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Leases

 

Potential accounting change

The new rules propose that all leases will be on balance sheet, measured at the present value of future estimated lease payments. This means that ‘operating leases’ will no longer exist. This change is a result of a joint project between the IFRS and US GAAP standard setters and so will be applicable to both IFRS and US GAAP financial statements.

 

  • When?

The new standard will likely be applicable from 2013

 

  • Valuation impact - Enterprise Value

There will be no need to convert operating leases into ‘debt equivalents’ since this information will be available on the balance sheet. No more ‘Rule of 8’ for those who had previously used this multiples based approach to making the adjustment

 

  • Valuation impact - EBIT/EBITDA

Also potentially no more ‘EBITDAR’, as all lease rentals will be treated consistently in the income statement (part depreciation and part interest)

 

Defined benefit pensions

 

Accounting changes

Only the IFRS rules have been amended and there are two key changes: The IFRS corridor method has been abolished. This method allowed smoothing of actuarial changes through the income statement, thus avoiding presenting the true pension surplus or deficit on the balance sheet. This brings IFRS closer to US GAAP in that now all companies will use ‘full recognition method’ such that the true pension surplus or deficit is shown on the balance sheet. Actuarial changes will be booked directly to equity. US GAAP however continues to recycle these changes to the income statement gradually over time.

 

The pension expense calculation and presentation under IFRS has changed.

 

Old pension  expense (IFRS)

Service cost

X

Interest cost

X

Expected return on assets

(X)

Pension  expense

X

New pension  expense (IFRS)

Service cost

X

Net interest cost

X

Pension  expense

X

 

The new ‘net interest’ cost is calculated on the net pension deficit / surplus at the start of the period using a high quality corporate bond yield at the end of the accounting period. US GAAP pension expense is not due to change.

 

  • When?

The new IFRS rules are effective 1 January 2013 with early adoption allowed. This means the new rules could be seen in financial statements with year-ends of 2011 onwards.

 

  • Valuation impact - Enterprise Value

When treating pension as a debt equivalent, although the full pension surplus or deficit will always be presented on the balance sheet, it is still possible that it could be split across different items, for example, some shown in ‘current’ and some shown in ‘non-current’ assets and/or liabilities. Also during the transition period, some may not be applying the new rules yet. This means we continue to recommend that the pension footnote is used to establish the surplus or deficit.

 

  • Valuation impact - EBIT/EBITDA

When treating pension as debt equivalent, EBIT / EBITDA will need to be cleaned of non- operating items as before so that it is AFTER service cost but BEFORE other pension line items. For IFRS companies, instead of removing both ‘interest cost’ and ‘expected return on assets’, just the ‘net interest cost’ will need to be removed from earnings.

 

Financial instruments

 

Accounting changes

The IFRS accounting rules on derivatives are being re-written. US GAAP continues unchanged at present which means potentially significant differences between financial statements. The IFRS rules are being re-written in three stages. Stage 1 about classifications and measurement of financial assets/liabilities, has been completed.

 

Classification

 

Financial  assets (old IFRS)

Fair value through P&L / IS

Available for sale

Held to maturity

Loans and receivables

Financial  assets (new IFRS)

Fair value through P&L / IS (FVTPL)

Fair value through OCI (FVOCI)

Amortized cost

The rules for valuing the financial assets have not changed, however where previously the ‘available for sale’ category was the default for any asset which did not fit into another category, now FVTPL is the default category. Fair value changes on FVOCI assets will be booked directly to equity as before, but will not be recycled to the income statement when the assets are sold.

 

  • When?

The new IFRS rules are effective 1 January 2013 with early adoption allowed. This means the new rules could be seen in financial statements with year-ends of 2011 onwards.

 

  • Valuation impact - Enterprise Value

A decision will still need to be made as to whether these investments, especially derivatives (FVTPL) are core or non-core. Balance sheet values should approximate to market values.

 

  • Valuation impact - EBIT/EBITDA

A decision will need to be made whether fair value movements which have affected operating profit are operating in nature or not. Interest and dividends received are typically excluded from EBIT/EBITDA.

  

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