IFRS 16 adoption, policies, judgements and estimates, lessee and lessor disclosures

Brewin Dolphin Holdings PLC – Annual report – 30 September 2020

Industry: financial services

2. Application of new and revised International Financial Reporting Standards (‘IFRSs’) and changes in accounting policies

a. New standards, amendments and interpretations adopted

IFRS 16 ‘Leases’, a new standard, has been applied for the first time, it replaces IAS 17.

The Group adopted IFRS 16 Leases with effect from 1 October 2019 and elected to apply the standard retrospectively under the modified retrospective approach with the cumulative effect of initial application being recognised at 1 October 2019; comparative information has therefore not been restated.

Further information and changes to significant accounting policies as a result of the application of the standard for the first time are described below in note 2b.

b. Changes in accounting policies

There have been no changes to accounting policies in the year except for the changes described below:

IFRS 16 Leases

IFRS 16 represents a significant change in the principles for the recognition, measurement, presentation and disclosure of leases. IFRS 16 requires lessees to account for most leases under a single lessee accounting model.

Under the single lessee accounting model, a right of use (‘ROU’) asset and corresponding lease liability is recognised which represents future lease payables with movements through the Income Statement. The movements through the Income Statement are for depreciation, additions or releases on the liability and unwinding of the discount for all leases unless the underlying asset has a low value, or the remaining lease term is less than twelve months at the date of transition.

Lessor accounting under IFRS 16 is substantially unchanged from IAS 17. Lessors continue to classify leases as either operating or finance leases using similar principles as in IAS 17.

Transition

The Group has applied the modified retrospective approach with the cumulative effect of initial application being recognised at the transition date; comparative information has therefore not been restated and continues to be reported under IAS 17.

The Group has used the following practical expedients when applying the modified retrospective approach to leases previously classified as operating leases under IAS 17. The Group has:

  • elected to use the transition practical expedient allowing an entity not to reassess whether a contract is, or contains, a lease at the date of initial application of the standard;
  • relied on its assessment of whether leases are onerous immediately before the date of initial application by adjusting the ROU asset at 1 October 2019 by the amount of provision for onerous lease rental payments previously recognised under IAS 17 as at 30 September 2019, as an alternative to performing an impairment review;
  • elected not to recognise the ROU assets and lease liabilities for leases where the lease term ends within 12 months of the date of initial application;
  • excluded initial direct costs from the measurement of the right of use asset at the date of initial application;
  • used hindsight when determining the lease term where the contract contains options to extend or terminate the lease; and
  • applied a single discount rate to a portfolio of leases with reasonably similar characteristics.

The Group has chosen not to apply the practical expedient to account for any associated non-lease components of a lease as a single arrangement.

Impact

The details of the significant changes are set out below. The Group is primarily a lessee and is also a sub-lessor for a small number of property leases that have been identified as onerous.

The adoption of IFRS 16 has had a material impact on the Group’s Consolidated Balance Sheet, in which the Group recognised right of use assets of £43.3m, lease liabilities of £57.8m, finance lease receivables of £1.3m, and a negative impact on the Group’s equity of £5.8m net of deferred tax assets, onerous provisions and trade payables and receivables adjustments at 1 October 2019 on transition.

Details of the quantitative impact of IFRS 16 are provided in note 37.

Classification and measurement as a lessee

Right of use assets

The right of use assets recognised on adoption have been calculated as if the standard applied at the commencement of each lease and are discounted using the borrowing rate at the date of initial application.

The depreciation charge is recognised in the Income Statement.

The ROU assets are assessed for impairment annually in accordance with IAS 36 (incorporating any onerous lease assessments) and depreciated on a straight-line basis over the shorter of the expected life of the asset and the lease term, adjusted for any remeasurements of the lease liability.

Lease liabilities

Leases previously classified as operating leases under IAS 17 have been measured at the present value of the remaining lease payments on adoption and discounted using an incremental borrowing rate at the lease commencement date as the interest rate implicit in the lease is not readily determinable.

After the commencement date, the lease liability recognised will reduce over time by the lease payments which will be offset by the unwinding of the liability over the lease term and any amendments for the impact of any lease modifications. Interest recognised on the lease liability is included in finance costs in the Income Statement.

Short-term leases and lease of low value assets

The Group has adopted certain optional recognition exemptions available under IFRS 16 for short-term (less than 12 months) and low value (< £5,000) leases. These leases continue to be off balance sheet with rentals charged to the Income Statement on a straight-line basis over the lease term and are classified as operating leases.

Classification and measurement as a lessor

Subleases

The Group has identified certain property leases as onerous where there is surplus office space and in these instances the Group acts as an intermediate lessor. The Group classifies its subleases as operating or finance leases by reference to the right of use asset arising from the head lease (rather than by reference to the underlying asset) or if the head lease belonging to the Group is a short-term lease, the subleases are classified as operating leases.

The Group has reclassified some of its subleases previously recognised as operating leases under IAS 17 as finance leases under IFRS 16.

Finance lease receivable

A finance lease receivable has been recognised on adoption and represents the net investment in the finance sublease.

The lease payments included in the measurement of the net investment in the finance lease comprise the present value of fixed payments (including in-substance fixed payments), less any lease incentives payable for the right to use the underlying asset during the lease term that are not received at the lease commencement date.

Any difference between the right of use asset and the net investment in the sublease is recognised in the Income Statement.

The lease liabilities relating to the head leases have been retained on the Balance Sheet and represent the lease payments payable to the head lessor.

Operating subleases

For subleases which are classified as an operating lease, the Group has recognised both the lease liability and the right of use asset relating to the head lease.

Lease income from the operating sublease is recognised in the Income Statement as other operating income.

37. Impact of application of IFRS 16 Leases

Group

The Group adopted IFRS 16 from 1 October 2019. In accordance with the transition requirements of IFRS 16, comparative information for 2019 has not been restated.

The adoption of IFRS 16 has resulted in a significant increase in the Group’s reported assets and liabilities on its Consolidated Balance Sheet. The depreciation (of the ROU asset) and interest charges (unwind of the discounted lease liability) have replaced the lease costs charged to other operating costs in the Income Statement on a straight-line basis under the previous standard (IAS 17).

The application of IFRS 16 has had no impact on the consolidated cash flows of the Group except that lease payments and associated interest payments are shown within financing activities rather than net cash flows from operating activities and include interest received and cash payments from lessees. There has been no impact on the basic and diluted earnings per share for the Group.

Impact on the Consolidated Balance Sheet as at 1 October 2019

The table below shows the amount of adjustment for each financial statement line item affected by the initial application of IFRS 16.

ROU assets

These assets (see note 15) represent the Group’s contractual right to access an identified asset under the terms of the lease contract.

Finance lease receivables

Amounts due from lessees under finance leases are recognised as finance lease receivables (see note 16) and represent the Group’s net investment in the finance sublease.

Lease liabilities

The liabilities represent the Group’s contractual obligation to minimum lease payments during the lease term. Any liability payable in the next 12 months is recognised in current liabilities and all other liabilities are recognised in non-current liabilities.

To measure the lease liabilities, the remaining lease payments were discounted using a weighted average incremental borrowing rate of 3.9%. See note 4b(iv) for an explanation of the determination of the incremental borrowing rate.

The table below reconciles the operating lease commitments as at 30 September 2019 disclosed in note 32 and the lease liability recognised at the date of initial application of IFRS 16.

Deferred tax

A deferred tax asset has been recognised and represents the temporary corporation taxation timing difference on the transition adjustment taken to reserves.

Trade and other payables/trade and other receivables and provisions

The adjustments to these balances are in relation to lease incentives, onerous property provisions, dilapidation provisions and certain lease incentives which were recognised on the Consolidated Balance Sheet under IAS 17. These items are now reflected in either the ROU assets or lease liabilities.

Retained earnings

The impact on opening retained reserves on the initial application of IFRS 16 was to reduce reserves by £5,813,000.

Impact on the Consolidated Income Statement for the year ended 30 September 2020

The Group recognised lease liability finance costs of £2,327,000 for the year; depreciation expense of £6,250,000 for the ROU assets (see note 15); and rental income of £572,000 from operating subleases (shown in note 5 within other operating income).

For the year ended 30 September 2019, the Group recognised rental costs of £8,041,000 in accordance with IAS 17.

3. Significant accounting policies (extract)

k. Leases

The Group has applied IFRS 16 as described in note 2b and comparative information has not been restated. The details of accounting policies under both IAS 17 and IFRS 16 are presented separately below.

The Group is primarily a lessee of property and is also a sub-lessor for a small number of property leases.

Policies applicable from 1 October 2019

(a) The Group as a lessee

For any new contracts entered into on or after 1 October 2019, the Group considers whether a contract is, or contains a lease by assessing whether the contract meets three key criteria which are:

  • the contract contains an identified asset, which is either explicitly identified in the contract or implicitly specified by being identified at the time the asset is made available to the Group;
  • the Group has the right to obtain substantially all of the economic benefits from use of the identified asset throughout the period of use, considering its rights within the defined scope of the contract; and
  • the Group has the right to direct the use of the identified asset throughout the period of use.

Right of use assets (‘ROU’)

The Group recognises right of use assets at the commencement date of the lease (i.e. the date the underlying asset is available for use). Right of use assets are measured at cost, less any accumulated depreciation and impairment losses, and adjusted for any remeasurement of lease liabilities. The cost of the right of use assets includes the initial amounts of the corresponding lease liabilities recognised, initial direct costs incurred, and lease payments made at or before the commencement date less any lease incentives received.

An estimate of any costs to return the leasehold asset to the condition required by the contract is included in the related ROU asset and a corresponding provision is recognised.

The depreciation charge is recognised in the Income Statement and is calculated over the shorter of the ROU’s useful life and the lease term on a straight-line basis from the commencement date of the lease.

The ROU assets are assessed for impairment annually (incorporating any onerous lease assessments).

Lease liabilities

At the commencement date of a lease, the Group recognises lease liabilities measured at the present value of lease payments to be made over the lease term. Lease payments included in the measurement of the lease liability comprise the following items, where applicable:

  • fixed payments less any lease incentives receivable;
  • variable lease payments that depend on an index or rate, initially measured using the index or rate at the commencement date;
  • the amount expected to be payable by the lessee under residual value guarantees;
  • the exercise price of purchase options, if the lease term reflects the exercise of an option to terminate the lease; and
  • payments of penalties for terminating the lease, if the lease term reflects the exercise of an option to terminate the lease.

In calculating the present value of lease payments, the Group uses the incremental borrowing rate at the lease commencement date if the interest rate implicit in the lease is not readily determinable. After the commencement date, the lease liabilities are reduced for payments made and increased for interest. Interest recognised on the lease liability is included in finance costs in the Income Statement.

The carrying amount of lease liabilities is remeasured if there is a modification, a change in the lease term, a change in the in-substance fixed lease payments or a change in the assessment to purchase the underlying asset. On remeasurement of the lease liability, the corresponding adjustment is reflected in the ROU asset; if the ROU asset is already reduced to nil, the adjustment is recognised in the Income Statement.

Short-term leases and lease of low value assets

The Group has adopted certain optional recognition exemptions available under IFRS 16 for short-term (less than 12 months) and low value (< £5,000) leases. These leases are held off balance sheet with rentals charged to the Income Statement on a straight-line basis over the lease term and are classified as operating leases. Benefits received and receivable as an incentive to enter into an operating lease are recognised as a liability. The aggregate benefit of incentives is spread on a straight-line basis over the lease term.

(b) The Group as an intermediate lessor

Subleases

The Group acts as an intermediate lessor in respect of surplus office space, in which the Group classifies its subleases either as an operating or finance lease by reference to the right of use asset arising from the head lease (rather than by reference to the underlying asset) or if the head lease belonging to the Group is a short-term lease, the sublease is classified as an operating lease. The Group accounts for the head lease and the sublease as two separate contracts.

Finance lease receivable

Amounts due from lessees under finance leases are recognised as a finance lease receivable and represent the Group’s net investment in the finance sublease.

Any difference between the right of use asset and the net investment in the sublease is recognised in the Income Statement.

The Group applies the discount rate used for the head lease (adjusted for any initial direct costs associated with the sublease) to measure the net investment in the sublease.

Finance lease income is allocated to accounting periods so as to reflect the constant periodic rate of return on the Group’s net investment outstanding in respect of the leases.

Any allowances for expected credit losses are recognised against finance lease receivables as required by IFRS 9, if applicable.

The lease liabilities relating to the head leases are retained on the Balance Sheet and represent the lease payments payable to the head lessor.

Operating subleases

For subleases which are classified as an operating lease, the Group recognises both the lease liability and the ROU asset relating to the head lease. Rental income from the operating sublease is recognised in the Income Statement as other operating income on a straight-line basis over the term of the relevant sublease.

Initial direct costs incurred in negotiating and arranging an operating lease are added to the carrying amount of the leased asset and recognised on a straight-line basis over the lease term.

Policies applicable prior to 1 October 2019

Rentals on operating leases are charged to the Income Statement on a straight-line basis over the lease term. Benefits received and receivable as an incentive to enter into an operating lease are recognised as a liability. The aggregate benefit of incentives is spread on a straight-line basis over the lease term.

4. Critical accounting judgements and key sources of estimation uncertainty (extracts)

a. Critical judgements in applying the Group’s accounting policies

i. Leases – determining the lease term

The Group determines the lease term as the non-cancellable term of the lease, together with any periods covered by an option to extend or terminate the lease. In making this judgement, the Group evaluates whether it is reasonably certain to exercise the option to renew or break the lease term.

That is, it considers all relevant factors that create an economic incentive for it to exercise the renewal and the circumstances and facts for each lease including past experience to determine the likely lease term and whether the break option is likely to be exercised. This includes an assessment on the length of time remaining before the option is exercisable, current trading conditions and future trading forecasts on the ongoing profitability of the business.

After the lease 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 (or not to exercise) the option to renew (for example, a change in business strategy).

As at 30 September 2020, it has been assumed that all leases will be until the end of the lease term for the Group.

b. Key sources of estimation uncertainty (extract)

iv. Leases – determination of the appropriate rate to discount the lease payments

The Group uses its incremental borrowing rate as the discount rate for determining its lease liabilities at the lease commencement date since the rate implicit in the lease cannot be readily determined. The calculation of the incremental borrowing rate involves estimation and has been obtained from the Group’s bank to determine the rate on a lease-by-lease basis that the Group would have to pay to borrow money to purchase the type of assets being leased. Rates applied are dependent on the entity leasing the asset and the following factors have been considered:

  • Lease term;
  • Credit risk of the entity; and
  • Level of indebtedness of the entity.

The impact of an increase in the incremental borrowing rates used for calculating the discount rate in determining the lease liabilities for all entities on transition to IFRS 16 ‘Leases’ as at 1 October 2019 is set out below.

15. Leases

Group

With the exception of short-term leases and leases of low value underlying assets, each lease is reflected on the Consolidated Balance Sheet as a ROU asset and a lease liability.

The Group’s ROU assets are in respect of leases for the offices it occupies. The leases generally have a term ranging from 5 to 15 years. There were four new leases in the year, one of the new leases replaced an expired lease. The leases require the Group to keep the properties in a good state of repair and to return the offices in their original condition at the end of the lease. The average lease term is 6.3 years.

Right of use assets

Other information

At 30 September 2020, the Group was committed to short-term leases with a total commitment of £378,000.

The total cash outflow for leases recognised as right of use assets was £8,765,000 for the year ended 30 September 2020.

Finance lease receivables are presented in note 16 and lease liabilities including the maturity analysis of the lease liabilities are presented in note 23.

The Group had not entered into any leases which are yet to commence at the end of the reporting period.

23. Lease liabilities

Reconciliation of lease liability:

The Group does not face a significant liquidity risk from its lease liabilities.

Lease payments not recognised as a liability are presented in note 32 operating lease arrangements.

32. Operating lease arrangements

Group

The Group as lessor

Disclosure required by IFRS 16

Operating leases, in which the Group is lessor, relate to certain property leases where there is surplus office space that the Group has sublet. The Group acts as an intermediate lessor in the sublease, where the Group has not transferred substantially all the risks and rewards of the head lease to the lessee, the sublease is classified as an operating lease.

The subleases have terms of 9 to 12 years and may contain tenant exercisable break options.

Maturity analysis of the operating lease payments receivable:

Disclosure required by IAS 17

As at 30 September 2019, there was £6.6 million of future minimum sublease payments expected to be received under non-cancellable subleases. These expected future sublease receipts are deducted in arriving at the onerous contracts provision.

The Group as lessee

Disclosure required by IAS 17

The Group recognised operating leases payments as an expense in 2019 as follows:

The Group had significant operating lease arrangements with respect to the premises it occupies. Hire of equipment is in relation to multifunctional printers and vending machines.

At 30 September 2019, the Group had outstanding commitments for future minimum lease payments under non-cancellable operating leases, which fall due as follows:

The balances disclosed above include future minimum onerous operating lease payments which are included in the onerous contracts provision calculation.

16. Finance lease receivables

Finance lease arrangements

The Group has entered into various sub-lease arrangements as a lessor. The subleases relate to surplus office space that is leased by the Group. Where the Group has transferred substantially all of the risk and rewards of ownership of the asset, the sub-leases are classified as finance leases.

During the year, the finance lease receivable increased following the Group subletting surplus office space in its Cambridge office.

The Group does not face foreign currency risks, as the leases are denominated in the local currency of each subsidiary.

The maturity analysis of lease receivables, including the undiscounted lease payments to be received, are as follows:

See note 9 for the amount recognised as finance income on the net investment in the finance leases.

The Group’s finance leases do not include variable payments.

Impairment of finance lease receivables

The Group estimates the loss allowance on finance lease receivables at an amount equal to the lifetime Expected Credit Loss (‘ECL’). The lifetime ECL is determined to be £nil taking into account the historical default experience and future expectations. At the reporting date none of the finance lease receivables are past due or impaired.

9. Finance income and finance costs

1. Following the adoption of IFRS 16 ‘Leases’ interest on lease liabilities is presented in finance costs.