Ferguson plc – Annual report – 31 July 2020
1 – Accounting policies (extract)
Accounting developments and changes (extract)
On August 1, 2019, the Group adopted IFRS 16 “Leases”. The standard makes changes to the treatment of leases in the financial statements, requiring the use of a single model to recognize a lease liability and a right of use asset for all leases, including those classified as operating under IAS 17 “Leases”, unless the underlying asset has a low value or the lease term is 12 months or less. Rental charges in the income statement previously recorded under IAS 17 are replaced with depreciation and interest charges under IFRS 16 and right of use assets are subject to impairment reviews in accordance with IAS 36 “Impairment of Assets” replacing the previous requirement to recognize a provision for onerous lease contracts.
The Group has applied the modified retrospective transition method and has not restated comparatives for the year ended July 31, 2019. For the majority of leases, the right of use asset on transition has been measured as if IFRS 16 had been applied since the commencement of the lease, discounted using the Group’s incremental borrowing rate as at August 1, 2019, with the difference between the right of use asset and the lease liability taken to retained earnings. For the remaining leases which relate to the Group’s US fleet, where sufficient historic information has not been available, the right of use asset has been measured as equal to the lease liability on transition. The US fleet represented $252 million of the lease liability on transition.
The Group has elected to apply the following practical expedients on transition:
- To not reassess whether contracts are, or contain, a lease at the date of initial application;
- Application of a single discount rate to a portfolio of leases with reasonably similar characteristics;
- Reliance on previous assessment of whether leases are onerous in accordance with IAS 37 “Provisions, Contingent Liabilities and Contingent Assets” immediately before the date of initial application as an alternative to performing an impairment review;
- Election to not apply the measurement requirements of the standard to leases where the term ends within 12 months of the date of initial application;
- Exclusion of initial direct costs from the measurement of the right of use asset at the date of initial application; and
- Use of hindsight, such as in determining the lease term.
The impact of the adoption of IFRS 16 on the income statement in the year ended July 31, 2020 was to decrease rental costs by $337 million, increase depreciation by $268 million and increase finance costs by $53 million. The impact on the cash flow statement was to increase cash generated from operations by $348 million, increase interest paid by $53 million and increase lease liability capital payments by $295 million. There was no impact on the net increase in cash, cash equivalents and bank overdrafts. The impact of the adoption of IFRS 16 on the opening balance sheet at August 1, 2019 was as follows:
A reconciliation of the operating lease commitments previously reported under IAS 17 in the Group’s Annual Report and Accounts for the year ended July 31, 2019 to the lease liability at August 1, 2019 under IFRS 16 is as follows:
1. The weighted average incremental borrowing rate applied by the Group upon transition was 3.5 per cent.
Critical accounting judgments (extract)
Property leases entered into by the Group typically include extension and termination options to provide operational flexibility to the Group. Management applied significant judgment in determining whether these options were reasonably certain to be exercised when determining the lease term on adoption of IFRS 16. In making this judgment management considered the remaining lease term, future business plans and other relevant economic factors. Specifically in respect to property leases, which represent the majority of the lease liability, a renewal option was determined to be reasonably certain to be exercised when a lease expired within the Group’s three year strategic planning horizon.
Leases (applicable for the year ended July 31, 2020)
The Group enters into leases in the normal course of its business; these principally relate to property for the Group’s branches, distribution centers and offices which have varying terms including extension and termination options and periodic rent reviews. The Group recognizes a right of use asset and a lease liability at the lease commencement date. Non-lease components of a contract are not separated from lease components and instead are accounted for as a single lease component.
Lease liabilities are initially measured at the present value of lease payments using the interest rate implicit in the lease, or if this is not readily available, at the Group’s incremental borrowing rate. Lease payments comprise fixed payments, variable payments that depend on an index or rate, payments expected under residual value guarantees and payments under purchase and termination options which are reasonably certain to be exercised. Lease terms are initially determined as the non-cancellable period of a lease adjusted for options to extend or terminate a lease that are reasonably certain to be exercised and management judgment is required in making this determination.
Lease liabilities are subsequently measured at amortized cost using the effective interest method. Lease liabilities are remeasured when there is a change in future lease payments as a result of a rent review or a change in an index or rate, or if there is a significant event which changes the assessment of whether it is reasonably certain that extension or termination options will be exercised.
Right of use assets are carried at cost less accumulated depreciation and impairment losses and any subsequent remeasurement of the lease liability. Initial cost comprises the lease liability adjusted for lease payments at or before the commencement date, lease incentives received, initial direct costs and an estimate of restoration costs. Right of use assets are depreciated on a straight-line basis to the earlier of the end of the useful life of the asset or the end of the lease term and tested for impairment if an indicator exists.
Leases that have a term of 12 months or less and leases for which the underlying asset is of low value are recognized as an expense on a straight-line basis over the lease term.
Operating leases (applicable for the year ended July 31, 2019)
Leases where the lessor retains substantially all the risks and rewards of ownership are classified as operating leases. The cost of operating leases (net of any incentives received from the lessor) is charged to the income statement on a straight-line basis over the period of the leases.
13 – Leases
Movement in right of use assets for the year ended July 31, 2020 were as follows:
The Group’s land and building leases include leases for branches, distribution centers and offices. Leases in the USA and Canada often include one or more options to extend the lease term and some of the Group’s leases include options to terminate early. Certain leases include variable lease payments that are linked to a consumer price index or market rate. The Group’s land and building leases have a weighted average remaining lease term at July 31, 2020 of 5.9 years.
The Group’s plant and machinery leases include leases for fleet vehicles, trucks and company cars. These leases have a weighted average remaining lease term at July 31, 2020 of 4.5 years.
The maturity of lease liabilities at July 31, 2020 was as follows:
At July 31, 2020 the Group was committed to future undiscounted lease payments of $nil relating to short-term leases.
Amounts charged/(credited) to the Group income statement during the year were as follows:
Operating lease commitments under IAS 17
Future minimum lease payments under non-cancelable leases for the year ended July 31, 2019 were as follows:
6 – Net finance costs
27 – Reconciliation of opening to closing net debt
1. Liabilities from financing activities.
2. Total cash outflow in relation to leases including short-term leases, leases of low value assets and sublease income in the year ended July 31, 2020, was $377 million.