Accounting for Leases Ronan Doyle, Partner, PricewaterhouseCoopers - - PowerPoint PPT Presentation

Accounting for Leases Ronan Doyle, Partner, PricewaterhouseCoopers

School of Aviation Finance

Lea se a ccounting Ronan Doyle

Partner – Pw C Dublin

www.pwc.ie/aviationfinance

Slide 3

Com pany Law Regim e

• Accounts must be prepared each year and approved by the directors
• Accounts subject to audit by registered statutory auditor – very limited exemption
• Public filing of accounts in most cases
• Tiered levels of disclosure/ compliance depending on
• GAAP applied
• Size
• Directors Compliance Statement *
• Confirmation to the statutory auditor
• Audit Committee *
• Disclosure on directors interests, directors emoluments and related parties is extensive *

* New in 2014 Companies Act – Not all yet effective

Slide 4

Basis of preparation of financial statem ents

• All Irish registered companies require a set of financial

statements every year

• These statements must be approved by the directors
• Choice of accounting principals
• International Financial Reporting Standards (IFRS)
• Irish GAAP
• FRS 101 – IFRS measurement with limited

disclosure

• FRS 102 – Irish GAAP principals
• Certain changes in this regime were effective from 1 January 2015

Slide 5

Lease Accounting today

• Existing standards are SSAP21 and IAS 17 (as well as ASC840

under US GAAP)

• Differentiation between an operating and a finance lease
• Operating lease accounted for as an annual income/ expense
• n a straight line basis
• No asset or liability on the balance sheet
• Finance lease accounted for a financing with an interest

charge and depreciation

• Both asset and liability to pay for asset on the balance sheet
• Tests commonly used to differentiate between the two
• Other guidance to cover sale and leasebacks, bargain purchase
• ptions, rent free periods, extensions to leases etc

Slide 6

IFRS 16 – Lease Accounting – The end of the w orld as w e know it?

• Traditionally, much of the world’s leased assets were “off balance

sheet” for their operators – Hides leverage – Undisclosed commitments – Lack of comparability within industry

• New rules will end this treatment – bringing all leases back on

b a la nce sheet of lessees

• Rents will be replaced by interest costs and depreciation (as if asset

were owned)

• International accounting rules final and effective 1 January 2019 (but

can adopt earlier)

• US GAAP rules not yet finalized – likely before end of Q1 2016
• No impact on Irish GAAP…

… … YET

Reporting rule adds $3tn of leases to balance sheets globally.

A new financial reporting standard — the culmination of decades of debate over “off- balance sheet” financing — will affect more than one in two public companies globally.

FT – 13 January 2016

The distinction between operating leases and finance leases that is required by present standards is arbitrary and unsatisfactory. The comparability (and hence usefulness) of financial statements would be enhanced if the present treatment of operating leases and finance leases were replaced by an approach that applied the same requirements to all leases.

Accounting for leases – a new approach (1996)

Slide 7

The Highlights – IFRS 16

• Lessees will be required to

1. Recognise a lease liability for present value of future lease payments 2. Recognise a right of use asset reflecting the benefit to be gained from the leased asset over the term of the lease

• The calculation of the asset and liability are tightly defined

1. Use of Asset vs Service Costs 2. Fixed vs Variable Rents 3. Term of the Lease 4. Discount Rate 5. Contingent Rents 6. Costs of Restoration

• Subsequent accounting comprises an interest charge on the liability and amortization of the asset
• Some limited exemptions for smaller/ short term assets
• Direct impact on lessors less significant (change in definition of a lease) but significant secondary impacts likely
• US GAAP likely to permit straight line accounting in the income statement in certain cases

Slide 8

Illustrative Exam ple under IFRS 16 - Lessee

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total Depreciation 1,554 1,554 1,554 1,554 1,554 1,554 1,554 1,554 1,554 1,554 15,540 Interest Expense 1,019 955 883 805 719 624 520 406 282 147 6,359 Combined Expense 2,573 2,509 2,437 2,359 2,273 2,178 2,074 1,960 1,836 1,701 21,899 Current Accounting 2,190 2,190 2,190 2,190 2,190 2,190 2,190 2,190 2,190 2,190 21,899 (2,000) (1,800) (1,600) (1,400) (1,200) (1,000) (800) (600) (400) (200)

• 2001

2002 2003 2004 2005 2006 2007 2008 2009 2010

Impact on Profit and Leverage

Profit Impact Leverage Impact The chart above depicts the im pact on earnings and leverage for a basic 10 year lease w ith an initial annual rent of $2,000, a 2% annual escalation rate and an assum ed increm ental borrow ing rate of 7%.

Slide 9

Practical Im plications

Balance Sheet Assets Liabilities Incom e statem ent Lease expense Depreciation Interest expense EBIT EBITDA EBITDAR EPS Cash flow statem ent Cash from ops Cash from finance

Cha ng es from current

• ff b a la nce sheet

a ccounting

Many KPIs are redefined:

• Current ratio
• Asset Turnover
• Interest cover
• Net income
• ROCE
• ROE
• Operating cash flows

May also im pact future transactions:

• (re) financing or raising capital

to fund growth

• Acquisitions and Mergers
• Sale and leaseback
• Lease versus buy decisions

Im pacting various arrangem ents:

• Financing arrangements and

covenants

• Supply arrangements
• Remuneration and employee

schemes

• Tax arrangements
• Hedging arrangements

Need to m anage stakeholders:

• Banks/ lenders
• Investors/ analysts
• Rating agencies
• Suppliers
• Management/ staff
• Tax authorities
• Oversight bodies

Slide 10

The potential im pact of IFRS 16 – field testing the requirem ents

Slide 11

The Balance Sheet – Other Matters

• Aircraft assets should be booked at their initial costs

– Recognise premium/ discount on lease if purchased with the aircraft – Capitalisation of directly attributable costs only – Spilt out of acquired maintenance reserves

• SEC view on the use of business combination accounting

– Often requires the booking of a maintenance asset – Could result in goodwill

• Impairment Testing

– Choice of Assumptions (discount, downtime, release rate, transition costs) – Third Party Appraisers

• Useful Lives
• Residual Value Guarantees

Slide 12

The Incom e Statem ent - Other Matters

• Accounting for maintenance/ supplemental rents

– Considerable variation in treatment – Typically recognised as a % of the supplemental rent received or on termination of the lease – IFRS 15 (Revenue) likely to restrict the options

• Financial Instruments

– Typically limited use of hedging – derivatives should be at fair value – More instruments at fair value (care with Profit Participating Notes) – Level Yield/ Effective Interest Rate accounting for interest expense

Slide 13

IFRS vs US GAAP

• Currently, Irish GAAP/ IFRS and US GAAP are broadly

aligned.  Finance vs operating lease  Depreciation on a straight line basis  Interest on debt on an accruals basis

• There are some differences

 Purchases of aircraft with leases attached  Accounting for maintenance  Impairment (Discounted vs Undiscounted)

Slide 14

Q&A

Lea d ership in Glob a l Lea sing

Ronan Doyle Partner - Assurance ronan.doyle@ie.pwc.com Telephone: +353 (0) 1 792 6559 Yvonne Thom pson Partner - Tax yvonne.thompson@ie.pwc.com Telephone: +353 (0) 1 792 7147 Brian Leonard Partner - Tax brian.a.leonard@ie.pwc.com Telephone: +353 (0) 1 792 6179