IFRS 16, disclosure of potential effect of future adoption, joint operations, lease and non-lease components, oil industry

Statoil ASA – Annual report – 31 December 2017

Industry: oil and gas

2 Significant accounting policies (extract)

Standards, amendments to standards, and interpretations of standards, issued but not yet adopted (extract)

IFRS 16 Leases

IFRS 16, effective from 1 January 2019, covers the recognition of leases and related disclosure in the financial statements, and will replace IAS 17 Leases. The new standard defines a lease as a contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. In the financial statement of lessees, IFRS 16 requires recognition in the balance sheet for each contract that meets its definition of a lease as right-of-use asset and lease liability, while lease payments are to be reflected as interest expense and a reduction of lease liabilities. The right-of-use assets are to be depreciated in accordance with IAS 16 Property, Plant and Equipment over the shorter of each contract’s term and the assets’ useful life. IFRS 16 will also lead to changes in the classification of lease-related payments in the statement of cash flows, and the portion of lease payments representing payments of lease liabilities will be classified as cash flows used in financing activities. The standard consequently implies a significant change in lessees’ accounting for leases currently defined as operating leases under IAS 17 and for other contracts that do not meet this definition but are considered to be leases under IFRS 16, impacting both the balance sheet, the statement of income and the statement of cash flows.

As a practical expedient, IFRS 16 allows for contracts already classified either as leases under IAS 17 or as non-lease service arrangements, to maintain their respective classifications upon the implementation of IFRS 16. Statoil expects to apply this “grandfathering” transition option.

IFRS 16 requires adoption either on a full retrospective basis, or retrospectively with the cumulative effect of initially recognising the standard as an adjustment to retained earnings at the date of initial application (“the modified retrospective method”), and in the latter case allows a number of practical expedients in transitioning existing leases at the time of initial application. Statoil anticipates applying the modified retrospective method in the implementation of IFRS 16.

Implementation of IFRS 16 will affect all Statoil’s segments. Statoil will adopt IFRS 16 on 1 January 2019, and is in the process of evaluating the impact of the standard. The actual impact on the Consolidated financial statements of applying IFRS 16 will depend on future economic conditions, including Statoil’s borrowing rate and the composition of Statoil’s lease portfolio at implementation. IFRS 16 involves several implementation choices and interpretations which may also significantly impact Statoil’s Consolidated financial statements. The accounting issues which at this stage are expected to most significantly affect the implementation of IFRS 16 in Statoil, as well as their expected impact where this can currently be determined, are summarised below. In addition to these issues, Statoil has identified several other leasing related interpretations and policy decisions which are under evaluation. Work is continuing in order to determine the impact and the proper accounting for all identified issues, but the assessments have not yet been concluded. Statoil is consequently not yet in a position to determine the expected impact of IFRS 16 on its Consolidated financial statements.

Distinguishing operators and joint operations as lessees, including sublease considerations;

IFRS 16 establishes that when a lease contract is entered into by a joint arrangement, or on behalf of a joint arrangement, the joint arrangement is considered to be the customer, and hence the lessee, in the contract. In the oil and gas industry, where activity frequently is carried out through joint arrangements or similar arrangements, the application of this IFRS 16 requirement depends on evaluations of whether the joint arrangement or its operator is the lessee in each lease agreement. In many cases where an operator is the sole signatory to a contract to lease an asset to be used in the activities of a specific joint operation, the operator does so implicitly or explicitly on behalf of the joint arrangement. In certain jurisdictions, and importantly for Statoil this includes the NCS, the concessions granted by the authorities establish both a right and an obligation for the operator to enter into necessary agreements in the name of the joint operations (licences). As is the customary norm in upstream activities operated through joint arrangements, the operator will manage the lease, pay the lessor, and subsequently re-bill the partners for their share of the lease costs. In each such instance, it is necessary to determine whether the operator is the sole lessee in the arrangement, and if so, whether the billings to partners may represent sub-leases, or whether it is in fact the joint arrangement which is the lessee, with each participant accounting for its proportionate share of the lease. Depending on facts and circumstances in each case, the conclusions reached may vary between contracts and legal jurisdictions. This issue may materially impact the financial statements of Statoil both as an operator and joint operation participant in the oil and gas industry.

Separation of lease and non-lease components;

IFRS 16 allows for additional services and non-lease components included in lease contracts to be accounted for either separately, or as part of the lease. The standard’s presumption is that non-lease components should be accounted for separately, while accounting for such components as part of a lease is an exemption that must be taken consistently by class of underlying asset. In the case of significant non-lease components in contracts containing leases, the choice of accounting policy may impact the financial statements significantly, as it entails choosing between expensing service elements as a form of operating cost as incurred, or reflecting them as part of right of use assets (with a corresponding increase in the lease liabilities), with related amortisation and financial expenses. Many of Statoil’s lease contracts, such as rig and vessel leases, involve a number of additional services and components, including personnel cost, maintenance, drilling related activities, and other items. For a number of contracts, the additional services may represent a not inconsiderable portion of the total contract value, and such additional services are not always identified and separately priced. The full extent of non-lease components in Statoil’s contracts has yet to be established, and Statoil has not yet determined whether it will account for additional services as parts of the lease, and if so, for which underlying classes of assets.

Leases applied in activities that are capitalised;

In exploration activities, direct costs are capitalised until the result of the exploration has been evaluated. In the development phase of projects, direct costs are likewise capitalised and normally become part of Property, plant and equipment (PP&E). During upstream production activities, asset enhancements such as the drilling of production wells are also capitalised. In all these activities, Statoil will frequently employ leased drilling rigs and other leased assets. Statoil is in the process of evaluating how leases under IFRS 16 will be reflected when leased assets are used in an activity for which the costs are capitalised.

Evaluating the impact of option periods for the lease terms;

The term of a lease determines the period of time for which cash flow will be discounted and reflected in the balance sheet. Under IFRS 16 the lease term therefore impacts the recognised amounts of right of use assets and lease liabilities. Many of Statoil’s major leases, such as leases of vessels, rigs and buildings, include term options. In applying IFRS 16 it is of increasing importance for Statoil to determine whether each lease contract’s term options should be considered to be reasonably certain to be exercised. Such evaluations will be made at commencement of the leases and subsequently when facts and circumstances require it. In Statoil’s view, the term ‘reasonably certain’ implies a probability level significantly higher than ‘probable’, and this will be reflected in Statoil’s ongoing evaluations.

Distinguishing fixed and variable lease payment elements;

Under IFRS 16, fixed and in-substance fixed lease payments are to be included in the commencement date computation of a lease liability, while variable payments dependent on use of the asset are not. Particularly as regards drilling rig leases, Statoil’s lease contracts may include fixed rates for when the asset in question is in operation, and alternative, lower rates (“stand-by rates”) for periods where the asset is idle, but still under contract. Statoil is currently evaluating the appropriate rates to be reflected in the lease liability.

Use of the standard’s short-term lease exemption;

As a practical expedient, IFRS 16 allows an entity not to capitalise short term leases on its balance sheet. The choice must be made by class of underlying asset. The practical expedient provides a simplification, but will also result in less comparability in the Statement of income, as the short-term lease expenses will be presented as a form of operating expenses, while the cost for long-term leases will be presented as interest expenses and depreciation. Statoil has not yet determined whether the exemption will be applied, and if so, for which classes of underlying assets.