Welcome to the KPMG Aviation Thought Leadership Series, a series which has been designed to give you an in-depth look into topics within the Aviation sector.
In this edition, Cormac O’Laoide, an associate director in KPMG’s aviation accounting advisory practice, sets out some of the key accounting considerations for two topical issues:
In the current year, we have observed a rise in sale and leaseback transactions across the aviation sector. Seller-lessees are looking to enhance their liquidity, whereas buyer-lessors are seeking to solve their supply challenges.
The accounting for sale and leaseback transactions can be complex, particularly for seller-lessees. The requirements of IFRS 16 Leases (IFRS 16) apply to a sale and leaseback arrangement if, and only if, the sale transaction meets the criteria to be deemed a sale under IFRS 15 Revenue from Contracts with Customers (IFRS 15).
Determining whether a sale has occurred requires both parties to consider all the relevant facts and circumstances specific to the transaction. For example, if the seller-lessee has a substantive option to repurchase the aircraft at a future date whether under the sale agreement or the leaseback arrangement, the transaction is not a sale under IFRS 15.
For transactions which meet the sale criteria, the seller-lessee derecognises the carrying amount of the aircraft and recognises a lease liability and a right-of-use asset representing the portion of the previously owned aircraft retained through the lease agreement. As a result of the accounting treatment, a portion of the gain or loss on sale is recognised in the income statement.
Measuring the lease liability and right-of-use asset which arises in the context of a sale and leaseback arrangement can be significantly more challenging than the general requirements of the IFRS 16 lessee accounting model. There are several considerations which a seller-lessee may have to work through to appropriately account for these transactions. For example:
From a buyer-lessor perspective, the accounting is usually less complex i.e., if a sale has occurred, the buyer-lessor will recognise the aircraft on its balance sheet and will apply the lessor accounting model as normal.
Importantly, for both a seller-lessee and a buyer-lessor, if the transaction does not meet the IFRS 15 sale criteria (i.e., is a “failed sale”), the requirements of IFRS 9 Financial Instruments are applicable to the arrangement.
Dual reporters should also keep in mind that there are some notable differences between the requirements of IFRS 16 and ASC 842 regarding sale and leaseback accounting. For example, if the lease would be classified as a finance lease by the seller-lessee, or a sales-type lease by the buyer-lessor, then the transaction cannot be deemed a sale under US GAAP.
IFRS 16 is prescriptive regarding what a seller-lessee must consider when accounting for a sale and leaseback arrangement, even though significant judgement may be needed to estimate certain amounts. There are several data points to be assessed and key judgements to be made and documented to ensure that the accounting treatment is compliant with IFRS 16.
Groups in the aviation industry may undertake a reorganisation of their legal entities for a variety of reasons. Following the IASB’s decision to end its project on businesses under common control without developing any new recognition and measurement requirements, our accounting advisory practice continues to assist clients in dealing with the complexities surrounding group reorganisations.
While each group reorganisation is unique, most involve the same considerations from an accounting perspective – some of which we have set out below. Whether the group reorganisation involves setting up new entities, merging/dissolving existing legal entities, and/or transferring assets and businesses between group entities, determining the appropriate accounting treatment at each step can be difficult.
We advise our clients to consider the accounting for each step in the step plan at the outset, to avoid undesirable accounting outcomes or complications at a later stage.
A key judgement in a group reorganisation is whether an asset/group of assets or a business is being transferred between entities within a group.
If a business combination has occurred, the acquirer may not have to apply the full requirements of IFRS 3 Business Combinations (IFRS 3) in its consolidated financial statements if both the acquirer and the acquiree are businesses under common control. In which case there may be an accounting policy choice to apply book value accounting or IFRS 3 in full. It is important to note that a business combination which is determined to be under common control in accordance with IFRS will not always be considered under common control under FRS 102 and vice versa, due to different definitions within each framework.
Common control transactions may also provide accounting choices to entities within their separate financial statements, regarding the measurement of the acquired investment in subsidiary i.e., being measured at book value, fair value or (less commonly) exchange value.
It is worth noting that if a company has made an accounting policy choice for a similar transaction in the past, it should apply that same policy to such transactions going-forward.
The form of consideration transferred between group entities to affect an acquisition under common control can impact the accounting treatment. If shares are issued as consideration, the acquirer must consider the different reliefs available under Irish and UK Company Law when determining how to account for the transaction in the equity section of the balance sheet of its separate financial statements.
To make a lawful distribution, an entity must have sufficient distributable reserves. Distributable reserves are an entity’s accumulated realised profits less its accumulated realised losses. A careful assessment is required to determine the profits available for distribution, particularly for entities that have received capital contributions (which may or may not constitute realised profits).
For example, if an entity received a capital contribution in the form of an aircraft, initially the capital contribution would not constitute a realised profit. However, over time the capital contribution would incrementally become a realised profit, in line with the depreciation of the aircraft (or in the event that the aircraft is subsequently sold).
Groups should review the distributable reserves of all entities that are impacted by the reorganisation, including those entities on whom the impact is transitory. For example, if a business is being transferred to an intermediate entity before being further transferred upstream, it is crucial that the intermediate entity has sufficient distributable reserves to affect the transaction, even if it is only serving as a passthrough entity.
Neither IFRS nor FRS 102 include comprehensive guidance on accounting for common control transactions. Being aware of the rules and reliefs available ensures that pitfalls are avoided and opportunities to simplify the accounting treatment are not overlooked.
KPMG has a specialist aviation accounting advisory team who can assist with your queries on all the above and more.
We provide clients with our insights and expertise, assisting them with documenting their key judgments to allow for a smoother audit process at year-end.
Our goal is to deliver bandwidth to your finance team so that they can focus on the issues which are pressing to your business.
