Victor Chan, Partner, EY 29 November 2016FILE/ey-ifrs-roundtable-victor-chan.pdfVictor Chan,...

10TH European IFRS power and utilities roundtableVictor Chan, Partner, EY

29 November 2016

European IFRS Power and Utilities roundtable IFRS 16 Leases: the journey so far

November 2016

European IFRS Power and Utilities Roundtable

Agenda

► Overview

► Definition of a lease

► Variable lease payments and discount rate

► Transition

► Practical considerations


Accounting substantially the same

Overview

Key changes primarily affecting

lessees

Lessors

Recognise assets and liabilities for most leases

New presentation and disclosure requirements

New standard will be effective for annual periods beginning on or after 1 January 2019 with limited early adoption permitted


Agenda

► Overview



► Transition



Definition of a lease

Lease

There is an identified asset(consider substitution rights)

The contract conveys the right to control the use of the identified asset for a period

of time in exchange for consideration

Could the last mile of a network be an identified asset?


Right to control the use of the identified asset

Definition of a lease (cont.)

Right to obtain substantially all of the economic benefits

Relevant decisions about how and for what purpose the asset is used are predetermined, AND► The customer has the right to

operate the asset without the supplier having the right to change those operating instructions. OR

► The customer designed the asset in a way that predetermines how and for what purpose the asset is used.

OR

ANDRight to direct the use

Customer has the right to direct how and for what purpose the asset is used:► Can change how and for what

purpose.► For example, what the asset is used

for, when it is used, whether it is used and how much it is used.


Definition of a lease: portions of assets

► A capacity portion of an asset is an identified asset if it is physically distinct► Example: a floor of a building

► The capacity portion of an asset is not an identified asset unless it represents substantially all the capacity of the entire asset► Example: contract for a portion of the capacity of a power

plant


► Designed and constructed the wind farm

► Has no substitution rights► Operates and maintains the

wind farm and retains certain rights to protect its interest

► Cannot determine or change the amount of output during the contract

► Will pay a fixed capacity charge and a variable charge based on actual production

Definition of a lease: illustrative example –fact pattern A utility company (Customer) enters into a contract with a power company (Supplier) to purchase all of the electricity produced by its wind farm for five years.

Question: Does the arrangement contain a lease?

Supplier Customer


Definition of a lease: illustrative example –analysis and conclusion

► The wind farm is an identified asset as it is explicitly identified and Supplier has no substitution rights

► Customer has the right to obtain substantially all the economic benefits as it has the right to 100% of the ouput

► However, Customer does not have the right to direct how and for what purpose the asset is used► The decisions about how and for what purpose the asset is used

are predetermined► The supplier operates the asset

Conclusion: the arrangement does not contain a lease


Definition of a lease: illustrative example –additional consideration► How would the analysis be affected by the following

individually?► Customer is getting less than substantially all of the capacity output► Supplier may deliver energy from any power plant or purchase from

any third party► Customer determines (i.e., changes) the amount of output during the

contract ► Customer designed the asset in a way that pre-determined how and

for what purpose the asset is used► Customer operates the asset► Customer pays a fixed amount per unit of output for the arrangement

The analysis is sensitive to facts and circumstances


Agenda

► Overview



► Transition



Measurement of lease liability by a lessee

► Fixed payments during the lease term► Including in-substance fixed payments► Less lease incentives receivable

► Variable lease payments► Based on an index or a rate

► Residual value guarantee amount expected to be payable by the lessee

► Exercise price of purchase options (if included)► Termination penalties (if included)

Identify LEASE PAYMENTS

► Rate implicit in the lease, if readily determinable► Otherwise, incremental borrowing rate

Apply DISCOUNT RATE

► Non-cancellable period► Extension options ► Termination options

‘Reasonably certain’ assessment

Determine LEASE TERM


Variable lease payments

► Variable lease payments that depend on an index or rate are:► Included in lease payments at the commencement date► Measured using the index or rate at that date► Remeasured when there is a change in the cash flows

► Variable lease payments that do not depend on index or rate are:► Not included in lease payments at the commencement date► Recognised in profit or loss in the period in which the event which

triggers the payment occurs► Example: payments based on usage of the asset► Lease payments based on the actual solar power plant output

considered variable as sunshine could be fairly predictable?


Discount rate for a lessee

► Lease payments are discounted using:► Interest rate implicit in lease, if readily determinable

► Otherwise use lessee’s incremental borrowing rate

► Lessee’s incremental borrowing rate:► Rate of interest that a lessee would have to pay to borrow over a

similar term, and with similar security, the funds necessary to obtain an asset of similar value to the right-of-use asset in a similar economic environment


Agenda

► Overview



► Transition



Transition

► Full retrospective or modified retrospective approach for lessees – apply consistently to all leases► Full retrospective approach – as if IFRS 16 had always applied

► There are a number of practical expedients available► Specific disclosures required for expedients used

► Practical expedient: permitted to not reassess whether contracts are, or contain, a lease► Must be applied to all contracts ongoing at the date of initial

application and disclose that fact


Selected transition requirements

► If the modified retrospective method is adopted, for leases previously classified as operating leases► Recognise a right-of-use asset at the date of initial application

► As if the standard had been applied (discounted using the lessee’s incremental borrowing rate at the date of initial application)

Or► An amount equal to the lease liability, adjusted by the amount of any

prepaid or accrued lease payments

► Disclose, at the date of initial application► The weighted average lessee’s incremental borrowing rate applied an

explanation of any difference between► Discounted operating lease commitments disclosed applying IAS 17And► Lease liabilities recognised in the statement of financial position


Agenda

► Overview



► Transition



► Does the entity use a standard lease/service contract or do the form and content vary?

► Does the entity operate in a decentralised or centralised environment?

► What type of arrangements does an entity have that could be affected by the revised definition of a lease?

► How does an entity plan to identify any necessary changes?

► Will management be required to make more judgements when evaluating contracts?

… verify the completeness of their portfolio of leases

Entities need internal processes, controls and systems in place to…

… evaluate whether a contract is or contains a lease

Definition of a lease: practical considerations


► What are the factors affecting the decisions to renew, extend or terminate a lease arrangement?

► Are any payments in-substance fixed payments?

► Term specific► Security specific► Right-of-use asset specific► Economic environment specific► May need professional valuation assistance

… evaluate items to be included in lease payments

… evaluate the appropriate discount rate

Measurement of lease liability: practical considerations

Entities need internal processes, controls and systems in place to…


Other practical considerations

► Understand how the standard may affect the business, especially customers’ behaviour► Whether arrangements are or contain a lease► Fixed vs variable payments

► Understand how the standard will affect KPIs and covenants► Keep stakeholders (boards, shareholders, analysts) informed► Consider interpretation and views from regulators, standard

setters, practitioners and peers► Seek advice when necessary

10TH European IFRS power and utilities roundtable

29 November 2016

Victor Chan, Partner, EY 29 November 2016FILE/ey-ifrs-roundtable-victor-chan.pdfVictor Chan,...

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Transcript of Victor Chan, Partner, EY 29 November 2016FILE/ey-ifrs-roundtable-victor-chan.pdfVictor Chan,...