IFRS 16 Leases Rosenswig Mc Rae Thorpe LLP

IFRS 16 - Leases Rosenswig Mc. Rae Thorpe LLP ROSENSWIG MCRAE THORPE LLP

IFRS 16 brings almost all leases, including leasing of real estate, onto the balance sheet. Key performance metrics will be affected as assets and liabilities are increased and expenses become front-loaded. Leasing clients will need to consider the financial statement impact of leases that are significantly different from today. ROSENSWIG MCRAE THORPE LLP

Agenda §IFRS 16 §Overview §Accounting details §Transition §Example §Impact of changes §Takeaways for Company’s business ROSENSWIG MCRAE THORPE LLP

IFRS 16 - Overview §Elimination of operating lease classification for lessees §Effective for periods beginning on or after January 1, 2019 §Replaces current lease standards (mainly IAS 17) §Increased transparency and comparability and removes the need for analysts to adjust for off-balance-sheet leases ROSENSWIG MCRAE THORPE LLP

IFRS 16 - Overview § Lessees have to recognize assets and liabilities for most leases; exceptions: §Lease term is 12 months or less §Underlying asset has a low value (<$5, 000 for example) § Lessors can classify leases as operating or finance (fairly similar to current standards) ROSENSWIG MCRAE THORPE LLP

Accounting for Lessees Initial Recognition § Record an asset (right-of-use asset) §= Lease Liability + Direct Costs + Any adjustments § Record a liability (lease obligation) §= Present value of lease payments over the lease term ROSENSWIG MCRAE THORPE LLP

Accounting for Lessees Leases: a guide to IFRS 16. Deloitte. June 2016 ROSENSWIG MCRAE THORPE LLP

Accounting for Lessees Subsequent Measurement § Asset §Use the Cost Model – record it at cost less accumulated depreciation less accumulated impairment §Exception for Investment Properties that are recorded at fair value § Liability §Amortized using effective interest method ROSENSWIG MCRAE THORPE LLP

Accounting for Lessors § Fairly similar to IAS 17 as they continue to classify the lease as either an operating lease or a finance lease §Application of IFRS could result in different accounting treatment between lessor and lessee ROSENSWIG MCRAE THORPE LLP

Transition TWO OPTIONS FOR THE LESSEE: 1) Apply IFRS 16 to all contracts that potentially contain leases §Higher cost and increased comparability OR 2) Apply IFRS 16 to only to contracts signed after adoption §Lower cost and reduced comparability ROSENSWIG MCRAE THORPE LLP

Transition If applied to all contracts, there is a choice between: 1) Apply with and state full retrospective effect §Higher cost and increased comparability 2) Do not restate comparative information and recognise the cumulative effect as an adjustment to opening equity at the date of adoption §Lower cost and reduced comparability ROSENSWIG MCRAE THORPE LLP

EXAMPLE § The lessee enters into a 10 year lease for a floor of a building, with the option to extend for 5 more years. § Lease payments are $50, 000 during the initial term of the lease and $55, 000 during the optional period. § All payments are payable at the beginning of the period. § The lessee pays $5, 000 to a real estate agent for commission for arranging the lease and $15, 000 to a former tenant that was previously occupying the floor. § The lessor, as an incentive, agrees to reimburse the lessee for the $5, 000 paid for commission and also pay for the lessee's leasehold improvements of $7, 000 ROSENSWIG MCRAE THORPE LLP

EXAMPLE § At the commencement date, the lessee concludes that it is not reasonably certain to exercise the option to extend the lease (making the lease term 10 years) § The interest rate implicit in the lease cannot be determined. § The company’s borrowing rate is 5%. This is the rate that the company could borrow funds to get an asset of the same nature for the same term. ROSENSWIG MCRAE THORPE LLP

EXAMPLE Initial Recognition (IFRS 16) Dr. Right-of-use asset $405, 391* Cr. Lease Liability $355, 391 Cr. Cash (payment for the 1 st year) $50, 000 To record the present value of the lease payments. Dr. Right-of-use asset Cr. Cash To record direct costs $20, 000 Dr. Cash Cr. Right-of-use asset $5, 000 To record lease incentive $20, 000 $5, 000 Initial Recognition (IAS 17) No asset recorded on the books Dr. Expense Cr. Cash To record direct costs Dr. Cash Cr. Lease Incentive To record lease incentive $20, 000 $5, 000 *present value of 10 payments of $50, 000 made at the beginning of the year, discounted at 5% ROSENSWIG MCRAE THORPE LLP

EXAMPLE Subsequent Measurement: (IFRS 16) Dr. Amortization $42, 039* Cr. Accumulated Depreciation $42, 039 To record depreciation Dr. Lease Liability $50, 000 Cr. Cash $50, 000 To record payment of lease liability Subsequent Measurement: (IAS 17) No depreciation recorded. Dr. Lease Expense $49, 500 Dr. Lease Incentive $ 500 Cr. Cash $50, 000 To record payment of lease liability Dr. Interest expense $17, 770** Cr. Lease Liability $17, 770 To record interest expense on lease liability *Value of the asset is $420, 391 initially – depreciated straight line over 10 years **Value of the lease liability is $355, 391 initially – recognize interest at 5% of remaining balance ROSENSWIG MCRAE THORPE LLP

IMPACT ROSENSWIG MCRAE THORPE LLP

IMPACT Income Statement Impact 80, 000 70, 000 60, 000 Expense 50, 000 40, 000 30, 000 20, 000 10, 000 - 1 2 3 IFRS 16 4 5 Operating Year ROSENSWIG MCRAE THORPE LLP 6 7 8 9 10

IMPACT Equity - 1 2 3 4 5 6 - 100, 000 - 200, 000 - 300, 000 - 400, 000 - 500, 000 - 600, 000 IFRS 16 Operating ROSENSWIG MCRAE THORPE LLP 7 8 9 10

Impact of Changes - Basics Financial Statement Balance Sheet Income Statement Cash Flow Impact Higher Assets and higher liabilities Front-loading of expenses Shift operating cash flows to financing cash flows (presentation only) Note: the impact described above and in the following slides apply to lessees who accounted for a particular lease as an operating lease under the current standards ROSENSWIG MCRAE THORPE LLP

Impact of Changes – Balance Sheet §Higher assets (non-current) §Higher liabilities (split between current and non-current); lessees appear more leveraged as leases are brought onto the balance sheet Ratios §Working capital ratios weakened by current portion of lease obligation §Capital turnover ratios are weakened by increased assets ROSENSWIG MCRAE THORPE LLP

Impact of Changes – Income Statement IFRS 16 Current standards Amortization expense on asset Rent expense straight-lined + over the lease term Interest expense on liability §In earlier years, the expense under IFRS 16 will exceed the expense that would have otherwise be recognized under current standards (frontloading expenses) §Transaction costs capitalized and amortized over the lease term rather than fully expensed in current period (reduces front-loading for year 1) ROSENSWIG MCRAE THORPE LLP

Impact of Changes – Income Statement §Lower net income in earlier years due to the frontloading effect §Higher EBITDA; lease expense is now classified as interest and amortization, which are below-the-line items for EBITDA §Generally a unfavourable impact on interest coverage ratios in earlier years ROSENSWIG MCRAE THORPE LLP

Impact of Changes – Lease vs. Buy §Much more consistent financial statement impact §Asset recognized in both scenarios, however: § Cost of asset could be very different if market price is not consistent with PV of lease payments §Liability recognized in both scenarios, however: § Lease obligation shows higher leverage than a mortgage on a purchased asset §Decision should now be focused on economic factors rather than FS presentation considerations ROSENSWIG MCRAE THORPE LLP

Impact of Changes – Sale and Leaseback §Sale and lease back arrangements no longer effective as an offbalance-sheet financing structure because leases are brought back onto the balance sheet §Could reduce the volume of sale and leaseback transactions ROSENSWIG MCRAE THORPE LLP

Take-aways for Company’s business §Larger, public companies will be forced to apply IFRS 16, but small businesses currently do not have to apply these standards and there are no equivalent standard in the pipeline for small businesses that apply Accounting Standard for Private Enterprises (ASPE) instead of IFRS §Expect a reduction in appetite for sale-and-leaseback transactions from clients who apply IFRS ROSENSWIG MCRAE THORPE LLP

Take-aways for Company’s business §For clients who apply IFRS 16, they will likely prefer to arrive at a lower lease liability to be recognized on their books in one of these two ways: 1. Reduce the accounting lease term by adding some uncertainty to the renewal options; 2. Shift some fixed payments to become variable payments; true variable payments are not included in the lease obligation ROSENSWIG MCRAE THORPE LLP

Questions? Further questions can be sent to: Rosenswig Mc. Rae Thorpe LLP Chartered Professional Accountants Associated Worldwide with CPA Associates International, Inc. Jeff Mc. Rae: jeff@rmtcpa. ca Yale Ren: yale@rmtcpa. ca Amrita Siva: amrita@rmtcpa. ca ROSENSWIG MCRAE THORPE LLP Michael Rosenswig Jeff Mc. Rae Lori Thorpe Tony Rosso Lorraine Varga