As we come to the end of the first accounting period for the new standard, Imogen Massey provides a quick guide for mining companies.
The new lease accounting standard, IFRS 16, came into effect on 1 January 2019 and many companies will already have adopted it in their interim financial statements. The standard supersedes IAS 17 and introduces a single lease accounting model.
The standard applies to all leases, including those within a sublease arrangement, except for the following:
Leases to explore for or use minerals, oil, natural gas
Leases of biological assets
Service concession arrangements
Licences of intellectual property
Rights held by a lessee under licensing agreements within the scope of IAS 38 Intangible Assets.
What is the focus of IFRS 16?
The new approach aims to achieve greater comparability between companies for both users and preparers of financial statements. It does that by obtaining a more faithful representation of the assets and liabilities that are, in substance, held.
It impacts lessees by requiring them to recognise assets and liabilities for the rights and obligations created by leases. The objective is greater transparency through enhanced disclosure.
Lessor accounting remains substantially unchanged. But lessees must now recognise right of use assets (the right to use the underlying leased asset) and corresponding lease liabilities (the obligation to make lease payments) for all leases, with these limited exceptions:
Lease term under 12 months (‘short term leases’)
Underlying asset of low value (‘low value leases’).
Exactly what is meant by ‘low value leases’ is not clearly defined. So this can be decided lease-by-lease, taking into account the type of underlying asset, its inherent value, and its importance in the core operations of the business.
What are the chief impacts?
Key financial metrics
When they implement IFRS 16, companies will see an impact on financial position, financial performance and cash flows. They must recognise depreciation of the right of use asset and finance costs on the lease liability. The cash repayments of the liability will be classified into a principal and an interest portion and presented in this way in the statement of cash flows.
These changes will affect a company’s key financial metrics, which may vary depending on the nature of the business. Companies will see changes in gross/net assets, liabilities (including classification as current or non-current), depreciation and interest expense, profit before/after tax and EBIT/EBITDA.
As a result, it will be important to consider the impact on bank covenants, key performance indicators including those affecting bonus structures, ability to obtain financing, or fluctuations in share price. Also vital will be an open dialogue to keep key stakeholders informed.
The changes in disclosure under IFRS 16 aim to provide sufficient information for users of the financial statements to assess the impact of leases on the mining company’s financial position, performance and cash flows. Disclosure requirements should be presented in tabular format.
They include but are not limited to:
Depreciation charge for right-of-use assets by class of underlying asset & interest expense on lease liabilities.
Expense relating to short-term leases & low value assets (see above).
Expense relating to variable lease payments not included in the measurements of lease liabilities.
Total cash outflow for leases
Carrying amount of right-of-use assets by class of underlying asset
A maturity analysis of lease liabilities required by IFRS 7, shown separately from other financial liabilities.
Any qualitative information considered relevant to understanding the impact of leases should also be included.
Mining industry specific considerations
Consider contracts that may be affected by IFRS 16, such as:
Service contracts which include use of assets
Mine camp arrangements
Mining services/construction contracts
Power supply contracts.
There are three key considerations to establish whether a contract contains a lease.
1. Is there an identified asset?
If all of the following apply, then there is an identified asset:
An asset is specified in the contract
The asset is physically distinct, or the customer has the right to receive substantially all of the capacity of the asset
The supplier does NOT have substantive substitution rights.
EXAMPLE: Customer A has entered into a contract for the rights to store spare equipment parts in supplier B’s warehouse. The contract terms stipulate a specific area of the warehouse, exclusively available to customer A, and supplier B has no substitution rights à there is an identified asset.
2. Does the customer obtain substantially all of the economic benefits?
This includes the primary output of the asset as well as any by-products and other commercial benefits arising, such as subleasing transactions.
EXAMPLE: Mining entity A entersinto a contract with power supplier B to purchase all electricity produced by the plant over a 20-year period. A will therefore obtain all of the primary product (electricity) from use of the asset. However, B will obtain tax credits relating to ownership of the plant as well as renewable energy credits from use of the asset à it is not clear whether A obtains all of the economic benefits from use of the asset, so further analysis would be required.
3. Who has the right to direct the use of the asset? Who decides HOW and FOR WHAT PURPOSE the asset is used?
Customer: contract contains a lease
Predetermined: further analysis required
Supplier: contract does not contain a lease
EXAMPLE: Mining entity A enters into a contract with supplier B for the use of accommodation units at a mine camp over a five-year period, in which compensation is based on occupancy rates. The assets are identified and the purpose of the units is predetermined in the contract. However, A has control over when and how much the assets are used and where they are to be placed on the mine site à A makes the HOW and FOR WHAT PURPOSE decisions. Written by Imogen Massey in our London office.