensurate to
stand-alone price for increase in scope
Modification increases
Corresponding adjustment to right
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Account for lease modification by remeasuring the lease liability using the discount rate at
that date
Modification increases scope
Modification decreases scope
Corresponding adjustment to right-of-
use asset
Decrease right-of-use asset to reflect partial termination and gain/loss to
reflect the decrease in scope
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Sale and leasebackHow does it work
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Lessor accountingIFRS 16 vs IAS 17
Lessor accounting largely unchanged
Definition of a lease 1
Enhanced disclosures 2
Main changes are…
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Lessor accounting largely unchanged
Enhanced disclosures
Initial direct costs consistently defined with concepts in IFRS 15
3Additional guidance on subleases 4
Main changes are…
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Presentation and disclosure (Lessees)What will the accounts tell me?
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Presentation and disclosure
What will the accounts tell me?
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Balance sheet Presentation and disclosure
Balance Sheet 20xx$
Lease assets Xxx
Lease liabilities Xxx
Balance Sheet 20xx$
Property, plant and equipment Xxx
Other liabilities Xxx
OR
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Present separately (except if
investment property)
Present in the line item it would have
been if it was ownedDisclose the line
item in which they are included
OR
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Income statement Presentation and disclosure
Income statement
Variable lease payments, re-measurement gains/losses, short term, low value leases
Depreciation
Finance cost
Profit before tax
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20xx$
Xxx
Xxx
Xxx
Xxx
Present interest expense separate from depreciation
(interest is a component of
finance cost under IAS 1)
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Presentation and disclosureIn the notes
Investment property leases
Revalued RoU assets (IAS 16)
Lease liabilities
Single note/ separate section
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Financial information• Depreciation by class, interest expense • Low-value or short-term lease expenses (not<1
month)• Variable lease payments• Income from subleases• Total cash flow• RoU asset: additions, carrying amount at end• Gain or losses on sale and leasebacks• Fact: low-value or short-term lease exemption
Revalued RoU asset (IAS 16)• Effective date of revaluation• Whether independent valuation expert involved
Lease liabilities • Separate IFRS 7 maturity analysis
Investment property leases • Some IAS 40 disclosures
Qualitative and quantitative disclosures• Nature of leasing activities,
• Exposure to possible future cash outflows
• Restrictions or covenants
• Sale and leaseback transactions
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TransitionHow do I transition from IAS 17 to IFRS 16?Effective from 1 January 2019
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do I transition from IAS 17 to IFRS
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Approaches: Lessees Transition
Transition
Full retrospective (as if always
applied)
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Transition
Modified retrospective
Do not restate comparatives
(adjust opening retained earnings)
Specific disclosure requirements
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When will this impact accounts?
Effective date
1 Jul 2019
1 Jan 2018
1 Jul 2018
1 Jan 2017
December year-ends:Retrospective application with restatement
June year-ends:Retrospective application with restatement
Entities can elect to apply full retrospective approach or a ‘modified’ retrospective approach with no restatement of comparatives
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When will this impact accounts?
1 Jan 2019
1 Jul 20201 Jul 2019
Retrospective application with restatement
December year-ends:Effective date
June year-ends:Effective date
Entities can elect to apply full retrospective approach or a ‘modified’ retrospective approach with no restatement of comparatives
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Definition of a lease – practical expedient Transition
Definition of a lease Not required to reassess, entities are permitted…
Entities can choose to grandfather the definition of all its leases Only apply definition of a lease under IFRS 16 to leases entered into on or after date of
initial application (DIA)
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practical expedient
Not required to reassess, entities are permitted…
…to apply IFRS 16 to contracts previously identified as a lease
…not to apply IFRS 16 to contracts that were not
previously identified as a lease
Entities can choose to grandfather the definition of all its leases Only apply definition of a lease under IFRS 16 to leases entered into on or after date of
initial application (DIA)
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Lessees: Modified retrospective approach considerations
Transition (previously operating leases)
Operating lease previously accounted
for as investment property
No transition adjustment required
RoU asset – investment property
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Lessees: Modified retrospective approach – specific Transition (previously operating leases)
Operating lease previously not
accounted for as investment property
Shall account for the right-of-use
asset as investment property going
forward
Measure right-of-use asset at fair
value at DIA
investment property
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Lessees: Modified retrospective approach expedient
Transition (Previously operating leases)
Practical expedients
low value assets
initial direct costs
may use hindsight (e.g.
lease term)
lease term of less than 12
months of DIA
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Lessees: Modified retrospective approach – practical Transition (Previously operating leases)
Practical expedients
low value assets
portfolio of leases
onerous contracts
initial direct costs
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Lessees: Modified retrospective approach
Transition (previously finance leases)
IAS 17• Carrying
amount of lease asset and lease liability
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Lessees: Modified retrospective approach
Transition (previously finance leases)
IFRS 16 • Carrying
amount of lease liability and right-of use asset
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Lessees: Disclosure
Transition
If applying modified
retrospective:
Weighted average
incremental borrowing rate
Explain difference
between IAS 17 commitment disclosed and lease liability recognised
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If applying modified
retrospective:
Explain difference
between IAS 17 commitment disclosed and lease liability recognised
Use of practical expedient
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LessorsTransition
•No adjustments
except for:
• Intermediate lessors: reassess subleases classified as operating leases
When operating under IAS 17, but finance
under IFRS 16…
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Intermediate lessors: reassess subleases classified as operating leases
When operating under IAS 17, but finance
under IFRS 16… •Account for sublease as a new finance lease at DIA
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Sale and leaseback Transition
Sale and finance lease
Leaseback same as any finance lease
Continue amortising any gain on sale over lease term
Do not reassess whether transfer satisfies IFRS 15 requirements for sale
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Sale and operating lease
Leaseback same as any operating lease
Adjust leaseback RoU asset for any deferred gains or losses relating to off-market terms
Do not reassess whether transfer satisfies IFRS 15 requirements for sale
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Amounts recognised in business combinations
Transition
Favourable or unfavourable
terms of operating lease
Derecognise that asset or
liability
Adjust the carrying
amount of the right-ofasset at DIA
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Amounts recognised in business combinations
Favourable or unfavourable
terms of operating lease
Adjust the carrying
amount of the of-use
asset at DIA
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SummaryKey judgements, policy choices and exemptions
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judgements, policy choices and
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Key judgements, policy choices and exemptions
Summary
Judgement, policy choice or exemption
Judgement: identifying a lease will sometimes require a significant amount of judgement based on the elements of the definition of a lease
Judgement: determining whether it is reasonably certain whether an extension or termination option will be exercised
Judgement: identifying the appropriate rate to discount the lease payments will require significant judgement
Exemption: Short-term leases (by class of asset) or low(lease-by-lease basis)
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Key judgements, policy choices and exemptions
policy choice or exemption Topic
a lease will sometimes require a significant amount of judgement based on the elements of the definition of a lease
Identifying a lease
whether it is reasonably certain whether an Lease term
the appropriate rate to discount the lease Incrementalborrowing rate
term leases (by class of asset) or low-value leases Recognition
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Key judgements, policy choices and exemptions
Summary
Judgement, policy choice or exemption
Policy choice: Full retrospective approach or modified retrospective approach, definition of a lease - choice to grandfather all or not, initial direct cost in measurement of RoU asset - choice lease by lease and other practical expedients on transition
Policy choice: Lessee may elect not to separate non-lease components by class of asset
Policy choice: Lessee may, but is not required to, apply IFRS 16 to leases of intangible assets
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Key judgements, policy choices and exemptions
policy choice or exemption Topic
Full retrospective approach or modified retrospective choice to grandfather all or not, initial direct
choice lease by lease and other practical
Transition
-lease components from Components
not required to, apply IFRS 16 to leases of Scope
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Wider business considerations internal and external
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Wider business considerations
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Internal Wider business considerations
Finance and Tax
Information and systems
Business unit leaders, strategy managers and procurement managers
Internal audit
Legal advisors
Human resources
Acquisitions
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Wider business considerations
Business unit leaders, strategy managers and procurement
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External Wider business considerations
Impact on financial report, key ratios and disclosures
Cost of implementation
InvestorsImpact on financial report, ratio and disclosures
Impact on business valuation and free cash multiples
Ability to access desired information
Analysts
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Wider business considerations
Impact on financial report, ratio and disclosures
Impact on business valuation and free cash multiples
Ability to access desired information
Impact of covenants and debt renegotiations
Financiers
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US GAAPWhat are the key differences to US GAAP?
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are the key differences
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US GAAPKey differences to US GAAP
Lessees of intangible assets may apply new lease standard
Classification
Exemption for low value assets
Balance sheet measurement:
• Lease liability: re-assess inflation-linked payments when payments change
• Depreciation of lease asset
• Right of use asset: option to revalue (IAS 16 and IAS 40)
Income statementPresentation title
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IFRS 16 US GAAP
Single model
(exemption for short term and low value)
Dual model
Operating and finance lease
(exemption for short term)
Typically straight lineTypically increasing for
former off balance sheet leases
Depreciation
Interest
Single expense
No interest
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US GAAPKey differences to US GAAP (continued)
Cash flow statement :
• Financing activities
• Investing / operating activities
Sale and leaseback - has a sale occurred?
Sale and leaseback - recognition of gain
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Key differences to US GAAP (continued)IFRS 16 US GAAP
Principal & interest
Interest
Principal & interest
-
• If seller-lessee has substantive repurchase option then no sale
• No other guidance
No sale if:
• Leaseback a finance/sales lease
• Repurchase option unless asset nonspecialised and price is the fair value of the asset on date the option is exercised
• Limited to portion related to residual asset
• Remaining gain: reduction to initial measurement of RoU asset
Recognise in full
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US GAAPKey differences to US GAAP (continued)
Classification of sublease by intermediate lessor
Private companies
Presentation:
• Lease liability
• Lease asset
Lessor accounting - recognition of profit/revenue
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Key differences to US GAAP (continued)
IFRS 16 US GAAP
Reference to RoU asset from head lease
Reference to underlying asset eg PPE
No specific guidance Accounting policy choice: may use a risk-free rate to discount the
lease liability
IAS 1.54-55
Part of PPE or own line
Separate presentation for former off and on balance sheet leases
• Permits recognition of selling profit at commencement of direct financing leases
• Lessor precluded from recognising selling profit/sales revenue at commencement of lease that does not transfer control of the underlying asset
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US GAAPKey differences to US GAAP (continued)
Lessor accounting
Guidance on collectability of lease payments and amounts necessary to satisfy a residual value guarantee
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Key differences to US GAAP (continued)
IFRS 16 US GAAP
Guidance on collectability of lease payments and amounts necessary
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