Accounting for Leases: CAM Focus November 2017

Your presenter today Lara Truman Executive Director Financial Accounting Advisory Services Ph: 0274 899 896 Email: lara.truman@nz.ey.com

Current status of the lease accounting in New Zealand Webcast title 8/20/2019 Agenda Current status of the lease accounting in New Zealand Future developments / proposals for lease accounting Practical considerations

Lease Accounting

For now, continue to use PBE IPSAS 13 but this will change! Leases in the PBE Space For-profit entities will be required to apply NZ IFRS 16 for periods beginning 1 January 2019 PBEs currently apply PBE IPSAS 13 Leases (based on NZ IAS 17) Operating vs financing model for accounting for leases Very different accounting outcomes based on bright-lines In Nov 2016, NZASB decided not to adopt NZ IFRS 16 into PBE Standards NZ IFRS 9 has been included in PBE standards to assist with the mixed group issue but NZ IFRS 16 wont be NZASB will continue to monitor the situation at the IPSASB For now, continue to use PBE IPSAS 13 but this will change!

Leases in the PBE Space The IPSASB* has a project to draft a new standard on leases Expected to issue an ED end of 2017, early 2018 Discussions to date indicate the standard will be similar to IFRS 16, adapted for the public sector Lessee accounting is likely to be similar to NZ IFRS 16 However, lessor accounting is not expected to be aligned with NZ IFRS 16 – IPSASB preferred a symmetrical approach to lessee accounting Control based model or residual asset approach? NZASB** will need to consider this further when developing its version of the IPSASB standard *IPSASB – International Public Sector Accounting Standards Board **NZASB – New Zealand Accounting Standards Board

Leases in the PBE Space IPSASB considerations to date of specific public sector issues relate to peppercorn rentals (concessionary rentals) No guidance currently – PBE IPSAS 13 states lower of FV and present value of minimum lease payments This is likely to lead to no recognition if lease payments are for example $1 Proposals - Measure concessionary lease at fair value and subsidised portion accounted for similar to concessionary loan IPSAS 23 – non-exchange revenue – revenue or deferred revenue if conditions attached. Todays discussion focusses on lessee accounting and the NZ IFRS 16 requirements as a starting point

Key changes primarily affecting lessees Webcast title 8/20/2019 NZ IFRS 16 Leases Key changes primarily affecting lessees Recognise assets and liabilities for most leases New presentation and disclosures There is an identified asset What is a Lease The contract conveys the right to control the use of the identified asset for a period of time in exchange for consideration

IFRS 16 Leases Scope and definition of a lease Webcast title 8/20/2019 IFRS 16 Leases Scope and definition of a lease The new standard applies to leases of all assets except: Leases to explore for or use non-regenerative resources Leases of biological assets Service concession arrangements Licences of intellectual property granted by a lessor Rights held by a lessee under certain licensing agreements (e.g., films) Some exemptions apply regarding “low value” items and short-term leases Overview of IFRS 16 Leases January 2016

NZ IFRS 16 Leases Separating components of a lease Lease and non-lease components are accounted for separately Each lease component – apply IFRS 16 Each non-lease component – apply other standards Practical expedient: Lessees can make a policy election (by underlying asset class) to account for lease and non-lease components as lease components Allocate consideration to lease and non-lease components: Lessees – on a relative stand-alone price basis (unless the practical expedient is elected) Overview of IFRS 16 Leases January 2016

IFRS 16 Leases Lease term and lease payments Webcast title 8/20/2019 IFRS 16 Leases Lease term and lease payments Lease term includes any non-cancellable periods and ‘reasonably certain’ optional periods Lease payments Fixed payments Purchase options* (exercise price) Residual value guarantees – amounts expected to be payable (lessees only) Termination option penalties** Variable lease payments that depend on an index or rate * Include only if reasonably certain of exercise. ** Include unless reasonably certain not to be exercised.

NZ IFRS 16 Leases Lessee accounting – recognition and measurement Right-of-use (ROU) asset Lease liability Initial recognition Measure at present value of lease payments using interest rate imputed in the lease or lessee’s incremental borrowing rate Subsequent measurement Cost less accumulated depreciation/amortisation; OR Fair value of ROU (under NZ IAS 16 Property, Plant and Equipment, NZ IAS 38 Intangible Assets or NZ IAS 40 Investment Property) Effective interest rate method: Accrete interest expense using a discount rate determined at lease commencement Reduce lease liability by payments made Profit and loss Depreciation expense (generally, straight-line over the shorter of useful life or lease term); OR Change in fair value of investment property Interest expense (annual charge is reducing over the lease term) Initial measurement of the ROU asset would also include the lessee’s initial direct costs and prepayments made to the lessor less lease incentives received from the lessor, if any. As long as a reassessment and a change in the discount rate have not occurred.

NZ IFRS 16 Leases Example Fact pattern 5 year lease of equipment Lessee makes annual payments of $10,000 Discount rate 7.5% p.a. PV of annual lease payments is $40,460 Depreciation recognised on a straight-line basis over the life of the lease Overview of IFRS 16 Leases January 2016

NZ IFRS 16 Leases An example Year 1 Year 2 Year 3 Year 4 Year 5 Total PBE IPSAS 13 Lease expense 10,000 50,000 Total assets - Total liabilities NZ IFRS 16 Interest expense 3,034 2,512 1,950 1,347 697 9,540 Depreciation 8,092 40,460 Total Expense 11,126 10,604 10,042 9,439 8,789 ROU asset 32,368 24,276 16,184 Lease liability 33,494 26,006 17,956 9,303 Impact Profit before tax impact (1,126) (604) (42) 561 1,211 EBITDA impact

NZ IFRS 16 Leases An example Total expense Annual payment allocation

IFRS 16 Leases Lessee accounting – Presentation Balance sheet Income statement Statement of cash flows ROU asset: Separately from other assets (e.g., owned assets), or with corresponding underlying assets and disclose line items containing ROU assets Depreciation expense (separate from interest expense) Principal payments within financing activities Lease liability: Separately from other liabilities, or together with other liabilities and disclose line items containing lease liabilities Interest expense (separate from depreciation expense) Interest payments consistent with policy election in IAS 7 Statement of Cash Flows Present or disclose: Variable lease expense Short-term lease expense Low-value asset lease expense Lease payments for low-value assets, short-term leases and variable lease payments (not included in the lease liability) within operating activities Supplemental non-cash disclosure of new leases Overview of IFRS 16 Leases January 2016

Recognition and measurement Lessee accounting – exemptions Small value items Small value not defined (proxy: US$5,000) No need to combine items (e.g. 100 laptops) Short-term leases Leases with initial lease term shorter than 12 months Renewals not considered, unless reasonably certain

IFRS 16 Leases Disclosure Webcast title 8/20/2019 IFRS 16 Leases Disclosure New disclosures for lessees include: Depreciation of ROU assets by class of underlying asset Interest on lease liabilities Expenses for short-term leases and leases of low-value assets Sublease income Total cash outflows A single location; quantitative disclosures in tabular format Overview of IFRS 16 Leases January 2016

Practical Considerations

Lease accounting change journey IT environment challenges Systems architecture Data Lease contracts may not be maintained in a central repository Existing data structures may not have sufficient depth to support all critical data elements (e.g., discount rate, separation of lease and non-lease components and information required for disclosures) and may not allow documentation of management estimates and assumptions Applications Existing lease management systems may require review and modification because they lack computational ability to: Calculate the balance sheet and income statement adjustments that vary based on whether the lease is classified as a finance lease or operating lease Determine the impact of lease renewal, termination or purchase options, as well as reassessment requirements Manage differences between US GAAP and IFRS requirements General ledger and chart of accounts may require enhancement to accommodate new asset and liability classifications and reporting requirements Reports Parallel reporting may be necessary for comparative periods presented upon transition Financial reports may need to be enhanced to reflect presentation and disclosure requirements Management reports and key performance indicators may need to be modified to reflect new operating metrics

Impact on NZ IFRS 16 for Asset Managers Do you have many operating leases now? These will be recognised on balance sheet Decisions in the future re lease v buy will change Terms of the lease can impact recognition such as variable payments and the term of the lease Key asset management metrics Property Plant and Equipment per EFTS Return on net assets ratio Facilities burden ratio Revenue to net assets

Impact of NZ IFRS 16 for Asset Managers Profit-based KPIs and bonus arrangements Debt ratios and covenants Tax impact (for for-profit subs); Impact on financial reporting obligations Transitional provisions – choices to make Modified less onerous but will not preserve trend data

Summary

Summary PBEs are currently required to apply PBE IPSAS 13 for leases – operating vs finance distinction For-profits will move to NZ IFRS 16 on 1 Jan 2019 IPSASB is completing a project to implement IFRS 16 into IPSAS This will be included in PBE Standards in the future General requirements is that all leases are on balance sheet Impact of the expected changes will be significant on the balance sheet and profit or loss. Important to understand the expected changes now as they will impact decisions being made today!

Questions?

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