An end to off-balance sheet aircraft operating leases

From 1 January 2019, a lessee under an aircraft operating lease with a lease term of more than 12  months will be required to report on-balance sheet a right-of-use asset and its lease liability based on net present value rent and (if applicable) maintenance reserves payments taking into account the lease term as determined under IFRS 16. Depreciation of lease assets will also be recognised separately from interest on profit and loss statements.

Implications for an airline

• Airlines which have adopted IFRS financial reporting will appear to be more asset rich but also more indebted as a result of increased liabilities recorded on-balance sheet.
• Airlines should be mindful of the need to communicate with, and, if need be, educate, their shareholders about this accounting change and its impact on their financial results.
• Airlines should be aware that IFRS 16 could affect nearly all commonly used financial covenants including in particular those in unsecured loan agreements.
• Financial covenants in any airline contract will need to be reviewed and may also need to be revised to more appropriately reflect an airline's post-implementation financial performance. This may also affect an airline's borrowing costs.

Implications for lessors

Lessor accounting should not change as a result of IFRS 16 with lessors continuing to reflect operating lease assets on balance sheet for leases classified as operating leases. For finance leases, the balance sheet will continue to reflect a lease receivable and the lessor’s residual interest, if any.

Tax implications

The UK tax regime in relation to leases relies on the distinction between finance leases and operating leases. However Section 53 of the Finance Act 2011 provides that any change in lease accounting from IAS 17 can be ignored for UK tax purposes. As such the UK tax treatment of lease amounts will continue to be determined by reference to IAS 17 and not IFRS 16, after its implementation.

Conclusion

The implementation of IFRS 16 reflects a fundamental change in the accounting treatment of aircraft assets and is expected to add almost $3 trillion of leasing commitments to balance sheets globally.

Airlines with aircraft on operating lease, their debt and equity providers and also their lessors need to be prepared for the impact that IRFS 16 could have, in particular, on an airline's financial reporting and (if applicable) any financial covenants with respect to that airline.