IFRS 16 Leases and the Mining Industry

Introduction

The International Accounting Standards Board (IASB) issued IFRS 16 Leases on 13 January 2016.  Revising the lease accounting requirements was first added to the IASB’s agenda in 2006, since then a number of exposure drafts have been issued and hotly debated. 
The IASB estimates that listed companies using International Financial Reporting Standards (IFRSs) or US Generally Accepted Accounting Principles (USGAAP) currently have approximately US$3.3 trillion of lease commitments, of which 85% are operating leases and therefore have no balance sheet impact.
IFRS 16 is effective for reporting periods beginning on or after 1 January 2019.  This article discusses the key implications of IFRS 16 on the energy, mining and resources sector (EMR).
 
Key changes

Under IFRS 16 there is no longer a distinction between finance and operating leases for lessees.  Lessees will now bring to account a right-to-use asset and lease liability onto their balance sheets for all leases [1].  Effectively this means the vast majority of operating leases as defined by the current IAS 17 Leases which currently do not impact the balance sheet will be required to be capitalised on the balance sheet once IFRS 16 is adopted.

Day 1

Dr Right-to-use asset

                Cr lease liability

This will increase both assets and liabilities on the entities balance sheet and may impact bank covenants such as Debt/Equity and times interest earned ratios.  Entities will need to consider revising any bank covenants likely to be impacted upon in the lead up to adopting IFRS 16.

From a P&L perspective operating leases are typically expensed on a straight line basis under IAS 17.  The new IFRS 16 treatment will result in both a depreciation and interest charge impacting upon the P&L.

Depreciation is likely to be on a straight basis however interest is higher in the initial years.  This will have the effect of front loading expenses in the P&L which will reduce over the life of the lease.

The impact of IFRS 16 on lessors is expected to be minimal.
 
What types of leases are impacted?

Many people are under the impression that IFRS 16 only applies to leases of property.  This is incorrect.  IFRS 16 applies to the following arrangements:

‘A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration (IFRS 16.9)’

This means, leases of vehicles, mining equipment (such as drilling rigs), mine camps and even generators will be classified as leases under IFRS 16 [2].
 
Non-lease components

Some lease contracts contain both a lease and non-lease component.  IFRS 16 paragraph 12 states:
‘For a contract that is, or contains, a lease, an entity shall account for each lease component within the contract as a lease separately from non-lease components of the contract, unless the entity applies the practical expedient in paragraph 15.’

The practical expedient allows a company to elect:
  • not to separate non-lease components from lease components, and instead account for each lease component and any associated non-lease components as a single lease; or
  • separate out the different components within the lease and account for non-lease components applying other applicable Standards.
Example

My client has a lease of a motor vehicle $1,000 per month.  Included in the cost is $100 per month related to future servicing and maintenance of the vehicle.

How is this treated under IFRS 16?

The client has two options:

1. Separate out the non-lease component (servicing and maintenance of $100 per month) and include the $900 per month in the calculation of the lease liability; or
2. Include $1,000 per month in the calculation of the lease liability (using the practical expedient in paragraph 15)
 
Initial measurement

Once you have established there is a lease then IFRS 16.27 requires you to measure the lease liability at inception by present valuing the following payments:
  • fixed payments less any lease incentives receivable;
  • variable lease payments that depend on an index or a rate;
  • amounts expected to be payable by the lessee under residual value guarantees;
  • the exercise price of a purchase option if the lessee is reasonably certain to exercise that option; and
  • payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.
These payments will be discounted using the interest rate implicit in the lease or if that rate cannot be readily determined, the lessee’s incremental borrowing rate.  For the majority of leases in the EMR sector the implicit rate will not be determinable so companies will need to establish an estimate of their incremental borrowing rate.  IFRS 16 defines the incremental borrowing rate as:

‘the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment’

This will require significant judgement particularly for those entities in the exploration and evaluation phase!
Once the lease liability is measured you will then need to calculate the right-of-use asset (ROU).  IFRS 16. 24 states that the cost of the right-of-use asset shall comprise:
  • the amount of the initial measurement of the lease liability;
  • any lease payments made at or before the commencement date, less any lease incentives received;
  • any initial direct costs incurred by the lessee; and
  • an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories.
 
Transition

IFRS 16 permits 2 main transitional options. These are:

1. Retrospectively to each prior reporting period presented as if the standard always applied (including changing the comparative year P&L and the opening balance sheet of the comparative year).
2. Retrospectively but with the cumulative effect of initially applying the Standard recognised at the date of initial application (i.e. the start of the actual year with no restatement of the comparative year).

The lessee must apply the election described above consistently to all of its leases in which it is a lessee (i.e. all leases under option 1 or all leases under option 2).

Under option 2 there are two choices of how to measure the ROU asset (which can be applied on a lease by lease basis):

1. Recognise a lease liability at the present value of the remaining lease payments, discounted using the lessee’s incremental borrowing rate at the date of initial application and recognise a right-of-use asset as if IFRS 16 had always applied, but discounted using the lessee’s incremental borrowing rate at the date of initial application; or
2. Recognise a lease liability at the present value of the remaining lease payments, discounted using the lessee’s incremental borrowing rate at the date of initial application and recognise a right-of-use asset an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease recognised in the statement of financial position immediately before the date of initial application (the date of initial application is the start of the actual year).

This means there are effectively 3 transitional options and a variety of practical expedients under the standard.  The transition will be complicated!
 
Next steps

To make this transition less arduous for businesses, Moore Stephens has developed some templated models which apply the new AASB/IFRS 16 Lease standard. Significantly simplifying the steps involved to achieve the calculation, there are only five to 10 data inputs per lease required and accounts for multiple scenarios. For a straightforward leasing arrangement, the process should take less than 30 minutes per lease to complete.
Access to the templates is not restricted to ongoing Moore Stephens’ clients, as each template is available for stand-alone purchase by contacting our audit and assurance team

(https://www.moorestephens.com.au/landing-pages/aasb-16-leases). The lease models are delivered as an Excel Zip file of Excel workbooks that cover the periods 2010 to 2040. If your requirements are outside these date ranges, or for technical support, please email vicleasesupport@moorestephens.com.au

Some companies may require greater guidance, particularly if a CFO or technical accountant is not directly employed within the business or the leasing portfolio is extensive, and that’s when it would be best to call on our expert advice. For you local contact, please click here.
 
[1] IFRS 16 contains an exemption from these requirements for short-term or low value assets.  Typically these are leases of less than 12 months or leases of items such as laptops or phones.
[2] Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources are scoped out of the standard.