End of the runway for off balance sheet leases

End of the runway for off balance sheet leases

James Stamp, global head of aviation at KPMG, comments on the impact on the airline sector of the new lease accounting standard published by the International Accounting Standards Board (IASB).

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James Stamp, global head of aviation at KPMG, comments on the impact on the airline sector of the new lease accounting standard published by the International Accounting Standards Board (IASB). He said: 

“Airlines have over US$150bn of future lease payments currently sitting off-balance sheet. This represents about 29% of total assets, and IFRS 16 - which has arrived after a long and painful gestation - will have a significant impact on Balance Sheets and gearing. Profit metrics will also change markedly. Moving from straight-line to front loaded recognition of total lease expense will mean that the timing of major fleet renewals (or expansion) will impact the profile of profit generation over time.

“It is clear that the IASB’s intention is to increase transparency and comparability in financial statements by removing what they saw as an arbitrary distinction between finance and operating leases.  Whilst there will be little impact for aircraft lessors, airline balance sheets and income statements will be dramatically affected.”

Impacts include:

Airlines with operating leased aircraft will appear to be more asset-rich, but also more heavily indebted;

Sale and leaseback – as a method of off balance sheet financing – ceases to be an option;

Airlines will now recognise a front-loaded pattern of expense for most leases, even when they pay constant annual rentals;

Lease expense will now be presented as part depreciation and part interest rather than as operating cost, increasing EBIT and EBITDA;

Airlines expanding or renewing their fleets on operating leases will see their EPS suffer versus the old treatment in the early years of the leases.  Those with fleets towards the end of their lease terms should see their EPS benefit.

Airline lease payments are generally denominated in USD.  For non US carriers, the USD debt will be revalued at each reporting period whilst the asset will not, creating currency volatility in the profit and loss unless it has been hedged.

“With the expansion in the use of operating lease in recent years, in particular narrow bodied fleets, the impact on airlines indebtedness collectively is likely to very significant. Whilst bankers and analysts have been well aware of these structures and economic exposures, the balance sheets of many airlines will look very different from 2019 when the standard takes effect.”

ENDS

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Notes to Editors:About KPMG

KPMG LLP, a UK limited liability partnership, operates from 22 offices across the UK with approximately 12,000 partners and staff.  The UK firm recorded a revenue of £1.96 billion in the year ended September 2015. KPMG is a global network of professional firms providing Audit, Tax, and Advisory services. It operates in 155 countries and has 174,000 professionals working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity.  Each KPMG firm is a legally distinct and separate entity and describes itself as such. 

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