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

E: kevbutler@deloitte.ie

John Kelly

Director

Audit & Assurance

T: +353 (0)21 4207867

E: johkelly@deloitte.ie

Oliver Holt

Director

Audit & Assurance

T: +353 (0)1 4175731

E: oliverholt@deloitte.ie

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