Leases and IFRS16

[Snoopy]

Hello Snoopy
Why are you adding the lease interest to EBIT? I saw your explanation in the earlier post, but it does not make sense.

To contextualize this discussion, we are talking about the FY2020 results of Chorus and I am trying to decide whether to add lease interest payments to EBIT or not. The post you quote (post 4) is my 'method 2' calculation where I do add the lease interest to EBIT. The post you do not quote is my 'method 1' calculation (post 3) where I do not add the lease interest to EBIT. It sounds like you favour my 'method 1' (post 3) calculation, of my two options.

Although we are talking about EBIT, I am considering how that figure is useful in evaluating banking covenants - in particular EBIT/I.

I believe you are tying yourself in knots when the numbers we need are in the cashflow statement.*

I view the 2 options as being:
1) take the numbers as is,

Under method 1 you would use the published numbers - which I freely admit are "corked" due to the inclusion of lease interest and you lose the ability to compare to prior periods which did not have IFRS16.

OK under method 1, I just used the published figure of EBIT which is $246m (AR2020 p22). The contentious factor in doing this is that what used to be classed as 'rent' has now been moved to a 'finance expense' under 'Other interest expense' header of $27m (AR2020 p27). In the text further down that same page we find that $27m figure includes $21m of 'lease interest' (formerly called rent). I notice that in your own adjusted 'method 2' calculation (quoted further down this page), you have adjusted for this. But you did not adjust for the rest of the 'Other interest expense' (again refer to AR2020 p27) where $5m of 'amortisation arising from the difference between fair value and proceeds received from interest rate swaps' and $1m of 'one off expense in FY2020 for restructuring forward interest rate swaps'. Of course that $5m and $1m are not directly related to IFRS16, which may be why you did not mention them. But in the context of the EBIT/I banking covenant, I considered those one off charges that any bank would look through, which is why I added those back to the EBIT as well (my post 4).

However with the aim of keeping this discussion 'on topic' to IFRS16, I will forgo those other adjustments and go with your figure of $21m

or 2) adjust the numbers back to the old method

Under method 2 we would adjust EBIT down (not up) for the rent payments (ie the total lease payments outflow from the cashflow statement, less GST = $23/1.15 = $20)

I think you made a typo in that GST calculation (now corrected). When I corrected the GST rate from 12% to 15% it worked, giving the $20m figure you quoted.

and adjust EBIT up by the depreciation component of leased assets (i.e. $14),

OK I see that $14m 'right of use asset' depreciation, listed in the Depreciation & Amortisation break down in AR2020 on p26

and would adjust "I" down for the lease elements only (i.e. $21).

"lease interest of $21m" in the text in AR2020 p27, - gotcha

EBIT: $246 - 20 + 14 = $240
I: $173 - $21 = $152
EBIT/I = 240 / 152 = 1.58

OK this is where you and I have rather different adjusted EBIT calculations.

I hadn't considered depreciation before. Because as we were talking about EBIT, I had considered the 'D'epreciation' part of the EBITDA to EBIT calculation already dealt with. But now I see you are correct Ferg, because the 'depreciation of the lease liability' did not exist under the old accounting rules. So to make a comparison with previous years, you have to increase the EBIT by any depreciation that was not present and in fact did not even exist at all under the old accounting rules.

Under the new accounting rules, what were 'rent payments' (an operating cost) have turned into 'lease interest liabilities' (a finance cost). Under the new rules of EBIT, all financing costs are yet to be subtracted before NPAT is calculated. Under the old accounting rules the equivalent of 'lease interest liabilities' (the old 'rent') would have already come out of the EBIT figure. This means in consideration of interest payments only, that to convert the EBIT you see published in the annual accounts under IFRS16, back to the lower EBIT figure we would have seen under the old accounting rules, we have to subtract the 'lease interest liability' from the EBIT figure quoted. So it looks like you are right again Ferg. (note: Typo on your interest calculation corrected).

What slightly puzzles me is why you have chosen to reduce the interest bill by the 'lease interest liability' ($21m), yet reduced the EBIT figure by an interest figure derived from the cashflow statement ($20m). Shouldn't these two numbers be exactly the same?

*Also, any differences between the P&L and cashflow will be due to accrual accounting.

FERG

You refer to the difference between $21m of "lease interest" (AR2020 p27) and the 'net outflow from leases' of $23m in the cashflow statement (AR2020 p38) ?

SNOOPY