Aker Solutions ASA – Annual report – 31 December 2018
Industry: construction, engineering
Note 32 New IFRS 16 Leasing Standard (2019)
The new IFRS 16 Leasing standard is effective from January 1, 2019. The standard will significantly change how the company accounts for its lease contracts for land, buildings and vehicles currently accounted for as operating leases. An on-balance sheet model similar to the current financial leases accounting will be applied to all contracts that contain a lease. This note summarizes the expected impact on the financial reporting of Aker Solutions from implementing the new standard. The new leasing standard will not impact debt covenants according to the company’s existing loan agreements.
The Lease Contracts
The company has a number of leases for office buildings and sites for manufacturing and service that account for the significant part of the lease liability. The company also leases machines and vehicles. A lease liability and right-of-use (ROU) asset will be presented for these contracts which previously were reported as operating leases. Sub-leases covering the major part of the period in the head-lease are classified as financial. According to the company’s loan agreements existing per December 31, 2018, the new lease accounting will not impact the debt covenants.
Recognition and Measurement Approach on Transition
The company has elected to use the recognition exemptions in the standard for short-term leases and leases of low value items such as computers and office equipment. The company will also apply the recognition exemption for leases that expire in 2019. The company will adjust the right-of-use asset on January 1, 2019 by the provision for onerous leases on December 31, 2018. The company has elected to exclude the initial direct costs from the measurement of right-of-use asset on implementation. The right-of-use asset for selected leases has been measured as if IFRS 16 had always been applied (using the incremental borrowing rate per January 1, 2019).
The discount rate has been determined for each asset according to the incremental borrowing rate at the date of implementation (January 1, 2019). The weighted-average rate applied on January 1, 2019 was 4.4 percent. The non-cancellable lease period is basis for the lease commitment. Periods covered by extension or termination options are included when it is reasonably certain that the lease period will be extended. Non-lease components such as electricity, insurance and other property-related expenses paid to the landlord are excluded from the lease commitment for offices and manufacturing sites, but included when renting apartments and vehicles if included in the agreed lease amount. An assessment is made for all sub-leases to determine if they are financial or operational.
IFRS 16 Leases replaces existing leases guidance, including IAS 17 Leases and IFRIC 4, SIC-15 and SIC 27. The company will use a modified retrospective implementation approach with cumulative effect recognized as an adjustment to the opening balance of retained earnings on January 1, 2019. Comparative figures will not be restated.
Impact on Equity
The net effect on equity as of January 1, 2019 is presented below.
Reconciliation of Lease Commitment and Lease Liability
A reconciliation between the lease commitment as reported under current IAS 17 and the expected lease liability when implementing IFRS 16 is presented below.
On transition to IFRS 16, the company will recognize a ROU asset of NOK 4,990 million related to its lease contracts. Recognizing a lease receivable for operating sub-leases becoming finance leases under IFRS 16, reclassifying onerous lease provision and some other adjustments will reduce the ROU asset to NOK 3,953 million upon implementation.
Expected Future Impact on the Income and Cashflow Statement
IFRS 16 Leasing will have a significant impact on the income statement when implemented in 2019. The estimated reduction of annual lease expense (and lease revenue for sub-leases) gives an improvement of EBITDA in the range of NOK 600-800 million. Annual depreciation expense of leased assets will increase in the range of NOK 500-700 million. Annual net interest expense will increase in the range of NOK 150-300 million. In the cashflow statement, operating cash flows will increase and financing cash flows will decrease as the lease payments will be classified as financial rather than operational. It is expected that IFRS 16 will be implemented in the reporting from the operating segments. The actual impact upon implementation may change as a result of changed interest rates, signing of new lease contracts, re-assessment of renewal options and re-assessment of onerous leases. The impact may also change if new information and guidance becomes known before the group presents its first consolidated financial statements using the new standard.
See note 19 for more information about operating lease commitments under current IAS 17