Atlas Copco AB – Annual report – 31 December 2018
1. Significant accounting principles, critical accounting estimates and judgments (extract)
New or amended accounting standards effective after 2018 (extract)
IFRS 16 Leases
IFRS 16 Leases is effective from January 1, 2019 and replaces IAS 17 Leases and IFRIC 4 Determining whether an Arrangement contains a Lease. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract. The changes relate mainly to the accounting treatment of the lessee. IFRS 16 introduces a single accounting model for leases and requires the recognition of substantially all leases in the balance sheet and the separation of depreciation of right-of-use assets from interest of lease liabilities in the income statement.
Atlas Copco has chosen to perform the transition by use of the modified retrospective approach, which does not require restatement of comparative periods. The comparative information continues to be reported in accordance with IAS 17 Leases and IFRIC 4 Determining whether an Arrangement contains a lease. Lease liabilities are measured at the present value of the remaining lease payments discounted using the Group´s incremental borrowing rate at 1 January, 2019. Details of the changes in accounting policies are presented below.
Atlas Copco’s lease portfolio consists mainly of leased buildings such as office and warehouse premises, vehicles and production equipment.
Group as a lessee
As a lessee, the Group has elected to apply a number of practical expedients. Recognition exemptions are set per asset category for short-term leases and leases for which the underlying asset is of low value. Leases that, at the commencement date, have a lease term of 12 months or less will not be recognized as leases on the balance sheet. The Group has elected to apply the exemption for low-value leases of office equipment such as printers and computers.
All finance leases are excluded at transition as well as leases where the lease term ends prior to 1 January, 2020. For short-term leases and leases where the underlying asset are of low value, the Group recognizes lease payments as an expense on a straight-line basis over the lease term.
Variable non-lease components such as service components and other variable components are to be accounted for as an expense, if they can be separated in the contracts for the leased asset. In most cases service components are variable and based on consumption for example.
For leases of other assets, previously classified as operating leases under IAS 17, the Group recognizes right-of-use assets and lease liabilities.
Leases previously classified as finance leases
Leases that were classified as finance leases under IAS 17 are determined at the carrying amount of the right-of-use asset and lease liability at 1 January, 2019.
Group as a lessor
Lessor accounting is substantially unchanged from the accounting under IAS 17, except for sub-lease contracts. Under IFRS 16, sub-lease contracts that were previously classified as an operating lease is required to be assessed with reference to the right-of-use asset instead of the underlying asset.
Impacts on financial statements
During 2018, the Group performed a detailed assessment on the impact of the adoption of IFRS 16. The impact is expected to be as follows:
At transition to IFRS 16, the Group recognized an additional 3 259 MSEK of right-of-use assets and 3 284 MSEK of lease liabilities. On initial analysis the difference between right-of-use assets and lease liabilities refers to prepaid or accrued lease payments and financial lease receivables on agreements from subleasing.
The Group discounted lease payments using its incremental borrowing rate at January 1, 2019, the weighted-average rate for the Group is 2.2% at transition. Incremental borrowing rates are set per country and maturity.
The below table presents the difference between operating lease commitments under IAS 17 at December 31, 2018 and the initial application for lease liabilities under IFRS 16 discounted using the incremental borrowing rate at January 1, 2019:
Recognizing depreciation of right of use assets instead of minimum lease payments is estimated to have a small positive impact on operating profit. Interest on lease liabilities is estimated to have a small negative impact on net financial items.
Since the principal payment will be recognized as financing activities, cash flow from financing activities will decrease with a corresponding increase in cash flow from operating activities. The interest portion of the lease payment will remain as cash flow from operating activities and be included in net financial items paid.
New accounting principles from January 1, 2019 (extract)
The following new accounting principles will be applied by the Group from January 2019.
IFRS 16 Leases
Group as lessee
Recognition of a lease
Upon initiation, contracts will be assessed by the Group, to determine whether a contract is, or contains a lease. If the contract conveys the right to control the use of an identified asset for a certain period of time in exchange for consideration, then it is or contains a lease. The right to control the use of an identifiable asset is assessed by the Group based upon if there is an identifiable asset, if the Group has the right to obtain substantially all economic benefits from use of the asset and if the Group has the right to direct the use of the asset. The policy is applied to contracts entered into, or changed, on or after January 1, 2019. The Group has elected to separate the non-lease components and also elected to apply a number of practical expedients with regard to short-term leases and leases for which the underlying asset is of low value. In cases where the Group acts as an intermediate lessor, it accounts for its interests in the head-lease and the sub-lease separately.
Measurement of a right-of-use asset and lease liability
Right of use asset
On commencement date, the Group will measure the right-of-use asset at cost, which includes the following: the initial amount of the lease liability adjusted for any lease payments made at or before the commencement date, less any lease incentives received and any initial direct costs incurred by the lessee as well as an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the lease contract. Cost for dismantling, removing or restoring the site on which it is located and/or the underlying asset is only recognized when the Group incurs an obligation to do so.
The right-of-use asset is depreciated over the lease term, using the straight-line method.
On commencement date, the lease liability is initially measured at the present value of the unpaid lease payments, discounted using the interest rate implicit in the lease, or if the rate cannot be readily determined, the Group’s incremental borrowing rate. Lease payments included in the measurement comprise of fixed payments, variable lease payments that depend on an index or a rate, amounts to be paid under a residual value guarantee and lease payments in an optional renewal period if the Group is reasonably certain to exercise an extension option as well as penalties for early termination of a lease, if the Group is reasonably certain to terminate early. If there is a purchase option present, this will be included if the Group is reasonably certain to exercise the option.
The lease liability is measured at amortized cost by using the effective interest method.
Short-term leases and leases of low value asset
The Group has elected to apply recognition exemptions for short-term leases and leases of low value-asset. The Group has elected to apply the exemption for low value leases of office equipment such as printers and computers. Lease payments associated with those leases are recognized as an expense on a straight-line basis over the lease term.
Group as a lessor
At inception of a lease contract, the Group assess whether the lease is a finance lease or an operating lease. If the lease transfers substantially all of the risks and rewards incidental to ownership of the asset, it is considered to be a finance lease; if not, it is an operating lease. Under finance leases where the Group acts as lessor, the transaction is recorded as a sale and a lease receivable, comprising the future minimum lease payments and any residual value guaranteed to the lessor, is recorded. Lease payments are recognized as repayment of the lease receivable and interest income. In cases where the Group acts as a lessor under an operating lease, the lease payments are included in profit or loss on a straight-line basis over the term of the lease.
In cases where the Group acts as an intermediate lessor, it accounts for its interests in the head-lease and the sub-lease separately. The Group assesses the lease classification of a sub-lease with reference to the right-of-use asset arising from the head-lease.