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AASB 16 - The New Leasing Standard

11 August 2017

Susan Oldmeadow-Hall, Associate Director |

THE ‘TRIPLE WHAMMY’

Between now and 2020, financial reporting will undergo the most significant change this century with the introduction of three new accounting standards; AASB 9 Financial Instruments, AASB 15 Revenue from Contracts with Customers and AASB 16 Leases.

This ‘triple whammy’ of standards will have various impacts including; how bad debt provisions are calculated, make it easier for mining companies to achieve hedge accounting, introduce very complex rules as to when revenue can be recognised and effectively scrap the operating lease classification, bringing all leases, together with the lease liability onto a company’s balance sheet.

Much of the financial reporting focus to date has been on AASB 9 and 15, which are effective from 1 January 2018 with AASB 16 applicable from 1 January 2019, leading many to put the consideration of AASB 16 adoption on the back burner. However, adopting AASB 16 is especially complex for mining companies due to the asset intensive nature of the mining industry. It is highly recommended that miners perform a preliminary assessment as soon as possible, to determine how their financial reporting will be affected and what systems and processes should be put in place

NEW LEASING MODEL – BALANCE SHEET AND P&L EFFECTS

Under AASB 16 miners apply a single accounting model for all leases, with options not to recognise short term leases (those for a period of 12 months or less) and leases of low value assets (less than US$5,000 when new) on the balance sheet.

Miners will recognise a liability to make lease payments and an asset representing the right to use the asset during the lease term on commencement of a lease. Rent expense is replaced with the interest expense on the lease liability and the depreciation expense on the right of use asset in the profit and loss account. If the right of use asset is depreciated on a straight-line basis, this will result in a front loaded expense recognition pattern. In addition, miners will have to consider whether the right of use asset is impaired and may incur impairment charges to the profit and loss in respect of this asset.

CONTRACT ASSESSMENT IS IMPORTANT

Miners will need to exercise judgement to determine which contracts and arrangements are in the scope of the standard. Because accounting for operating leases under the current leasing standard AASB 117 and accounting for service contracts is similar, determining whether a service contract contains a leasing element has not been a focus for many mining companies. That will now have to change with the introduction of AASB 16.

Determining whether a mining company directs the use of an identified asset within some service contracts can be complicated. Consider the example of a miner that has outsourced mining services (wet hire) contracts. AASB 16 is likely to require significant judgement and analysis to determine whether the contract contains leasing elements. Consideration of which entity (the miner or the wet hire provider) has the right to make the decisions that most significantly affect the economic benefits derived from the use of the underlying assets. This involves judgement about who directs the use of wet hire equipment. Additional factors to consider are whether the contract miner can substitute equipment and whether the miner pays for insurance of the equipment

IDENTIFYING NON-LEASE COMPONENTS OF CONTRACTS

Many contracts contain a lease with an agreement to purchase or sell other goods or services (non-lease components). Examples of contracts entered into by mining companies that may comprise of non-lease components are:

  • On site power station and generation sets, including maintenance and staff to run the power station;
  • Wet hire contracts that include equipment and staff;
  • Transportation agreements that include vehicles and drivers;
  • Contract for a mine site camp that includes provision of cleaning and food preparation services; and
  • Exploratory drilling contracts.

SEPARATION OF LEASE AND NON-LEASE COMPONENTS

Whilst AASB 16 allows lessees to make an accounting policy election to include the non-lease components within the leasing obligation, to do so will result in more debt on the balance sheet. We anticipate that most miners will prefer to separate out the non-lease service elements within contracts and account for these separately as expenses when incurred.

Allocating amounts charged under agreements to the lease and non-lease components is likely to be a difficult exercise. Most supplier contracts do not separately identify the standalone prices of each element within the contract, nor provide information required to account for the leasing liability, such as the interest rate implicit in the agreement.

Miners will need to put in place robust systems and processes to identify leases and to separate the lease and non-lease components of contracts.

ENGAGEMENT WITH SERVICE PROVIDERS

With the adoption of AASB 16 less than 18 months away, we recommend that miners engage with their service providers to obtain the information they need to account for leased assets within contracts, particularly those long-term contracts that will still be in effect at transition date. Miners may want to consider renegotiating existing contracts to minimise the impact of the new standard. Miners may want to move to more service-type agreements rather than leases, move to a shorter lease term or include more variable lease payments based on the usage of the asset.

IMPACT ON FINANCIAL METRICS AND BUSINESS PROCESSES

Miners need to understand the impact of AASB 16 on their financial metrics such as the gearing ratio (which will deteriorate due to more debt) and EBITDA (which will improve because rent expense is replaced by depreciation and interest expense). This may affect covenants, credit ratings, borrowing costs, earn out clauses and employee bonus schemes.

Changes introduced by AASB 16 are likely to have a farreaching impact on miners’ business processes, systems and controls. Miners will require significantly more data around their leases. For miners that have operations in a number of different locations without a central office controlling contracts entered into, this is likely to present significant challenges.

As the implementation date of AASB 16 approaches, it is essential for miners to fully understand the changes introduced by this standard so they can keep audit committees, boards, auditors, shareholders, analysts and other key stakeholders informed about the impacts of this new standard.