School of Aviation Finance Accounting for Leases Ronan Doyle, Partner, PricewaterhouseCoopers
www.pwc.ie/aviationfinance Lea se a ccounting Ronan Doyle Partner – Pw C Dublin
Com pany Law Regim e • Accounts must be prepared each year and approved by the directors • Accounts subject to audit by registered statutory auditor – very limited exemption • Public filing of accounts in most cases • Tiered levels of disclosure/ compliance depending on • GAAP applied • Size • Directors Compliance Statement * • Confirmation to the statutory auditor • Audit Committee * • Disclosure on directors interests, directors emoluments and related parties is extensive * * New in 2014 Companies Act – Not all yet effective Slide 3
Basis of preparation of financial statem ents • All Irish registered companies require a set of financial statements every year • These statements must be approved by the directors • Choice of accounting principals • International Financial Reporting Standards (IFRS) • Irish GAAP FRS 101 – IFRS measurement with limited disclosure FRS 102 – Irish GAAP principals • Certain changes in this regime were effective from 1 January 2015 Slide 4
Lease Accounting today • Existing standards are SSAP21 and IAS 17 (as well as ASC840 under US GAAP) • Differentiation between an operating and a finance lease • Operating lease accounted for as an annual income/ expense on a straight line basis • No asset or liability on the balance sheet • Finance lease accounted for a financing with an interest charge and depreciation • Both asset and liability to pay for asset on the balance sheet • Tests commonly used to differentiate between the two • Other guidance to cover sale and leasebacks, bargain purchase options, rent free periods, extensions to leases etc Slide 5
IFRS 16 – Lease Accounting – The end of the w orld as w e know it? • Traditionally, much of the world’s leased assets were “off balance sheet” for their operators Reporting rule adds $3tn of – Hides leverage leases to balance sheets – Undisclosed commitments globally. – Lack of comparability within industry A new financial reporting standard — the culmination of decades of debate over “off- • New rules will end this treatment – bringing all leases back on balance sheet” financing — will affect more b a la nce sheet of lessees than one in two public companies globally. • Rents will be replaced by interest costs and depreciation (as if asset FT – 13 January 2016 were owned) The distinction between operating leases and finance • International accounting rules final and effective 1 January 2019 (but leases that is required by present standards is can adopt earlier) arbitrary and unsatisfactory. The comparability (and hence usefulness) of financial statements would be enhanced if the present treatment of operating leases • US GAAP rules not yet finalized – likely before end of Q1 2016 and finance leases were replaced by an approach that applied the same requirements to all leases. • No impact on Irish GAAP… … … YET Accounting for leases – a new approach (1996) Slide 6
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 7
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 Impact on Profit and Leverage - (200) (400) (600) (800) (1,000) Profit Impact (1,200) Leverage Impact (1,400) (1,600) (1,800) (2,000) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 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 8
Practical Im plications Cha ng es from current May also im pact future Many KPIs are redefined: transactions: - Current ratio off b a la nce sheet - (re) financing or raising capital - Asset Turnover a ccounting to fund growth - Interest cover - Net income - Acquisitions and Mergers - Sale and leaseback - ROCE Balance Sheet - Lease versus buy decisions - ROE Assets - Operating cash flows Liabilities Incom e statem ent Lease expense Depreciation Interest expense Im pacting various Need to m anage arrangem ents: stakeholders: EBIT - Financing arrangements and - Banks/ lenders EBITDA covenants - Investors/ analysts - Supply arrangements - Rating agencies EBITDAR - Remuneration and employee - Suppliers schemes - Management/ staff EPS - Tax arrangements - Tax authorities Cash flow statem ent - Hedging arrangements - Oversight bodies Cash from ops Cash from finance Slide 9
The potential im pact of IFRS 16 – field testing the requirem ents Slide 10
The Balance Sheet – Other Matters • Aircraft assets should be booked at their initial costs – Recognise premium/ discount on lease if purchased with the aircraft – Capitalisation of directly attributable costs only – Spilt out of acquired maintenance reserves • SEC view on the use of business combination accounting – Often requires the booking of a maintenance asset – Could result in goodwill • Impairment Testing – Choice of Assumptions (discount, downtime, release rate, transition costs) – Third Party Appraisers • Useful Lives • Residual Value Guarantees Slide 11
The Incom e Statem ent - Other Matters • Accounting for maintenance/ supplemental rents – Considerable variation in treatment – Typically recognised as a % of the supplemental rent received or on termination of the lease – IFRS 15 (Revenue) likely to restrict the options • Financial Instruments – Typically limited use of hedging – derivatives should be at fair value – More instruments at fair value (care with Profit Participating Notes) – Level Yield/ Effective Interest Rate accounting for interest expense Slide 12
IFRS vs US GAAP • Currently, Irish GAAP/ IFRS and US GAAP are broadly aligned. Finance vs operating lease Depreciation on a straight line basis Interest on debt on an accruals basis • There are some differences Purchases of aircraft with leases attached Accounting for maintenance Impairment (Discounted vs Undiscounted ) Slide 13
Q&A Slide 14
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
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