IFRS 16 adopted, modified retrospective, policies, judgements, estimates, transition and certain lessor disclosures


AB Volvo (publ) – Annual report – 31 December 2019

Industry: automotive

31 CHANGES IN VOLVO GROUP FINANCIAL REPORTING 2019
Implementation of new accounting standards
As from January 1, 2019 the Volvo Group applies IFRS 16 Leases and IFRIC 23 Uncertainty over Income Tax Treatments.

IFRS 16 Leases
IFRS 16 Leases replaced IAS 17 Leases and the related interpretations IFRIC 4, SIC-15 and SIC-27. The standard represents a new framework for recognizing leases with additional disclosure requirements.

IFRS 16 does not imply any significant changes to lessor accounting. Hence, the main impact of implementing the new standard is related to lessee accounting, as lease contracts are recognized in the balance sheet. The accounting model reflects that the lessee obtains the right to use an asset for a period of time and has an obligation to pay for that right. For the Volvo Group this implies a change in accounting of lease contracts for real estate, company cars and other leased items.

Implementing the new lease accounting for lessees results in increased assets and interest-bearing liabilities in the balance sheet, thereby affecting the net financial position. It also has a positive impact on operating income compared to prior years as a part of the lease expenses is recognized as interest expense within the finance net. In the cash flow statement the lease payments are allocated between interests paid in the operating cash flow and amortization of lease liabilities within the financing activities. Thus, it has a positive effect on the operating cash flow compared to prior years.

IFRS 16 is applied retrospectively but prior period reported financial information has not been restated. Hence, the opening balance for 2019 was adjusted in accordance with the new standard. For leases previously classified as operating leases with the Volvo Group as the lessee, a lease liability was recognized at the present value of future lease payments. A right-of-use asset was recognized at an amount equal to the lease liability; hence no transition effect was presented in equity.

On transition to IFRS 16 there are some exceptions from the lessee accounting model that the Volvo Group applied. Previous assessments of the lease definition remain on contracts entered into before January 1, 2019. At the transition, IFRS 16 was therefore only applied to the contracts that were identified as leases in accordance with IAS 17 and IFRIC 4. The IFRS 16 definition of a lease is applied on contracts entered on January 1, 2019 or after, to assess whether a contract contains a leased asset. If a contract includes a low value asset or has a short remaining lease term, i.e. ends during 2019, or is classified as a service contract, the lease payments are recognized as operating expenses in the income statement and are therefore not included in the lease liability and right-of-use asset. For leases previously classified as finance leases with the Volvo Group as the lessee, a lease liability was recognized at the previous carrying amount of the finance lease liability amounting to SEK 960 M. A right-of-use asset was measured as the previous carrying amount of the finance lease asset amounting to SEK 1,047 M.

The new lessee accounting model resulted in an increase of right-of-use assets by SEK 6,209 M and an increase of lease liabilities by SEK 6,209 M as of January 1, 2019. All right-of-use assets are recognized within tangible assets and all lease liabilities are recognized as current- and non-current within other loans.
Read more in Note 14 Leasing about accounting policy for 2019.

The effect from the transition to IFRS 16 is presented on page 173–174 in the restated balance sheet and net financial position as of January 1, 2019.

IFRIC 23 Uncertainty over income tax treatment
IFRIC 23 is a new interpretation of uncertain income tax treatments within the scope of IAS 12 Income Taxes. An assessment shall be made whether it is probable that the tax authority or court will accept the tax treatment in the income tax return, otherwise, the effect of uncertainty should be estimated and recognized in the financial statements as tax liability.

For the Volvo Group, the implementation of IFRIC 23 implies a changed classification for identified income tax-related risks that were previously recognized as a provision for tax charges that are probable to regulate the obligation. Uncertain income tax treatments are now reported as tax liabilities.

IFRIC 23 is applied retrospectively but prior period reported financial information has not been restated. Hence, the opening balance for 2019 was adjusted in accordance with the new interpretation. Income tax risks previously recognized as current and non-current provisions were reclassified to tax liabilities with an amount of SEK 295 M as of January 1, 2019. Thus IFRIC 23 had no impact on equity.

Read more in Note 10 Income taxes about accounting policy for 2019.

The effect from the transition to IFRIC 23 is presented on page 173 in the restated balance sheet as of January 1, 2019.

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14 LEASING
ACCOUNTING POLICY
Volvo Group as the lessor
Leasing contracts are defined in two categories, operating and finance leases, depending on the contracts’ financial implications.

Operating leases are offered from Financial Services (contractual operating leases) and from Industrial Operations (rental fleet agreements). Sales with residual value commitments (buybacks and tradebacks) are also accounted for as operating lease transactions when the customer has a significant economic incentive to exercise the option to return the vehicle and the control has therefore not been transferred to the customer. Operating lease agreements are recognized as tangible assets in assets under operating leases and are valued at cost less accumulated depreciation and impairment, if needed. The cost of an asset comprises the acquisition value and any initial direct costs related to the contract. Depreciation of the asset is recognized on a straight-line basis over the contract period. During the period the depreciable amount is adjusted through the income statement by depreciations or write-downs to correspond to the estimated realizable value at the end of the contract period. Lease income is equally distributed over the contract period and recognized within net sales.

Read more in Note 7 Revenue, about sales with residual value commitments.

Read more in Note 13 Tangible assets, about residual value risks related to assets under operating lease.

Finance lease contracts are offered from Financial Services. As Industrial Operations manufacture the vehicles which are leased from Financial Services to the customers, the Volvo Group is acting as a manufacturer lessor. Hence, a finance lease asset gives rise to a selling profit which is recognized within Industrial Operations. Finance lease contracts are recognized as non-current and current customer-financing receivables within Financial Services. The asset is measured at an amount equal to the net investment in the finance lease contract corresponding to the gross investment (future minimum lease payments and unguaranteed residual value) discounted with the rate in the finance lease contract and reduced by unearned finance income and allowance for expected credit losses. Assessment of allowance for expected credit losses is reflected in the valuation of customer-financing receivables and recognized at initial recognition and reassessed during the contract period. Lease income is recognized as interest income within net sales in Financial Services. Variable lease payments not dependent on an index or rate are recognized as income as they occur. Payments received from finance lease contracts are distributed between interest income and amortization of the receivable.

Read more in Note 15 Customer-financing receivables, about finance lease contracts.

Volvo Group as the lessee
Lease contracts are recognized as right-of-use (RoU) assets as well as interest-bearing lease liabilities in the balance sheet. Lease liabilities are recognized within other loans and are measured by the present value of future lease payments. The lease payments are discounted by using a rate reflecting what the Volvo Group would have to pay to borrow funds to acquire a similar asset, with similar collateral and similar term. RoU assets are presented as tangible assets and are valued at cost less accumulated depreciation and impairment, if needed. The cost of a RoU asset contains the initial amount of the lease liability adjusted for any lease payments made before the commencement date, less any lease incentives received. Moreover, any initial direct costs are included as well as an estimate of costs to be incurred in dismantling, removing or restoring the underlying asset. The leased asset is depreciated on a straight-line basis over the lease term, or over the useful life of the underlying asset if the ownership is transferred to the Volvo Group at the end of the lease term. The lease expense is recognized as depreciation of the asset within operating income and interest expense within the finance net. Payments made are distributed between interest paid and amortization of the lease liability.

Lease contracts with the Volvo Group as the lessee are primarily contracts of real estate (such as office buildings, warehouses and dealer premises), company cars and production related assets. For real estate and company car leases, service components are normally a considerable portion of the contracts and are therefore separated. Thus, the service components are recognized as operating expenses and not included in the RoU asset and the lease liability. For other lease contracts, both the leased asset and services are included in the RoU asset and the lease liability. If a lease contract includes variable lease payments not dependent on an index or rate, or include a low value asset or has a lease term that is twelve months or less, the lease payments are recognized as operating expenses as they occur.

SOURCE OF ESTIMATION UNCERTAINTY AND CRITICAL JUDGMENTS
Measurement of lease liabilities and right-of-use assets
When entering a lease contract, judgments related to contract scope, lease term and interest rate used when discounting future lease payments are made which affects the measurement of the lease liability and RoU asset.

Assessment of contract scope includes judgments whether a leased asset and/or a service component is identified in the contract. In combined contracts, the total contract amount is allocated between the leased asset and the service by using a market stand-alone price.

When determining the lease term of a contract, judgments are also required. The lease term includes the non-cancellable period. If the Volvo Group is reasonably certain to use an option to extend the lease, or not to use an option to terminate the lease in advance, this is also considered. The contracts contain a range of different conditions. Extension and termination options are mainly related to real estate leases. Thus, all relevant facts and circumstances that create an economic incentive to include optional periods are evaluated. The importance of the underlying asset in the operations and its location, availability of suitable alternatives, significant leasehold improvements, level of rentals in optional periods compared to market rates as well as past practice are examples of factors included in the assessment. Lease terms are negotiated on an individual basis and are reassessed if an option is exercised.

Judgments are also required to determine the interest rate when discounting future lease payments and whether the interest rate implicit in the lease can be readily determined and thereby used, or if the Volvo Group’s incremental borrowing rate should be used.

Volvo Group as the lessor

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During 2019, the selling profit for vehicles subject to finance lease contracts amounted to SEK 3,959 M and was recognized within Industrial Operations.

As of December 31, 2019, future lease income from non-cancellable finance and operating leases (minimum lease fees excluding sales with residual value commitments) amounted to SEK 75,198 M (75,833).

Read more in Note 15 Customer-financing receivables about finance leases.

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Volvo Group as the lessee (extract)
As from January 1, 2019, IFRS 16 Leases was applied retrospectively but prior period reported financial information was not restated. Hence, the opening balance for 2019 was adjusted in accordance with the new standard. Thus, the part of the tables attributable to 2018 is in accordance with the former lease accounting standard IAS 17, valid until December 31, 2018, and the part of the tables attributable to 2019 is in accordance with IFRS 16, valid as from January 1, 2019. As an effect of the implementation of the new accounting standard for leases, RoU assets and interest-bearing lease liabilities increased as lease contracts are recognized in the balance sheet.

Read more in Note 31 Changes in Volvo Group Financial Reporting 2019. The opening balance for 2019 is restated due to the implementation of IFRS 16.

A reconciliation of the future rental payments for operating leases as of December 31, 2018 and interest-bearing lease liabilities as of January 1, 2019 is presented in table 14:3. The Volvo Group used a weighted average incremental borrowing rate of 4.21% when calculating the lease liabilities recognized in the balance sheet at the date of transition.

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13 TANGIBLE ASSETS (extract 1)
ACCOUNTING POLICY
The Volvo Group applies the cost method for measurement of tangible assets, consisting of property, plant, equipment and investment property as well as assets under operating leases.

Buildings includes owner-occupied properties and investment properties. Investment properties are properties owned for the purpose of obtaining rental income and appreciation in value. Investment properties are recognized at cost. For disclosure purposes, information regarding the estimated fair value of investment properties is based on an internal discounted cash flow projection as relevant observable market inputs for the assets are not available. The required return is based on current property market conditions for comparable properties in comparable locations. Hence, the applied valuation method to measure fair value is classified as level 3 of the fair value hierarchy and there have not been any changes in valuation method during the year. Land contains land and land improvements. Machinery and equipment consists of production related assets such as machinery, type-bound tools and other equipment. Construction in progress are assets under construction and advanced payments. Right-of-use assets relates to lease contracts with the Volvo Group as a lessee.

Assets under operating leases are mainly owned by the Volvo Group. These transactions are accounted for as operating lease transactions and consists of contractual operating lease agreements with customers within Financial Services and rental fleet which are assets used in a fleet for rental business within Industrial Operations. Some rental fleet assets are leased by the Volvo Group and later sub-leased to customers as operating leases. Sales with residual value commitments within Industrial Operations are also recognized within assets under operating leases.

Read more in Note 7 Revenue about sales with residual value commitments.
Read more in Note 14 Leasing about right-of-use assets and assets under operating leases.

Depreciation and impairment
Property, plant, equipment and investment property are depreciated over their estimated useful lives. Land is not depreciated. Depreciation is recognized on a straight-line basis based on the cost of the assets, adjusted by residual value when applicable, and estimated useful lives. Right-of-use assets are generally depreciated over the lease term on a straight-line basis. Assets under operating leases are depreciated on a straight-line basis over the contract period. During the contract period, the depreciable amount is adjusted through the income statement to correspond to estimated future net realizable value to continuously reflect potential residual value risks at the end of the contract period. Depreciation is recognized in the respective function to which it belongs. Impairment tests are performed if there are indications of impairment by calculating a recoverable amount which is the higher of the asset’s fair value less cost of disposal and its value in use.

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SOURCE OF ESTIMATION UNCERTAINTY AND CRITICAL JUDGMENTS
Impairment of tangible assets
Impairment tests are performed if there is any indication that a tangible asset has been impaired. The impairment tests are based on estimation of the recoverable amount of the asset, or the cash-generating unit to which the asset belongs. To determine the recoverable amount, projections of future cash flows are used, which are based upon internal business plans and forecasts. While management believes that estimates of future cash flows and other assumptions made are reasonable, there are uncertainties
which could materially affect the valuations.

Residual value risks
Volvo Group is exposed to residual value risks related to assets under operating leases which is the risks that the Volvo Group in the future would have to dispose used vehicles at a loss if the price development of these products is worse than what was expected when the contracts were entered. The assessment of residual value risks is based upon an estimation of the used vehicle’s future net realizable value (fair market value). The estimated future net realizable value of the vehicles at the end of the contract period is monitored individually on a continuing basis. Thus, a decline in prices for used vehicles may negatively affect the Volvo Group’s operating income. High inventories in the truck industry and the construction equipment industry and low demand may have a negative impact on the prices of new and used vehicles. In monitoring estimated net realizable value of each vehicle included as assets under operating leases, management considers current price-level of the used product model. The price level are impacted by value of optional equipment, mileage, current condition, future price deterioration due to expected change of market conditions, alternative distribution channels, inventory lead-time, repair and reconditioning costs, handling costs, indirect costs associated with the sale of used vehicles and legislative demands.

13 TANGIBLE ASSETS (extract 2)

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