BAE Systems plc – Half year report – 30 June 2018
Industry: manufacturing. aerospace
Notes to the condensed half-yearly financial statements (extract 1)
New and amended standards adopted by the Group
A number of new or amended standards became applicable for the current reporting period, and the Group changed its accounting policies as a result of adopting IFRS 16 Leases.
The impact of the adoption of the new leasing standard and the new accounting policies are disclosed in note 11. The other standards did not have any impact on the Group’s accounting policies, and did not require retrospective adjustments.
Notes to the condensed half-yearly financial statements (extract 2)
11. Change in accounting policies
This note explains the impact of the adoption of IFRS 16 Leases on the Group’s financial statements and also discloses the new accounting policies that have been applied from 1 January 2019, where they are different from those applied in earlier periods.
IFRS 16 became effective from 1 January 2019 and replaced IAS 17 Leases and related interpretations. It results 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 have been 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 sub-leased). 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.
IFRS 16 Leases – impact of adoption
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), and lease liabilities of £1,486m (non-current £1,270m; current £216m), along with a deferred tax asset of £2m. A sub-lease finance receivable of £72m was also recognised. A transition adjustment of £92m was recognised as a debit to retained earnings. The Group has not capitalised 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. The weighted average incremental borrowing rate applied to lease liabilities was 3.43%.
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 is expected to improve by an estimated £50m under IFRS 16 as the new depreciation expense is expected to be lower than the IAS 17 operating lease charge; however the new finance costs are expected to broadly offset this, such that net profit after tax and the underlying earnings metric are not expected to be 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 is expected to see an improvement in 2019 of an estimated £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.
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.
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.
IFRS 16 Leases – accounting policies applied since 1 January 2019
Previously, under IAS 17 Leases, all of the Group’s leases were classified as operating leases and payments made (net of any incentives received from the lessor) were charged to the income statement on a straight-line basis over the lease term.
From 1 January 2019, leases 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 outstanding lease liability balance. 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.
Payments in respect of short-term leases, low-value leases and leases of intangible assets continue to be charged to the income statement on a straight-line basis over the lease term.
Previously, under IAS 17 Leases, all of the Group’s leases were classified as operating leases and payments received (net of any incentives granted by the Group) were recognised in the income statement on a straight-line basis over the lease term. Under IFRS 16 lessor accounting is broadly unchanged and therefore the majority of leases under which the Group is the lessor continue to be accounted for as operating leases.