Lease Accounting Developments Ronan Doyle Assurance Partner - - PowerPoint PPT Presentation

Lease Accounting Developments Ronan Doyle Assurance Partner PricewaterhouseCoopers

Lea se Accounting

The end of the w orld a s w e know it ?

Ronan Doyle – 20 January 2016

Slide 3

Agenda

• What has changed
• Practical implications
• Results of field test on the likely impacts
• Suggestions on how to respond
• Q&A

Slide 4

A change that is 30 years in the m aking

• 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

balance 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

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 5

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 6

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 7

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 8

The potential im pact – field testing the requirem ents

• PwC has completed a study of 3,199 entities who currently report under

IFRS.

• Using public information, we modelled the potential impact of the

leasing standard.

• Financial metrics and ratios (e.g. change in Debt, EBITDA, Leverage,

Solvency) were recalculated.

• Borrowing costs were estimated using a company’s credit rating to the

extent available or determined a synthetic rating.

• Results were analysed by industry and geography.
• Similar studies which include US GAAP reporters typically show a

slightly more pronounced effect in the airline industry.

Slide 9

The potential im pact – field testing the requirem ents

Slide 10

Suggestions on how to respond

• Build awareness within and with customer base
• Inventory of existing arrangements to identify scope/ benefit of changes
• “Future proof” the terms of new leases
• Options for renegotiation with lessees where change may be beneficial
• Ancillary and knock on impacts on business opportunities
• Develop and cost menu of options for front office
• Build into pricing and risk assessments
• Monitor impacts for tax and LILO structures

Slide 11

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