Atlas Copco AB – Annual report – 31 December 2019
SIGNIFICANT ACCOUNTING PRINCIPLES (extract)
Lease – IFRS 16
The Group applies the new standard, IFRS 16, from January 1, 2019. The new standard replaces IAS 17 Leases and IFRIC 4 Determining whether an Arrangement contains a Lease. The Group has performed the transition by using the modified retrospective approach, which does not require restatement of comparative periods. The comparative information continues to be reported in accordance with IAS 17 and IFRIC 4. The accounting principles for the comparative figures are presented below under the heading “Lease – IAS 17 (comparative figures), page 70. 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, had a lease term of 12 months or less are not recognized as leases in the balance sheet. The Group has elected to apply the exemption for leases for which the underlying asset is of low value regarding 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 January 1, 2020. For short-term leases and leases where the underlying asset are of low value, the Group recognized lease payments as an expense on a straight-line basis over the lease term.
Non-lease components such as service components and other variable components that do not depend on an index or price are accounted for as expenses, if they could be separated in the contracts for the leased asset. In most cases service components are variable and based on for example consumption.
For leases of other assets, previously classified as operating leases under IAS 17, the Group recognized right-of-use assets and lease liabilities.
Leases previously classified as finance leases
Leases that were classified as finance leases under IAS 17 were determined at the carrying amount of the right-of-use asset and lease liability at January 1, 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
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. 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 was 2.2% at transition. Incremental borrowing rates are set per country and maturity.
The table below 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 had a small positive impact on operating profit. Interest on lease liabilities had a small negative impact on net financial items.
Since the principal payment is recognized as financing activities, cash flow from financing activities decreased with a corresponding increase in cash flow from operating activities. The interest portion of the lease payment remains as cash flow from operating activities and is included in net financial items paid.
Group as lessee
Recognition of a lease
Upon initiation, contracts are 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 the use of the asset and if the Group has the right to steer 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
On commencement date, the Group measures 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 Group as well as an estimate of costs to be incurred by the Group 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 straightline method.
On commencement date, the lease liability is 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 lease liability 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 rate method.
Short-term leases and leases for which the underlying asset is of low value
The Group has elected to apply recognition exemptions for short-term leases and leases for which the underlying asset is of low value, for example 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 recognized as a sale and a lease receivable, comprising the future minimum lease payments and any residual value guaranteed to the Group. 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.
Lease – IAS 17 (comparative figures)
The Group acts both as lessor and lessee. Leases are classified as either finance leases or operating leases. A finance lease entails the transfer to the lessee of substantially all of the economic risks and benefits associated with ownership. If this is not the case, the lease is accounted for as an operating lease.
Group as lessee
For the Group, a financial lease implies that the fixed asset leased is recognized as an asset in the balance sheet. Initially, a corresponding liability is recorded. Upon initial recognition, the leased asset is measured at an amount equal to the lower of its fair value and the present value of the future minimum lease payments. Fixed assets under finance leases are depreciated over their estimated useful lives, while the lease payments are reported as interest and amortization of the lease liability. For operating leases, the Group does not account for the leased asset in its balance sheet. The costs of operating leases are recorded in the income statement on a straight-line basis over the term of the lease.
Group as lessor
In cases where the Group acts as the lessor under an operating lease, the asset is classified as rental equipment and is subject to the Group’s depreciation policies. The lease payments are included in profit or loss on a straight-line basis over the term of the 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 Group. Lease payments are recognized as interest income and repayment of the lease receivable. See note 22 for more details on leases.
CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS (extract)
The Group has several lease contracts that include extension options. The Group applies judgement in evaluating the lease term, it considers all facts and circumstances that create an economic incentive to exercise an extension option. Extension options are only included in the lease term if the lease is reasonably certain to be extended. For leases of premises, the following factors are normally the most relevant:
• If any leasehold improvements are expected to have a significant remaining value, the Group is typically reasonably certain to extend.
• Otherwise, the Group considers other factors including historical lease durations and the costs and business disruption required to replace the leased asset.
The renewal periods for leases of offices and warehouse premises with extension options exceeding 10 to 15 years are not included as part of the lease term as these are not reasonably certain to be exercised. In addition, renewal options for leases of motor vehicles are not part of the lease term because the Group typically leases motor vehicles for not more than three to five years and, hence, is not exercising any renewal options.
After the commencement date, the Group reassesses the lease term if there is a significant event or change in circumstances that is within its control and affects its ability to exercise the option to renew. Refer to note 22 for information on potential future rental payments relating to extension options that are not included in the lease term.
Key sources of estimation uncertainty:
When the Group cannot readily determine the interest rate implicit in the lease, it uses incremental borrowing rate (IBR) to measure lease liabilities. The IBR is the rate of interest that the Group would have to pay to borrow over similar terms which requires estimations when no observable rates are available. The Group estimates the IBR by using market interest rates and adjusting with entity specific estimates such as currency and country risk.