IFRS 16 adopted, modified retrospective method, policies, certain disclosures

BAE Systems plc – Annual report – 31 December 2019

Industry: manufacturing. aerospace

36. Adoption of IFRS 16 Leases
IFRS 16 became effective from 1 January 2019 and has replaced IAS 17 Leases and related interpretations. It has resulted in almost all leases being recognised on the balance sheet by lessees, as the distinction between operating and finance leases is removed. Under the new standard, a right-of-use asset and a financial liability for future lease payments are recognised. The only exceptions are short-term leases, low-value leases and leases of intangible assets.

The Group has applied the modified retrospective transition approach and has not restated comparative amounts for the year ended 31 December 2018. In the majority of cases the Group has elected to measure right-of-use assets at the amount of the lease liability on adoption (adjusted for any lease prepayments or accrued lease expenses, onerous lease provisions, and leased assets which have subsequently been subleased). For a number of property leases the Group has elected to measure the right-of-use asset as if IFRS 16 had been applied since the start of the lease, but using the incremental borrowing rate at 1 January 2019, with the difference between the right-of-use asset and the lease liability taken to retained earnings.

The Group has elected to adopt the following practical expedients on transition:
– not to capitalise a right-of-use lease asset or related lease liability where the lease expires before 31 December 2019;
– not to reassess contracts to determine if the contract contains a lease and not to separate lease and non-lease elements;
– where an onerous lease provision is in existence, to utilise this provision to reduce the right-of-use asset value rather than undertaking an impairment review;
– to use hindsight in determining the lease term;
– to exclude initial direct costs from the measurement of the right‑of‑use asset; and
– to apply the portfolio approach where a group of leases has similar characteristics.

Impact of adoption of IFRS 16 Leases
Balance sheet
Upon transition on 1 January 2019, the Group recognised a right‑of‑use lease asset of £1,298m (after adjustments for onerous lease provisions, lease prepayments and accrued lease expenses at 31 December 2018), and lease liabilities of £1,486m (non-current £1,270m; current £216m), along with a deferred tax asset of £2m. A sublease finance receivable of £72m was also recognised. A transition adjustment of £92m was recognised as a debit to retained earnings. The Group did not capitalise low-value leases on transition, or those which expire before 31 December 2019, and has opted not to apply IFRS 16 to leases relating to intangible assets. The right-of-use lease asset principally consists of property.

Income statement
Under IFRS 16 the Group sees a different pattern of expense within the income statement, as the IAS 17 operating lease expense is replaced by depreciation and interest charges. In 2019, the Group’s EBITA metric has improved by approximately £50m under IFRS 16 as the new depreciation expense is lower than the IAS 17 operating lease charge; however the new finance costs have broadly offset this, such that net profit after tax and the underlying earnings metrics are not materially different compared to the previous IAS 17 reporting basis.

Cash flow statement
The change in presentation as a result of the adoption of IFRS 16 has seen an improvement in 2019 of approximately £46m in operating business cash flow, offset by a corresponding decline in cash flow from financing activities. There is no overall cash flow impact from the adoption of the new Standard.

Lessor accounting under IFRS 16 is largely unchanged from IAS 17.

Accounting policy
The accounting policy in respect of leases applied from 1 January 2019 is set out in note 10.

Impact on Consolidated balance sheet at 1 January 2019 (extract)
The following table shows the effect of adopting IFRS 16 on the Consolidated balance sheet at 1 January 2019.

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The weighted average incremental borrowing rate applied to lease liabilities was 3.4%.

Reconciliation between operating lease commitments and lease liability
The following table explains the difference between the operating lease commitments disclosed applying IAS 17 at 31 December 2018 and the lease liability recognised on adoption of IFRS 16 at 1 January 2019.

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10. Leases
The Group as lessee
All leases in which the Group is lessee (except as noted below) are recognised as a right-of-use asset and a corresponding lease liability at the date at which the leased asset is available for use by the Group. Each lease payment is allocated between repayment of the lease liability and finance cost. The finance cost is charged to the income statement over the lease term to produce a constant periodic rate of interest on the lease liability. The right-of-use asset is depreciated over the shorter of the asset’s useful life and the lease term on a straight-line basis.

The lease liability is initially measured as the present value of future lease payments, discounted using the interest rate implicit in the lease. Where this rate is not determinable, the Group’s incremental borrowing rate is used, which is the interest rate the Group would have to pay to borrow the amount necessary to obtain an asset of similar value, in a similar economic environment with similar terms and conditions.

The right-of-use asset is initially measured at cost, comprising the initial value of the lease liability, any lease payments made (net of any incentives received from the lessor) before the commencement of the lease, any initial direct costs and any restoration costs.

The carrying amounts of the Group’s right-of-use assets are reviewed at each balance sheet date to determine whether there is any indication of impairment in accordance with the policy shown in note 8.

Payments in respect of short-term leases, low-value leases and leases of intangible assets are charged to the income statement on a straight-line basis over the lease term.

The Group as lessor
Leases in which the Group is lessor are classified as finance leases or operating leases. If the lease transfers substantially all of the risks and rewards of ownership to the lessee, the lease is classified as a finance lease. All other leases are classified as operating leases.

A sublease where the Group is an intermediate lessor is classified as a finance lease when it transfers substantially all of the risks and rewards of the right-of-use asset arising from the head lease.

Lease income under operating leases is recognised in the income statement on a straight-line basis over the lease term.

Amounts due from lessees under finance leases are recognised as a receivable discounted at the interest rate implicit in the lease. Finance lease income is recognised in the income statement over the lease term to produce a constant periodic rate of interest on the receivable.

IFRS 16 Leases became effective from 1 January 2019. The impact of adoption is set out in note 36.

The Group leases land, buildings, vehicles and equipment under non-cancellable lease arrangements. The leases have varying terms, including escalation clauses, renewal rights and purchase options. None of these terms represent unusual arrangements or create material onerous or beneficial rights or obligations.

Right-of-use assets

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Lease liabilities
A maturity analysis of the future undiscounted lease payments in respect of the Group’s lease liabilities is presented in the table below:

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The Group is also committed to future undiscounted lease payments of £84m in respect of leases which had not yet commenced at 31 December 2019.

The total cash outflow for leases in the year ended 31 December 2019, including short-term leases and low-value leases, amounted to £317m.

Amounts recognised in the income statement

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Operating leases
The Group is party to operating leases in which it is the lessor, primarily relating to investment property. Under the terms of the lease agreements, no contingent rents are receivable. The leases have varying terms including escalation clauses and renewal rights. None of these terms represent unusual arrangements or create material onerous or beneficial rights or obligations.

A maturity analysis of the future undiscounted lease receipts from operating leases in which the Group is lessor is presented in the table below:

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Finance lease receivables
From 1 January 2019, certain of the Group’s subleases where the Group is an intermediate lessor are now classified as finance leases under IFRS 16. A sublease is classified as a finance lease when it transfers substantially all of the risks and rewards of the right-of-use asset arising from the head lease. The Group did not have any leases classified as finance leases in 2018 before the adoption of IFRS 16.

A maturity analysis of the future undiscounted lease receipts from finance leases in which the Group is lessor is presented in the table below:

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