Leases and IFRS16

[Snoopy]

Spark went to the trouble of rewriting their FY2018 and FY2017 results to show the impact of IFRS16 (and also IFRS15 on realigning income and expenses to the appropriate time period) on their income statements of those two years.

https://investors.sparknz.co.nz/Down...204/291769.pdf

It is useful to have a fully worked actual example of the implementation of the IFRS16 rules such as this.

Time for a bit more detail from the above referenced document. I will rewrite page 5 of that document in a non-Spark specific way.

1/ IFRS16 replaces 'NZIAS17 Leases' and removes the distinction between operating and finance leases. Similar to the current finance lease model, this results in the recognition of 'right of use' assets and related lease liability balances.
2/ As a result, rental payments for leases previously recorded in relation to operating leases - including corporate property leases, and customer equipment leases will move from being included in operating expenses (within EBITDA) to depreciation and and finance expenses outside of EBITDA.
3/ The impact on net earnings before income tax from an individual lease over its term is unchanged.
4/ However, the new standard results in a higher interest expense in early years and lower interest expense in the later years of a lease , compared to the previous straight line expenses profile of operating leases, similar to a 'table mortgage'.

What is a table mortgage?

From the NZ Finance Act of 1933
"the term table mortgage means a mortgage in which provision is made for the payment of interest and the repayment of principal by periodical installments, consisting partly of principal and partly of interest."

Impact on Reported Financials

1/ This results in the combined depreciation and interest expense, for any lease in the early years of its cycle, being higher than the operating expenses previously recognised. With long term corporate property leases, being in the early years of their lease period, both net earnings before tax and retained earnings subsequently decrease following application of IFRS16.
2/ There is a change in the treatment of leases where the reporting company acts as the intermediate party e.g. in a back-to back lease.

What is a back-to-back lease?

https://www.bdo.com.au/en-au/account...k-arrangements

The seller receives a lump sum financing amount from the buyer on entering into the sale and leaseback transaction, and the seller (who is now the lessee), makes periodic payments to the buyer (who is now the lessor). Nevertheless the asset being sold and leased back, remains on the original sellers premises at all times.

In order to determine the appropriate accounting treatment under IFRS 16, the sale must first be assessed to determine whether it qualifies as a sale in accordance with the requirements of IFRS 15 (Revenue from Contracts with Customers). For the transaction to qualify as a sale the selling company must:

1/ Completely derecognise the asset in the books (remove from the accounts all traces of ownership) and apply lessee accounting requirements (set up a 'right of use asset' on the asset side of the balance sheet offset with a 'lease liability' on the debt side of the balance sheet).
2/ Measure the right-of-use asset as the retained portion of the previous carrying value. Then recognise a gain/loss on the rights transferred to the lessor.

IFRS 16 requires that any profit or loss on the sale side of the transaction from the seller-lessee’s perspective (and initial measurement of the asset purchased from the buyer-lessor’s perspective) to be determined by reference to the fair value of the asset, not the stated contractual sale price. Seller-lessees therefore need to determine the fair value of the asset in order to ensure they recognise the correct profit or loss on sale.

If it is determined that the fair value of the asset is less than, or greater than, the contractual sales price, the difference is accounted for by the lessee as an additional borrowing or a prepayment, respectively.

SNOOPY