IFRS 16, expected effect of future adoption quantified, maintenance provisions for leased aircraft

easyJet plc – Annual report – 30 September 2018

Industry: transport

Notes to the accounts (extract)

1c. New and revised standards and interpretations not applied (extract)

IFRS 16 ‘Leases’ – effective for the year ending 30 September 2020

easyJet will early adopt IFRS 16 on 1 October 2018, bringing the timing of adoption in line with that of IFRS 9 and IFRS 15.

The standard provides a single lessee accounting model, specifying how leases are recognised, measured, presented and disclosed. The main expected impacts of adopting IFRS 16 have been disclosed below.

easyJet will apply the cumulative catch-up (‘modified’) transition method. Under the cumulative catch-up method the comparative information will not be restated, but the retrospective cumulative impact of IFRS 16 will be recognised within the opening balance of retained earnings as at 1 October 2018.

easyJet has elected to use the following practical expedients proposed by the standard:

  • on initial application, the application of a single discount rate to a portfolio of leases with reasonably similar characteristics;
  • on initial application, the use of hindsight when determining the lease term if the contract contains options to extend or terminate the lease;
  • on initial application, the exclusion of initial direct costs from the measurement of the right-of-use asset;
  • on initial application, IFRS 16 will only be applied to contracts that were previously classified as leases; and
  • lease payments for contracts with a duration of 12 months or less and contracts for which the underlying asset is of a low value will continue to be expensed to the income statement on a straight-line basis over the lease term.

Capitalisation of lease contracts

Under IFRS 16, easyJet will capitalise the right of use of all aircraft and properties currently held under operating leases. The lease term will correspond to the duration of the contracts signed except in cases where the Group is reasonably certain that it will exercise contractual extension options. easyJet will recognise a right-of-use asset representing its right to use the underlying asset and a corresponding lease liability representing its obligation to make lease payments. Operating lease expenses will be replaced by a depreciation expense on right-of-use assets recognised and an interest expense as the interest rate implicit in easyJet’s lease liabilities unwinds. When the interest rate implicit in the lease cannot be readily determined, easyJet’s incremental borrowing rate will be used as an alternative.

Accounting for the maintenance of leased aircraft

easyJet has contractual obligations to maintain aircraft currently held under operating leases. Currently, provisions are created over the term of the lease based on the estimated future costs of major airframe checks, engine shop visits and end of lease liabilities. These costs are discounted to present value with the corresponding income statement charge recognised within maintenance costs. The unwinding of the discount is recognised within interest costs.

Under IFRS 16, contractual maintenance obligations which are not dependent on the use of the aircraft will be recognised in full on commencement of the lease. They will be capitalised as part of the right-of-use asset at the inception of the lease and depreciated over the lease term.

Contractual maintenance obligations which are dependent on the use of the aircraft will continue to be provided for over the term of the lease based on the estimated future costs, discounted to present value. However they will be capitalised to the right-of-use asset rather than recognised within maintenance costs in the income statement. This asset will be depreciated immediately as the obligation has arisen as a result of flying hours already undertaken.

Where an aircraft is sold and leased back, other than when first delivered to easyJet, a maintenance catch-up liability resulting from past flying activity arises at the point the lease agreement is signed and a corresponding maintenance provision catch-up charge is currently recognised immediately in the income statement. Under IFRS 16 this maintenance provision catch-up will be capitalised as part of the right-of-use asset at the inception of the lease and depreciated over the lease term.

These changes will result in a decrease in maintenance costs and an increase in depreciation expense.

On adoption of IFRS 16 on 1 October 2018, easyJet anticipates recognising approximately £550 million of lease liabilities, approximately £510 million of right-of-use assets, an increase in maintenance provisions of approximately £20 million, a £19 million derecognition of the net surplus on historical sale and leaseback transactions capitalised on the statement of financial position, and a corresponding decrease in equity of approximately £40 million. These figures do not include the tax impact which is subject to finalisation. Annual operating lease expenses and maintenance charges, which would have been recognised under existing accounting standards, will be replaced by anticipated similar levels of depreciation and interest expense such that no material impact on profit before tax is expected in the year of transition.

Headline return on capital employed is expected to improve by approximately 1.5 percentage points under IFRS 16, as the newly capitalised lease liabilities are less than the adjustment historically made for the capital implicit in aircraft operating lease arrangements (the annual charge for aircraft dry leasing multiplied by a factor of seven).