IFRS 16 for small Airlines with all dry operating leases

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zubairkhan
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Joined: 29 Aug 2020, 06:41

IFRS 16 for small Airlines with all dry operating leases

Post by zubairkhan »

Hi,

One of our domestic airlines had all aircrafts on dry operating leases (reported off balance sheet). Now they have to adopt IFRS 16. They are paying lease rentals and remaining period of lease is 144 months. The Pakistan Civil Aviation Authority requires a minimum threshhold of equity for renewal of operating licence. Adopting IFRS 16 is resulting in significant decline in equity. The calculation for recognising Right to Use Asset and Lease obligation, was performed, on remaining lease term using LIBOR as of July 1, 2019 as incremental borrowing rate. The financial year end is June 30. There is no right to purchase in the lease agreement nor it is a non-cancellable lease . In addition to that the National Aviation Policy is limiting operations of a passenger aircraft to maximum of 25 years. There is no way to have useful life longer enough to get some margin in depreciation expense. All rentals are paid in USD and their is huge exchange rate volatility.

My questions if anyone can help?

1) Should only remaining lease rentals be accounted for in adopting IFRS 16 or Maintenance Reserves (paid monthly) will also have to be taken into account
2) If this Airline succeeds in recognition with lessor by including purchase option or succeeds in converting the lease as non cancellable lease, will this convert the entire agreement into financial lease? I think these amendments will automatically make this arrangement a financial lease.

Would appreciate responses from members
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Marek Muc
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Re: IFRS 16 for small Airlines with all dry operating leases

Post by Marek Muc »

1) This is a policy choice, see here:
https://ifrscommunity.com/knowledge-bas ... components

2) Under IFRS 16, there is no distinction between operating and finance leases for lessees, see here how all leases are recognised by lessees:
https://ifrscommunity.com/knowledge-bas ... of-leases/
Adopting IFRS 16 is resulting in significant decline in equity.
That's surprising. What is the % impact on equity compared to the value of recognised right-of-use assets?
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nauman
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Re: IFRS 16 for small Airlines with all dry operating leases

Post by nauman »

Why are you using LIBOR to discount the lease rentals? IFRS 16 requires the entity to use incremental borrowing rate (if implicit rate of return is not available). I am pretty sure any entity (specially one in Pakistan and that too in aviation industry) would be able to borrow at LIBOR.

Second, you can recognize the liability on remaining lease rentals if you adopt the modified retrospective approach on date of adoption of IFRS 16 as the transition agreement. In this case you will calculate lease liability by discounting remaining lease payments using an appropriate discount rate. Given that your lease payments are in USD you will most probably use a LIBOR based discount rate (though it cannot just be LIBOR as you need to account for company specific risk). Once you calculate the liability, your right-of-use asset will be equal to liability and adjusted for any prepayments or lease accruals that you are currently carrying on your balance sheet.

On a net basis, the adoption of standard should not have any impact on your equity. So I am not sure why you are saying that adoption of IFRS 16 has resulted in a significant decline in equity. There is a front loading impact on earlier periods but that would come by end of the financial year (and should not be that significant).
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