emerging accounting & valuation · pdf filegareth is a partner in the financial services...

0© 2016 KPMG, an Irish partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in Ireland.

Emerging Accounting & Valuation Challenges

KPMG & IBA Breakfast Briefing

10 November 2016


Topic Presenter

■ Accounting issues Ian Nelson

■ Key valuation considerations Phil Seymour

■ Tax considerations Gareth Bryan

■ Other valuation hot topics Phil Seymour

■ Other accounting hot topics Ian Nelson

■ Wrap-up and Q&A All

Today’s agenda


Today’s speakersIan Nelson

Partner, Financial Services

KPMG

Phil Seymour

President and CEO

International Bureau of Aviation

Gareth Bryan

Partner, Tax

KPMG

Ian is a Partner in our aviation practice specialising in audit and assurance. Ian is an IFRS 9 and US GAAP specialist.

Gareth is a Partner in the financial services taxation practice specialising in both domestic and international corporate

tax. Gareth advises a range of domestic and international clients.

Phil is the CEO of IBA, a leading aviation consultancy where he specialises in strategic projects for lessors, airlines and

investors. Phil is a Senior ISTAT Certified Appraiser, and is the current elected Chairman of the ISTAT International

Appraisers’ Program.


Accounting issues - agenda1. Acquisition of mid-lease aircraft (main focus for today)

2. Other accounting topics

− IFRS 16

− Forward orders


Maintenance intangibles

1. AerCap Holdings N.V. Annual Report year ended 31 December 2015

2. Fly Leasing Reports Fourth Quarter & Full Year 2015 Financial Results

3. Fly Leasing Limited Annual Report year ended 31 December 2015


Key questions1. How to recognise/value of;

i. Metal (aircraft)

ii. Lease premium / deficit

iii. Maintenance intangible

2. Amortisation profiling of any intangibles recognised.


This is still an evolving accounting issue:

■ The aviation sector is still working through the implications;

■ We understand there is some reluctance to recognise maintenance intangible liabilities notwithstanding they could arise under this potential approach (due to

potential inflation of aircraft values); and

■ The proposed accounting is sometimes inconsistent with the commercial reality where often the current condition of the aircraft is viewed less relevant.

Status and our clients

Non- Believers

Believers but waiting

to see how industry

evolves

XIt now appears that only the third

option is really a runner – the guidance should be applied!

3. Believers –have applied

the requirements.

1. Believers –but waiting to

see how industry evolves

2. Non-believers:

quickly becoming

extinct!

http://www.google.ie/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0ahUKEwiM1v7gsorQAhUB8mMKHT6fA7oQjRwIBw&url=http://www.kongregate.com/forums/4-programming/topics/184273-disabling-a-fault-message&psig=AFQjCNGX-UsofEvdefynhykOL3MtvArsig&ust=1478187235516145

http://www.google.ie/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0ahUKEwiM1v7gsorQAhUB8mMKHT6fA7oQjRwIBw&url=http://www.kongregate.com/forums/4-programming/topics/184273-disabling-a-fault-message&psig=AFQjCNGX-UsofEvdefynhykOL3MtvArsig&ust=1478187235516145


US GAAP ■ The SEC have pointed to Topic ASC 350, ASC 360 and the contractual-legal element of ASC 805 in US GAAP in their comment

letters.

■ Subtopic 350-30 addresses accounting for intangible assets acquired individually or with a group of other assets. Paragraph 805-50-

30-3 indicates that the cost of a group of assets acquired in a transaction other than a business combination shall be allocated to the

individual assets acquired based on their relative fair values and shall not give rise to goodwill.

■ Fair value of aircraft can be more reliably determined due to the availability of independent third party-appraisers, fair value of the

aircraft on an “as-is, where is” maintenance adjusted for physical condition basis should be used first to determine the amount

allocated to the aircraft.

■ Material differences between the appraised amount allocated to the aircraft and the consideration paid for the aircraft would be an

indicator of an intangible asset or liability.

IFRS ■ IAS-38 requires an intangible asset is initially recognised at cost if it is probable that future economic benefits that are attributable to

the asset will flow to the entity; and the cost of the asset can be measured reliably.

■ Therefore it is necessary to recognise off-market leases and maintenance return condition elements separately –as the economic

benefits that will flow to the acquiring lessor will be realised, likely, through a sale of the asset or through future rentals (or a

combination of both).

■ Additionally IAS16 requires one to recognise the aircraft first-cost based on its then location and condition. Therefore it is not possible

to include the MTX-intangible as a component of aircraft cost.

■ Need to consider difference between business combination (IFRS 3) and aircraft acquisition (IAS 16) in terms of the

split-out of lease rate intangibles.

IFRS v’s US GAAP –Is there a GAAP difference ?

https://workspaces.ema.kworld.kpmg.com/aro/AROWeb/DocumentWindow.aspx?id=US_FASB_ASC_350_030

https://workspaces.ema.kworld.kpmg.com/aro/AROWeb/DocumentWindow.aspx?id=US_FASB_ASC_805_050_30_3


Intangible

Assets

The recognition of maintenance and lease intangibles issue arises only in respect of the purchase of aircraft on lease, from other

lessors/investors (i.e. it does not apply to new-purchases from OEMs or the PLBs with airlines, which were not previously on lease).

The following example assumes that in all cases we are considering a single aircraft transaction which has been determined is not a

business combination. But to note the identification and measurement of such intangibles is also required under business combination

accounting, as evidenced by the AERCAP accounting for the ILFC transaction. Also, the subject of whether a single aircraft acquisition

(on-lease) is a business combination is a lengthy debate !

Accounting for intangibles


Worked Example

The fair value of the aircraft

can be calculated using

specific MSN appraiser

values at date of acquisition

if available.

CMV – 50 % $33m

A lease intangible is an

asset/liability relating to any

off market rental terms.

Lease Rentals: $300k

Average lease rentals per

appraisers: $280k

Lease intangible= $1.2m

(300k-280k * 5 years)

A maintenance intangible is an asset/liability

relating to the difference between the current

aircraft maintenance-specific CMV at the date of

purchase (half life) and the CMV at date of

purchase based on the expected maintenance

condition at lease end (full life).

CMV of full life aircraft: $35m*

CMV of 50% aircraft: $33m*

Maintenance intangible =$2m ($35m-33m)**

* At 1 January 2015

** On assumption the aircraft redelivers in 100%

physical condition

The Remaining Purchase Price to be allocated is

$1.8m ($38m-$33m-$1.2m-$2m). This is required to

be allocated on proportional basis between all assets

and liabilities identified.

Aircraft: $34.64 (91% ($33m/$36.2m) of $38m)

Lease: $1.26 (3% ($1.2m/$36.2m) of $38m)

Maintenance $2.10 (6%($2m/$36.2m) of $38m)

Total $38m

Step 2:

Calculate the lease

intangible

Step 1:

Calculate the fair value of the

aircraft on acquisition

Step 3:

Calculate the Maintenance Intangible

Step 4:

Allocate the remaining purchase price on a

proportional basis (1)

Lease Intangible:

$1.2mAircraft: $33m Maintenance Intangible: $2m

Aircraft $34.64

Lease Intangible $1.26

Maintenance Intangible $2.10

On 1 January 2015, a 2013 vintage A320 aircraft in 50% maintenance condition is purchased from Lessor X for $38m with a lease attached. The below outlines a

high level example of how the individual assets and liabilities would be calculated. Please note the below calculation does not factor in the time value of money.

Lease Assumptions

Remaining Lease Term: 5 years

Maintenance Reserves: $1 million per

year

Lease Rentals: $300k per

month

Re-delivery terms: 100% MC

Market Assumption (A320-2013 aircraft)

Average appraiser rentals: $280k per

month

Average appraiser CMV-full life: $35m

Average appraiser CMV- half life: $33m

1. There may be other approaches of allocation, for example, using balancing figures.


BASED ON OUR WORKED EXAMPLE:

Subsequent

Measurement

Lease intangible

■ The lease intangible will be amortised to the Income Statement over the lease term. (US$1.2M OVER 5 YEARS = $20,000 PER MONTH)

DR: P&L US$20,000 (PM)

CR: Lease intangible US$20,000 (PM)

Maintenance Intangible and amortisation – Some potential options

Accounting for intangibles (continued)

1. Amortise over life of lease 2. Derecognise at lease end 3. Hold and capitalise onto the asset

■ Monthly charge to the P&L if $2.1m will be amortised

over the remaining life of lease of 5 years

− DR P&I Expense US$58,000

− CR: Maintenance intangible asset US$58,000

(Cash paying lease).

■ No P&L effect until end of lease.

In year 5:

− DR P&L Expense US$2.1m

− CR: Maintenance intangible asset US$2.1m

(Upsy/downsy lease, offset against any upsy payment

recorded in income).

■ No P&L charge

■ If determined maintenance check added value,

intangible/portion of intangible may be capitalised.

■ If full maintenance check completed and

determined value equals intangible:

− DR: Aircraft US$2.1m

− CR: Maintenance intangible asset US$2.1m

■ Also need to consider any EOL income / expense

as a separate P&L effect.


Extract from recent 20F’s

“The maintenance rights intangible asset represents the contractual right under our leases acquired as part of the ILFC Transaction to receive the aircraft in a specified maintenance

condition at the end of the lease (EOL contracts) or our right to an aircraft in better maintenance condition due to our obligation to contribute towards the cost of the maintenance

events performed by the lessee either through reimbursement of maintenance deposit rents held (MR contracts), or through a lessor contribution to the lessee.

For MR contracts, maintenance rights expense is recognized when the lessee submits a reimbursement claim and provides the required documentation related to the cost of a

qualifying maintenance event that relates to pre-acquisition usage. For EOL contracts, maintenance rights expense is recognized upon lease termination, to the extent the lease end

cash compensation paid to us is less than the maintenance rights intangible asset. Maintenance rights expense is included in leasing expenses in our Consolidated Income

Statements. To the extent the lease end cash compensation paid to us is more than the maintenance rights intangible asset, revenue is recognized in lease revenue in our

Consolidated Income Statements, upon lease termination.”

AerCap

““The Company now identifies, measures and accounts for maintenance right assets and liabilities associated with its acquisitions of aircraft with in-place leases. A maintenance right

asset represents the fair value of the Company's contractual right under a lease to receive an aircraft in an improved maintenance condition as compared to the maintenance

condition on the acquisition date. A maintenance right liability represents the Company's obligation to pay the lessee for the difference between the lease end contractual

maintenance condition of the aircraft and the actual maintenance condition of the aircraft on the acquisition date.

The Company's aircraft are typically subject to triple-net leases pursuant to which the lessee is responsible for maintenance, which is accomplished through one of two types of

provisions in the Company's leases: (i) end of lease return conditions (EOL Leases) or (ii) periodic maintenance payments (MR Leases).

Maintenance right assets in EOL Leases represent the difference in value between the contractual right to receive an aircraft in an improved maintenance condition as compared to

the maintenance condition on the acquisition date. Maintenance right liabilities exist in EOL Leases if, on the acquisition date, the maintenance condition of the aircraft is greater than

the contractual return condition in the lease and the Company is required to pay the lessee in cash for the improved maintenance condition. Maintenance right assets, net are

recorded as a separate line item on the Company's balance sheet.

When the Company has recorded maintenance right assets with respect to EOL Leases, the following accounting scenarios exist: ….

When the Company has recorded maintenance right liabilities with respect to EOL Leases, the following accounting scenarios exist:…

(i) the aircraft is returned at lease expiry in the contractually specified maintenance condition without any cash payment by the Company to the lessee, the maintenance right liability is

relieved and end of lease income is recognized; (ii) the Company pays the lessee cash compensation at lease expiry of less than the value of the maintenance right liability, the

maintenance right liability is relieved and any difference is recognized as end of lease income; or (iii) the Company pays the lessee cash compensation at lease expiry in excess of the

value of the maintenance right liability, the maintenance right liability is relieved and the excess amount is recorded as an aircraft improvement.”

Fly Leasing


Key valuation considerations

www.ibagroup.comwww.ibagroup.com

It’s complicated

www.ibagroup.com

What do you see?

www.ibagroup.com

Let’s take a closer look at that A320 “Maintenance Value” Element

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Mai

nte

nan

ce V

alu

e U

S$m

Age (years)

A320-200 Maintenance Value - 2016 Constant USD - V2500-A5, 2:1 (W.Europe)

Maintenance Value HL Level

www.ibagroup.com

Let’s take a closer look at that A320 “Maintenance Value” Element

• A swing of 14mUSD from a run out aircraft and engines versus full life

• Circa 7mUSD delta from “half life”

• And that is today - the inflated future cost and value will be a higher delta.

• Maintenance cost inflation has averaged 3-5% per annum in last 10 years

www.ibagroup.com

What do you see?

• A five year old B777-300ER with a CMV in half life condition of 100mUSD?

www.ibagroup.com

What do you see?

AIRCRAFT LEASE AGREEMENTLessor: B777#4 Limited, DublinLessee: Good Credit Airlines, The Republic of Good CreditB777-300ER: Serial Number 12345Registration: FUL-LIFETerm: 12 yearsDelivered: Jan 2011Redelivery: Jan 2023Lease rate: Fixed @ 1.3mUSD pmDelivered Price: 160mUSDMaintenance Reserves: NoneRedelivery Condition: Full life

www.ibagroup.com

What do you see?

AIRCRAFT LEASE AGREEMENTLessor: B777#4 Limited, DublinLessee: Good Credit Airlines, The Republic of Good CreditB777-300ER: Serial Number 12345Registration: FUL-LIFETerm: 12 yearsDelivered: Jan 2011Redelivery: Jan 2023Lease rate: Fixed @ 1.3mUSD pmDelivered Price: 160mUSDMaintenance Reserves: NoneRedelivery Condition: Full life

• Aircraft sold by B777#4 Limited to Newco Leasing in Jan 2016 for 125mUSD

• FMV @ sale - average of appraisers FMV = 105mUSD

• Delta of 20mUSD uses “full life added value” and buyers view on “value of income”

www.ibagroup.com

Illustrative Example…….

Appraisal Variances for CMV:

• The start price

• Depreciation

• Economic life

Then complicated by intangible of

• Value of the full life redelivery condition

• Cost of task versus value impact

• Full life/half life delta

Versus “today’s CMV and Lease rate”

• Then… rationale for the trade, macro economics, IFE trends and reconfigs

• Ticking the box might be a false economy

$

2011 2023

“Value of RC”$20m spread using 2016USD

2011 777 300ER

www.ibagroup.com

What is the source of the value presented to investors?

• An Appraiser website – generic data dump?

• More informed assessment using current maintenance data?

• Detailed assessment considering review of lease?

That’s just one aircraft, throw in 40 planes and:

• X operators

• Y jurisdictions; and

• Z contracts

Then the picture gets exponentially more complex at portfolio level.


Tax considerations

Tax Issues

Legal form v. accounting treatment?

Single asset (metal)

Separate assets

Corporate Tax/Income Tax



Tax Issues

Metal

Capital allowances claimed on

entire purchase price

No tax deduction taken for amortisation of lease intangible or maintenance intangible

Corporate Tax/Income Tax


Tax IssuesCorporate Tax/Income Tax

Separate intangible asset

Capital allowances

restricted to that part of

purchase price

attributable to metal

Is tax deduction available for amortisation of

intangibles / is rental income reduced purchase price attributable to intangibles?

Or does the ease

intangible or

maintenance intangible

represent a capital asset

on which no capital

allowances can be

claimed?


Tax Issues

Capital allowances

claimed on entire

purchase price but

assets (metal, lease

intangible, maintenance

intangible) split

in accounts

Treated as single

asset (aircraft) for

tax purposes

Deferred Tax Implications


Tax Issues

Separate assets for tax purposes

Capital allowances restricted

to purchase price

attributable to metal

Separate deferred tax calculation

for lease intangible

and maintenance intangible

Deductible:

Timing Difference

Not deductible:

Permanent Difference

Deferred Tax Implications


Tax Issues

Capital gain

on sale?

Stamp duties on assignment

/ novation of lease?

Sales taxes / VAT on assignment /

novation of lease?

Transactional Tax Issues


Tax Issues

Purchase contract for aircraft (only)

No purchase price allocation to lease – change in market conditions impacts value of the aircraft

No purchase price allocation to maintenance right –lessee obligation to pay for maintenance relates to capital expenditure

Conclusion

emerging accounting & valuation · pdf filegareth is a partner in the financial services...

Documents