Lassila & Tikanoja Plc: Impacts of the adoption of the IFRS 16 standard and the IFRS 16 adjusted opening balance sheet 1.1.2019

Lassila & Tikanoja plc
Stock exchange release
25 April 2019 9.15 am

Lassila & Tikanoja Plc: Impacts of the adoption of the IFRS 16 standard and the IFRS 16 adjusted opening balance sheet 1.1.2019

IFRS 16 Leases is effective for annual periods beginning on or after 1 January 2019. The standard sets out the principles for the recognition, measurement, presentation and disclosure of leases. The new standard supersedes the IAS 17 standard and related interpretations.

Lassila & Tikanoja Plc (L&T) adopted IFRS 16 Leases using the modified retrospective method of adoption in which the cumulative effect of initially applying the standard is recognised at the date of initial application of January 1, 2019 and comparative information is not restated. Lessor accounting remains substantially unchanged compared to the guidance under IAS 17 Leases and the adoption of IFRS 16 did not impact the accounting for lease contracts where L&T is the lessor.

Prior to the adoption of IFRS 16, lease contracts were classified as either finance leases or operating leases. A lease was classified as a finance lease if it transferred substantially all the risks and rewards incidental to ownership of the leased asset to the lessee. Commitments related to finance leases were recognised as finance lease liabilities and discounted using the interest rate implicit in the lease. An asset with an equivalent amount was recognised in tangible assets. Lease payments were apportioned between interest recognised as finance cost and a reduction of the lease liability. For leases classified as operating leases, lease payments have been recognised in earlier periods as lease expense in the income statement and the undiscounted commitments related to these leases have been presented in the notes to the financial statements.

IFRS 16 changes the accounting treatment for especially leases previously classified as operating leases. The standard requires lessees to account for the majority of lease contracts under a single on-balance sheet model. At the commencement date of the contract, a lessee recognises a lease liability and a corresponding right-of-use asset in the balance sheet. The lease liability is measured at the present value of the remaining lease payments at that date. In the income statement, instead of lease expense, L&T recognises depreciation on the right-of-use asset and interest expense on the lease liability.

Leases previously classified as finance leases according to IAS 17

L&T has lease contracts that were previously classified as finance leases under IAS 17. These assets have already in previous periods been recognised on balance sheet as lease assets and lease liabilities. In the transition to IFRS 16 the carrying amount of the right-of-use asset and the lease liability at the date of initial application is equal to the carrying amount of the lease asset and the lease liability immediately before that date measured applying IAS 17. This approach is consistent with the requirements of the modified retrospective method of application of IFRS 16. Leases previously classified as finance leases in accordance with IAS 17 include mainly heavy machinery equipment.

Leases previously classified as operating leases according to IAS 17

A significant part of L&T’s lease contracts has previously been classified as operating leases under IAS 17. The leases classified as operating leases consist mainly of production and office premises and related land areas and cars.

In transition to IFRS 16 L&T has recognised lease liabilities for the leases previously classified as operating leases. The amount of the lease liability recognised at the date of initial application of January 1, 2019 is based on the present value of the remaining lease payments discounted using L&T’s incremental borrowing rate at the date of the application. L&T measures the right-of-use asset at an amount equal to the lease liability, which means that the transition has not had impact on equity at the date of initial application. L&T does not have any prepayments on leases or accrued lease payments that would have an impact on the initial recognition of the right-of-use asset.

L&T has lease contracts valid until further notice relating mainly to real estate and land area leases. The lease term for open ended leases is based on management’s assessment of the lease term which takes into consideration e.g. any costs relating to the termination of the lease and the importance of the underlying asset to L&T’s operations. At the date of initial application L&T estimated the lease term for the majority of the open ended lease contracts relating to real estate and land area leases to be four years.

L&T has applied two recognition exemptions included in IFRS 16. L&T has not recognised right-of-use assets and lease liabilities for short-term leases with a lease term of 12 months or less or for leases of low value assets. L&T also uses the practical expedient of the modified retrospective method of application and does not recognise a right-of-use asset and a lease liability for lease contracts that end within 12 months from the date of the initial application and that do not contain a purchase option. Furthermore, L&T does not apply IFRS 16 to leases of intangible assets.

The impact of adoption of IFRS 16 on L&T’s balance sheet as at January 1, 2019 is EUR 53.8 million increasing the amount of right-of-use assets and lease liabilities. As a result, L&T’s equity ratio decreased by 3.4 percentage points, gearing decreased by 25.3 percentage points and net interest-bearing liabilities increased by 55.0 percent. In addition to the balance sheet impact adoption of IFRS 16 will also impact L&T’s the income statement. From the beginning of 2019 L&T will recognise a depreciation charge in the income statement instead of a lease expense, which will affect operating profit, and an interest expense related to the lease liability, which will impact the amount of finance costs. Due to the change the operating profit of L&T will be improved.

Adoption of IFRS 16 will also impact the presentation of cash flows. Lease expenditure for leases previously classified as operating leases has been presented in cash flow from operating activities, but after the implementation of IFRS 16 only the interest expense related to the lease liability will be presented in the cash flow from operating activities. The rest of the lease payment e.g. the principal part of the repayment of the lease liability is presented in the cash flow from financing activities.

Summary of new accounting policies

Lease liability

At the commencement date of the lease L&T recognises a lease liability measured at the present value of the remaining lease payments that are not paid at that date. The lease payments included in the measurement of the lease liability consist of the payments for the right to use the underlying asset during the lease term that are not paid at the commencement date of the lease. The payments included in the measurement of the lease liability include fixed payments less any lease incentives receivable and variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date.  A lease contract may also contain payments of penalties for terminating the lease. L&T includes the termination penalty in the measurement of the lease liability if it considers it to be reasonably certain that the termination option will be exercised. VAT is not included in the measurement of the lease liability.

L&T determines the present value of the lease payments using the interest rate implicit in the lease if this is readily available. For the majority of L&T’s lease contracts the interest rate implicit in the lease is not readily available and the incremental borrowing rate is used while calculating the present value of the lease payments.

The incremental borrowing rate is defined in the standard as the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment. L&T has determined the incremental borrowing rates taking into consideration the class of the underlying asset, maturity of the lease contracts and the different economic environments. Based on these factors L&T uses an interest rate matrix to determine the appropriate discount rate to be used while calculating the present value of the lease payments. The matrix is impacted by the maturity of the lease contracts and location.

Right-of-use-asset

L&T recognises a right-of-use asset from a lease contract at the commencement date of the lease, which is the date that the underlying asset is made available for use. Right-of-use assets are measured at cost less any accumulated depreciation and impairment losses and adjusted for any remeasurement of the lease liability. The cost of the right-of-use asset includes the amount of lease liability recognised, any initial direct costs incurred and lease payments made at or before the commencement date less any lease incentives received. L&T also considers possible asset retirement obligations in the cost of the right-of-use asset.  Right-of-use assets are subject to impairment testing in future periods.

Short-term leases and leases of low-value assets

L&T does not recognise leases of low-value assets on the balance sheet, but instead L&T recognises an expense on a straight-line basis over the lease term. L&T defines a low-value asset based on the value of the underlying asset as new irrespective of its current age and condition.

L&T does not recognise leases with a lease term of 12 months or less from the commencement date on the balance sheet. Lease payments relating to short-term leases are recognised as an expense on a straight-line basis over the lease term. In determining whether a contract is a short-term lease L&T takes into account reasonable certainty of exercising extension and termination options similarly as for other leases. If a lease contains a purchase option, L&T does not consider it to be a short-term lease.

Significant judgment

IFRS 16 requires lessees to determine the lease term as the non-cancellable period of a lease adjusted with any option to extend or terminate the lease, if the use of such option is reasonably certain. L&T makes an assessment on the expected lease term on a lease-by-lease basis and thereby assesses whether it is reasonably certain that any options to extend or terminate the contract will be exercised.

L&T has lease contracts relating mainly to real estate and land areas which are valid until further notice. For such contracts, the management evaluates the lease term on a lease-by-lease basis. In evaluating the lease term L&T considers e.g. any significant leasehold improvements undertaken over the lease term, costs relating to the termination of the lease and the importance of the underlying asset to L&T’s operations taking into account, for example, whether the underlying asset is a specialised asset, the location of the underlying asset and the availability of suitable alternatives. L&T reassesses the lease term in future periods to ensure that the lease term reflects the current circumstances.

IFRS 16 adjusted opening balance sheet

Bridge calculation of IFRS 16 change

LASSILA & TIKANOJA PLC

Eero Hautaniemi
President and CEO

Additional information:
Eero Hautaniemi, President and CEO, tel. +358 10 636 2810
Juha Jaatinen, Acting CFO, tel. +358 50 487 3020

Lassila & Tikanoja is a service company that is putting the circular economy into practice. Together with our customers, we keep materials and properties in productive use for as long as possible and we enhance the use of raw materials and energy. We help our customers maintain the value of their properties and materials while protecting the environment. We achieve this by delivering responsible and sustainable service solutions that make the daily lives of our customers easier. We operate in Finland, Sweden, and Russia. L&T employs 8,600 people. Net sales in 2018 amounted to EUR 802.2 million. L&T is listed on Nasdaq Helsinki.

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www.lt.fi/en