IFRS 16, quantified disclosure of effects of future adoption, reconciliation from IAS 17 operating lease commitments

Rio Tinto plc – Annual report – 31 December 2018

Industry: mining

1 Principal accounting policies (extract)

Mandatory in 2019

The impact on the Group of transition to the accounting pronouncements listed below that are mandatory in 2019 is currently expected to be immaterial other than for IFRS 16 “Leases”.

IFRS 16 “Leases” (Endorsed by the EU and mandatory in 2019) Under the new standard, a lessee is in essence required to:

(a) Recognise all right of use assets and lease liabilities, with the exception of short-term (12 months or fewer) and low value leases, on the balance sheet. The lease liability is initially measured at the present value of future lease payments for the lease term. Where a lease contains an extension option, the lease payments for the extension period will be included in the liability if the Group is reasonably certain that it will exercise the option. The liability includes variable lease payments that depend on an index or rate but excludes other variable lease payments. The right of use asset at initial recognition reflects the lease liability, initial direct costs and any lease payments made before the commencement date of the lease less any lease incentives and, where applicable, provision for dismantling and restoration.

b) Recognise depreciation of right of use assets and interest on lease liabilities in the income statement over the lease term.

(c) Separate the total amount of cash paid into a principal portion (presented within financing activities) and interest portion (which the Group presents in operating activities) in the cash flow statement.

The Group will implement the standard as at 1 January 2019. For contracts in place at this date, the Group will continue to apply its existing definition of leases under current accounting standards (“grandfathering”), instead of reassessing whether existing contracts are or contain a lease at the date of application of the new standard.

For transition, as permitted by IFRS 16, the Group will apply the modified retrospective approach to existing operating leases which will be capitalised under the new standard (ie retrospectively, with the cumulative effect recognised at the date of initial application as an adjustment to the opening balance of retained earnings with no restatement of comparative information in the financial statements). For existing finance leases, the carrying amounts before transition will represent the 31 December 2018 values assigned to the right of use asset and lease liability.

The Group has made the following additional choices, as permitted by IFRS 16, for existing operating leases:

  • Not to bring short-term leases (12 months or fewer to run as at 1 January 2019 including reasonably certain options to extend) or low value leases on balance sheet. Costs for these items will continue to be expensed directly to the income statement.
  • For all leases, the lease liability will be measured at 1 January 2019 as the present value of any future lease payments discounted using the appropriate incremental borrowing rate. The carrying value of the right of use asset for property, vessels and certain other leases will generally be measured as if the lease had been in place since commencement date. For all other leases the right of use asset will be measured as equal to the lease liability and adjusted for any accruals or prepayments already on the balance sheet. The Group will also exclude any initial direct costs (eg legal fees) from the measurement of the right of use assets at transition.
  • An impairment review must be performed on right of use assets at initial application of the standard. The Group has elected to rely on its onerous lease assessments under IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”, as at 31 December 2018 as permitted by IFRS 16. Any existing onerous lease provision is set against the right of use asset carrying value upon transition.
  • To apply the use of hindsight when reviewing the lease arrangements for determination of the measurement or term of the lease under the retrospective option.
  • To separate non-lease components from lease components for vessels and properties for the first time as part of the transition adjustment.
  • To continue not to apply lease accounting to intangible assets.
  • In some cases, to apply a single discount rate to a portfolio of leases with reasonably similar characteristics.

The impact of transition to IFRS 16 on the Group’s 1 January 2019 balance sheet is expected to be an increase in lease liabilities (debt) of US$1.2 billion, an increase in right of use assets/net investments in leases of US$1.1 billion, net adjustments to other assets and liabilities of US$0.1 billion, and a charge of less than US$0.1 billion to retained earnings. The weighted average incremental borrowing rate applied to the Group’s lease liabilities to be recognised in the balance sheet at 1 January 2019 is 4.7%.

The Group’s undiscounted non-cancellable operating lease commitments of US$1.7 billion at 31 December 2018 under IAS 17 “Leases” are shown on page 200 of this Report. The most significant differences between these lease commitments and a lease liability recorded on transition of US$1.3 billion as shown above are set out below:

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The lease liability of US$1.3 billion (inclusive of amounts already reported as finance leases under IAS 17) shown above will be included in net debt as at 1 January 2019.

The Group has implemented a lease accounting system which will be used for the majority of the Group’s leases. A separate contract linked system will be used for the Group’s shipping leases.

Contracts signed after 1 January 2019 will be assessed against the lease identification criteria under IFRS 16. This may increase or decrease the number of contracts which are deemed to be leases. Practical application of IFRS 16 continues to develop and the Group continues to monitor this.

In future periods EBITDA, as disclosed in the Financial Information by Business Unit on page 249 will increase as the operating lease cost is charged against EBITDA under IAS 17 whereas under IFRS 16 the charge will be included in depreciation and interest, which are excluded from EBITDA (although included in net earnings). Short-term leasing costs and non-lease components will continue to be charged against EBITDA. In 2018, an operating lease expense of US$787 million has been recorded in net operating costs; refer to note 4. This includes arrangements entered into and maturing during 2018 and therefore not disclosed as non-cancellable operating lease commitments at 31 December 2017. The Group has disclosed US$0.5 billion of non-cancellable operating lease commitments due within one year at 31 December 2018, approximately US$0.3 billion of which are not expected to be charged against EBITDA in 2019 as a result of implementing IFRS 16.

Operating cash flows will increase under IFRS 16 as the element of cash paid attributable to the repayment of principal will be included in financing cash flows. The net increase/decrease in cash and cash equivalents will remain the same.

The Group’s activities as a lessor are not material and hence the Group does not expect any significant impact on the financial statements. As the Group has some property sub lease arrangements, these must be reassessed for classification purposes as operating or finance leases at transition. Some additional disclosures will also be required from next year.

 

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