IFRS 16, quantified description of effects of future adoption, leased aircraft, subleases, maintenance, airline

Finnair Oyj – Annual report – 31 December 2018

Industry: airline

4.7 Changes in accounting principles (extract)

IFRS 16 Leases

The new leasing standard IFRS 16 will be effective from 2019 onwards. It replaces the previous standard (IAS 17 Leases). Finnair will adopt the standard from 2019 onwards and will apply the full retrospective method to each prior reporting period presented.

Finnair has carried out an extensive implementation project and the new standard will have a significant impact on its financial statements and key ratios. The present value of the future operating lease payments for aircraft, real estate and other qualifying operating lease arrangements will be recognised as right-of-use assets and as interest-bearing lease liabilities on the balance sheet. Currently, future lease payments for operating leases are presented in the notes as operating lease commitments at their nominal value. The currently reported operating lease commitments at the end of Q4 2018 amounted to 1,457 million euros (see note 2.2. Leasing arrangements for more detail).

Applying the full retrospective method and using the current interpretations of the relevant elements of the standard as set out below, Finnair estimates that its assets will increase by 1.0 billion euros due to recognition of right-of-use assets, of which the majority (~80%) are aircraft. Liabilities will increase in total by 1.1 billion euros due to the recognition of the present value of qualifying operating lease payments. The comparative information will be restated, and the cumulative effect of initially applying IFRS 16 is made as an adjustment to opening equity of 1.1.2018. The impact to equity will be 0.1 billion euros. The changes in the amount of equity and liabilities are reflected in the equity ratio, which Finnair expects to decrease by more than 10 p.p. due to adopting the standard.

Although the assets associated with operating leases will be denominated in euros when converted into right of use assets, the majority of Finnair’s aircraft lease contracts will remain payable in US dollars. As at January 2019, Finnair aims to mitigate the foreign exchange volatility introduced by this difference by adjusting its hedging policy.

Impacts to Finnair financial statements of 31.12.2018

Interest-bearing net debt will increase by the amount of the present value of qualifying operating lease payments of 1.1 billion euros. This will be reflected in the key figure Gearing %, which will increase significantly (by more than 100 p.p.), to approximately 70%. Finnair currently discloses a key ratio called ”Adjusted gearing”, which takes operating lease payments into account in the following way: aircraft operating lease costs for the last twelve months are multiplied by 7 and added to the interest-bearing net debt (see Balance sheet: “Additional information to Balance sheet: Interest-bearing net debt and adjusted gearing”). This key figure stood at 67% at the end of reporting year 2018. When the new standard is in effect, aircraft operating lease payments are no longer recognised in aircraft lease costs. Instead, the net present value of future aircraft lease payments is recognised in interest-bearing debt, which is already included in the calculation of “Gearing”. KPI “Adjusted gearing” will therefore be replaced with “gearing”.

The leasing standard will also impact Finnair’s income statement. From 2019 onwards, operating lease expenses will be no longer presented for the qualifying lease contracts in the income statement but in the income statement there will be instead the depreciations of the right-of-use assets (affecting the comparable operating result) and the interest costs associated with the liability (affecting finance net). The interest costs for the liability are at their highest in the beginning of the lease term, decreasing towards the end of the term as the lease liability is amortised. Currently, operating lease expenses are accrued over the lease term primarily on a straight-line basis and recognised in the operating result as lease payments for aircraft and other rents, according to the lease contract terms. In addition to the impact on operating result and EBITDA, cash flow from operating activities will also increase, as the amortisation of lease liabilities is transferred from operating activities to financing activities in cash flow.

Finnair estimates that its 2018 comparable operating result will improve by approximately 30% due to adopting the new standard. Depreciation will increase due to depreciation of right of use assets, but the qualifying operating lease payments will no longer be included in operating result and will be instead included in lease liability repayments and financial expenses Finnair’s net result in 2018 will, however, decrease by an estimated 30 per cent due to interest expenses and foreign exchange losses associated with USD denominated aircraft lease payments and liability. The majority of the decrease in Finnair’s net result is derived from unrealized foreign exchange losses caused by the translation of the USD denominated liability. The amount of the foreign currency exchange effect could be positive or negative, depending on the USD-rate at the closing date. As at January 2019, Finnair aims to mitigate the foreign exchange volatility introduced by this difference by adjusting its hedging policy. The annual effect in net result going forward is dependent on the size of the qualifying operating lease portfolio and the duration of the leases.

In the cash flow statement, repayments of lease liabilities will be moved from operating cash flow to financing cash flow in accordance with IFRS 16. Operating cash flow will increase by approximately 30%, with a corresponding negative adjustment in financing cash flow.

Impacts to Finnair accounting policy

The leases recognized as right-of-use assets under IFRS 16 based on Finnair’s analysis are comprised of operating leased aircraft and spare engines, real estate, cars and ground equipment. Aircraft will account for the majority (~80%) of the right-of-use asset and lease liability balance sheet value. The majority of the remaining (~20%) is real estate contracts.

Finnair will use the exemption provided by the standard not to account for lease liability for operating leases which have a term of 12 months or less, and which do not include an option to purchase the underlying asset. In addition, Finnair will not account for IFRS 16 lease liability for leases for which the underlying asset is not material to Finnair. The assessment of whether the underlying asset is material and is within the scope or excluded from the recognition requirements of IFRS 16 is based on the concept of materiality in the Conceptual Framework and IAS 1. Finnair recognizes the lease payments associated with such leases as an expense on a straight-line basis, similar to current accounting for operating leases.


Lease term: For the aircraft operating lease contracts, the lease term will correspond to the non-cancellable duration of the contracts signed except in cases where the Group is reasonably certain of exercising either an extension option or an early termination option that is included in the contract. At the initial measurement of the lease, Finnair does not normally include any option period in the lease term as there is significant uncertainty whether Finnair will continue the lease term, even if the lease allows for extensions. The negotiation of possible extension typically begins 12-18 months prior to the initial operating lease term expiry. Finnair remeasures the lease liability when it decides to use the extension option or when there is some other significant indication that the lease period will be extended. For example, major modifications to leased aircraft may be considered as indications of extending the lease, especially if done close to the end of leasing period.

Discount rate: Aircraft lease agreements do not clearly define the interest rate implicit in a lease. Since the fair values of the aircraft are provided publicly by third parties, Finnair is able to calculate the implicit interest rate for each qualifying aircraft operating lease. The rate implicit in the lease is defined as the rate that causes the sum of the present value of the lease payments and the present value of the residual value of the underlying asset at the end of the lease to equal the fair value of the underlying asset.

Maintenance costs: Finnair recognizes provisions for leased aircraft to maintain the aircraft during the period of the lease. For owned aircraft, provisions are not recognized because the cost is avoidable, by for instance selling the asset. IFRS 16 requires including restoration costs in the right-of-use asset. Finnair uses the criteria of whether the maintenance cost is avoidable or unavoidable in determining whether the maintenance cost is capitalized to the RoU asset or not.

Finnair is obliged to return leased aircraft and their engines according to the redelivery condition set in the lease agreement. If at the time of redelivery, the condition of the aircraft and its engines differs from the agreed redelivery condition, Finnair needs to either maintain the aircraft so that it meets the agreed redelivery condition or settle the difference in cash to the lessor. The maintenance costs can be divided into two main groups:

1) costs that incur independent of the usage of the aircraft / leasing period and

2) costs that incur dependent on the usage of the aircraft / leasing period

The final check and painting required at redelivery are considered unavoidable maintenance costs that realise when the aircraft is redelivered to the lessor, irrespective of the time or flight hours. The counterpart of the provision is recorded in the book value of the right-of-use asset at the commencement of the lease in accordance with IFRS 16 (IFRS 16:25).

Respectively, costs depending on the usage of the aircraft are not considered as part of the right-of-use asset cost.

Excluded contracts: Excluded, non-qualifying, aircraft lease contracts include wet leases and spare engines that have been mainly excluded based on short-term exemption. Finnair analyses the lease term separately for each lease based on contract term and possible extension and early termination options. When the lease term is 12 months or less and Finnair does not intend to continue the lease period after that, the lease agreement is excluded from lease liabilities.

Wet lease agreements are made to lease airline capacity typically on a short-term basis, for example when there are shortages in resourcing. The lease term of a typical wet lease agreement can vary from one day to one year.

Spare engines that have been leased on short-term basis in exceptional cases, are excluded from the lease liability. The lease term is usually only few days up to few months and Finnair does not intend to lease the spare engines for a longer period of time than they are needed.

Real estate

Lease term: The lease term corresponds to the non-cancellable duration of the contracts signed, except in cases where Finnair is reasonably certain of exercising either an extension option or an early termination option included in the contract.

Discount rate: Since facility agreements do not clearly specify the implicit interest rate in the lease contracts, Finnair uses an estimate of incremental borrowing cost for a portfolio of facilities, meaning that all of the facilities’ (land and real estate) lease contracts are discounted using the same discount rate. A management estimate of the incremental borrowing cost is used in determining the interest rate.

Excluded contracts: Based on Finnair’s evaluation, service contracts that relate to the usage of airports and terminals (HEL hub) do not qualify as lease arrangements for IFRS 16 purposes. In the contracts, the lessor has a substitution right to substitute the leased area with another area, which leads to classifying the contracts as non-leases. As an exception from this principle, there are specific lounge areas at Helsinki airport that are dedicated for Finnair’s use, and these are, therefore, included in lease contracts.

Finnair has analyzed lease contracts where the lease term is not fixed but both the lessor and lessee have an option to terminate the lease within 1-12 months’ notice and has concluded that these contracts are not material and termination of these contracts is practically realistic within the time of the notice (e.g. small storage space). Therefore, these contracts have been mainly excluded from the lease liability.

Other leases (cars and ground equipment)

Based on Finnair’s analysis, the other leases constitute mainly of company cars and ground equipment, where the lease is considered long-term and, therefore, qualify as IFRS 16 leases.

As a practical expedient, IFRS 16 permits a lessee not to separate non-lease components, and instead account for any lease and associated non-lease components as a single arrangement. Finnair has used this practical expedient for those company car and ground equipment leases that include service components.

The lease term will correspond to the non-cancellable duration of the contracts signed except in cases where Finnair is reasonably certain of exercising either an extension option or an early termination option included in the contract. Based on the analysis, current lease contracts do not include such options that would be reasonably certain to be exercised, so the lease term of the current contracts corresponds to the lease duration of the signed contract. Finnair uses an estimate of incremental borrowing cost for each portfolio of cars and ground equipment, meaning that all of the lease contracts are discounted using the same discount factor. A management estimate is used to determine the incremental interest rate. Lease contracts that individually (or by asset class) are not material to Finnair have been excluded from the lease liability. These contracts include small IT-equipment and office equipment.


IFRS 16 did not change substantially how a lessor accounts for leases. Under IFRS 16, a lessor continues to classify leases as either finance leases or operating leases and account for those two types of leases differently. Under IFRS 16, an intermediate lessor is required to classify the sublease as a finance or operating lease by reference to the right-of-use asset arising from the head lease (and not by reference to the underlying asset as was the case under IAS 17). Because of this change, Finnair has reclassified certain of its sublease agreements as finance leases as at 1st January 2019.

Finnair subleases 9 (nine) aircraft and a small amount of ground equipment, where by reference to the head lease, the lease term is for the majority of the remaining economic life arising from the Right-of-use asset and, therefore, these are classified as finance leases in accordance with IFRS 16. The right-of-use asset arising from the head lease is derecognized and a net investment corresponding to the discounted lease payments is recognized on the Finnair balance sheet.

In accordance with IFRS 16, for subleases where Finnair is the lessor and which are reclassified from operating subleases to finance leases due to IFRS 16, contracts ongoing at 1.1.2019 (date of initial application) are accounted for as new finance leases and the gain or loss arising on the subleases is included in the cumulative catch-up adjustment in retained earnings.