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IFRS 16 - LEASES: IMPLICATIONS FOR
ANALYSTS AND INVESTORS
Aantal woorden/ Word count: 15.878
Sébastien Rulmont Stamnummer/student number: 01305593
Promotor/ Supervisor: Prof. Dr. Heidi Vander Bauwhede
Masterproef voorgedragen tot het bekomen van de graad van:
Master’s Dissertation submitted to obtain the degree of:
Master of Science in Business Economics
Academiejaar/ Academic year: 2016 - 2017
IFRS 16 – LEASES: IMPLICATIONS
FOR ANALYSTS AND INVESTORS
Aantal woorden/ Word count: 15.878
Sébastien Rulmont Stamnummer/student number: 01305593
Promotor/ Supervisor: Prof. Dr. Heidi Vander Bauwhede
Masterproef voorgedragen tot het bekomen van de graad van:
Master’s Dissertation submitted to obtain the degree of:
Master of Science in Business Economics
Academiejaar/ Academic year: 2016 - 2017
I
Permission
I declare that the content of this Master’s Dissertation may be consulted and/or reproduced, provided that
the source is referenced.
Sébastien Rulmont
Signature:
II
Abstract
In January 2016, the IASB published IFRS 16, the new lease standard that will supersede IAS 17 on the
1st of January 2019. IFRS 16 will eliminate the relative recognition flexibility and requires the
capitalization of virtually all lease contracts on the lessees’ balance sheets. The IASB is convinced that
the recognition of both operating and finance leases will increase the transparency and comparability of
the Financial Statements (IASB, 2016). A limited amount of prior literature however (Libby et al., 2002),
claims equivalence between recognition and disclosure in the notes, implying that IFRS 16 will not have
any impact on company valuation and is therefore considered a useless intervention by the IASB. This
dissertation documents how and whether Belgian and Luxembourgish investment professionals
incorporate operating leases when valuing a company. The findings suggest that, on average, these
professionals do not incorporate off-balance sheet information in their valuation. The results of this
dissertation provide support for the IASB’s intervention and confirm their concerns of misled Financial
Statement users (IASB, 2016), although it is not always perceived as such by the investment professionals
themselves.
Keywords: IFRS 16, IAS 17, Lease Accounting, Lease Capitalization, Company Valuation, Market
Efficiency
III
Foreword
This research is the fruit of my labour at the Faculty of Economics and Business Administration at the
University of Ghent over the academic year 2016 - 2017. My master’s dissertation was written to obtain
the degree of Master of Science in Business Economics: Corporate Finance.
Several persons have contributed both academically and practically to my master thesis. First of all, I
would like to thank my head supervisor Professor Dr. Heidi Vander Bauwhede and the co-supervisor
Frederik Verplancke for their valuable input, feedback and support throughout the entire year.
Furthermore, I would like to thank the associations B.C.F.A., BVA and BAN for their help identifying
and contacting potential respondents. I am particularly grateful to Mr. Edwig Tanghe who introduced me
to the associations mentioned above and who has been a big help throughout the entire process.
I would also like to thank Mr. Jan Van Robaeys for his constructive comments to my dissertation. Last
but not least I would like to thank my friends and family for being supportive throughout the year.
I hope you will enjoy reading this thesis.
Sébastien Rulmont
Ghent, August 2017
IV
Table of contents
Permission..............................................................................................................................................................I
Abstract...................................................................................................................................................................II
Foreword..............................................................................................................................................................III
Tableofcontents...............................................................................................................................................IV
List–abbreviations...........................................................................................................................................VI
List–figures,tables,annexes.......................................................................................................................VII
1. Introduction..................................................................................................................................................1
2. Literaturereview........................................................................................................................................32.1. Analyst.........................................................................................................................................................................32.2. Investor.......................................................................................................................................................................4
3. Leasestandard.............................................................................................................................................63.1. CriticismIAS17.......................................................................................................................................................73.2. ScopeofIFRS16......................................................................................................................................................83.3. Leaseterm..................................................................................................................................................................93.4. RecognitionandMeasurement.........................................................................................................................93.5. Lessee–Lessoraccountancy..........................................................................................................................103.6. Transition................................................................................................................................................................103.7. IFRSvs.USGAAP..................................................................................................................................................11
4. Dataandmethodology............................................................................................................................124.1. (Empirical)Strategy...........................................................................................................................................124.2. ExperimentalDesign..........................................................................................................................................124.3. Measurementmethod........................................................................................................................................154.3.1. LeaseCapitalizationMethod...................................................................................................................154.3.2. EstimatingunrecordedAssetsandLiabilities.................................................................................154.3.3. EstimatingInterestExpensesandDepreciationExpense.........................................................174.3.4. EstimatingNetProfit..................................................................................................................................194.3.5. AdjustedendingBalanceSheet.............................................................................................................20
4.4. ManipulationCheck............................................................................................................................................204.5. CodingStrategy.....................................................................................................................................................21
V
5. Analysis........................................................................................................................................................215.1. EffectonBalanceSheet.....................................................................................................................................215.2. EffectonIncomeStatement.............................................................................................................................225.3. EffectonCashflow(s)........................................................................................................................................225.4. Effectonratios......................................................................................................................................................235.5. Conclusion...............................................................................................................................................................23
6. SamplingandResults..............................................................................................................................246.1. SampleDescription.............................................................................................................................................246.2. UnivariateDescriptiveEvidenceonEquityValue.................................................................................286.3. DescriptiveEvidenceonLeaseTreatments.............................................................................................296.4. DescriptiveEvidenceonPerceivedUsefulnessofIFRS16................................................................296.5. Descriptiveevidencepreferredvaluationtool.......................................................................................31
7. ExperimentalResults..............................................................................................................................31
8. Conclusionanddiscussion....................................................................................................................35
9. Limitations.................................................................................................................................................36
10. References..............................................................................................................................................VIII
11. Appendix...................................................................................................................................................XII
VI
List – abbreviations
ACCA Association of Chartered Certified Accountants
ASC Accounting Standards Codification
BAN Business Angel Network
BCFA Belgian Corporate Finance Association
BVA
DCF
Belgian Venture Capital and Private Equity Association
Discounted Cash Flow
D/E Debt to Equity
EBIT Earnings Before Interest and Taxes
EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization
EFRAG
EPS
European Financial Reporting Advisory Group
Earnings per Share
FASB Financial Accounting Standards Board
IAS International Accounting Standards
IASB International Accounting Standards Board
IFRIC International Financial Reporting Interpretation Committee
IFRS International Financial Reporting Standards
M&A Merger and Acquisition
PPE Property, Plant and Equipment
ROA Return on Assets
ROE
SD
Return on Equity
Standard Deviation
US GAAP United States General Accepted Accounting Principles
VC Venture Capitalist
WALT Weighted Average Lease Term
VII
List – figures, tables, annexes
Figure 1: Definition of a lease ....................................................................................................................... 8Figure 2: Ratio Analysis .............................................................................................................................. 24Figure 3: Sex and Age group ....................................................................................................................... 25Figure 4: Professional demographics for the Full Sample .......................................................................... 26Figure 5: Expected vs. Empirical Equity Value .......................................................................................... 28Figure 6: Lease treatment ............................................................................................................................ 29Figure 7: Opinion IFRS 16 .......................................................................................................................... 30Figure 8: Preferred Valuation Tool ............................................................................................................. 31
Table 1: Minimum future rental payments (lease payments) ...................................................................... 13Table 2: Minimum future rental payments .................................................................................................. 16Table 3: Present Value of minimum rental payments ................................................................................. 16Table 4: Change in lease assets and liabilities from new lease transactions ............................................... 17Table 5: Weighted average lease term ......................................................................................................... 19Table 6: Simplified income statement 2015 ................................................................................................ 20Table 7: Adjustments to ending Balance Sheet 2015 .................................................................................. 20Table 8: Financial Statement summary ....................................................................................................... 21Table 9: Income Statement .......................................................................................................................... 22Table 10: Ratio analysis .............................................................................................................................. 23Table 11: Equity value ................................................................................................................................. 28Table 12: Descriptive 5-point Likert item (1: Strongly disagree – 5: Strongly agree) ................................ 30Table 13: Paired sample t-test ..................................................................................................................... 32Table 14: Raised rationales overall and by category (panel 1 & panel 2) ................................................... 34
Annex 1: Flowchart – IFRS 16 .................................................................................................................. XIIAnnex 2: Questionnaire Category 1 (IAS 17) .......................................................................................... XIIIAnnex 3: Questionnaire Category 2 (IFRS 16) ........................................................................................ XIXAnnex 4: Sample Selection and Composition ....................................................................................... XXIV
1
1. Introduction
The reliability and transparency of Financial Statements have been long lasting issues under the IAS 17
lease standard (IASB, 2016). Due to the distinction between operating and finance leasing, respectively
off- and on-balance sheet, the Financial Statements do not always reflect the underlying business reality
(ACCA, 2014).
Due to the new lease standard, IFRS 16, promulgated in February 2016 by the IASB in close
collaboration with the FASB, capitalization of the majority of all lease contracts will become mandatory
(IASB, 2016). Under IFRS 16, the substantially different accountancy treatment of operating leases and
finance leases will be eliminated, therefore clearing the Financial Statements of the lessee from potential
asset and liability distortions (IASB, 2016). As of 1 January 2019, when IFRS 16 will supersede IAS 17,
the regularly criticized off-balance sheet treatment of operating leases (Chu et al., 2007) will be
prohibited.
According to the IASB, the recognition of assets and liabilities for all types of leases provides a more
genuine image of the financial position of a company and will lead to greater transparency and therefore
comparability (IASB – Effect Analysis, 2016). The past decade, standard setters have been placing more
and more emphasis on designing accounting information facilitating the valuation objective (Murphy et
al., 2013; Pelger, 2015). The IASB states that this will enable analysts and investors to improve their
assessment of the financial performance of a company hence their valuation. Contrary to the pre-IFRS 16
era when companies applied IAS 17 accounting requirements, some investors adjusted for off-balance
sheet leases whereas others did not (Hoogervorst, H., 2016). Given that today, 85 per cent1 of all leases
(IASB, 2016) are estimated to be off-balance sheet, the IASB is convinced that the augmented
transparency will lead to superior investment decisions.
This dissertation intends to discover whether analysts and investors today incorporate equally (or at all)
items that are currently only disclosed in the notes versus those that have been recognized in the Financial
Statements. A field study was conducted involving 58 questionnaires completed by Belgian and
Luxembourgish investment professionals. The focus of this research on investment professionals reflects
their importance both as target users of Financial Statements and as major capital providers (Cascino et
al., 2016). The participating investment professionals received a short case containing the abridged
Financial Statements from an existing quoted company. Depending on the category they were randomly
1 Based on a research conducted by the US SEC (2005) on 30.000 quoted companies
2
assigned to, the professionals received Financial Statements in compliance with either IAS 17 or IFRS 16.
This allowed me to test my main research question whether (and how) valuation experts take operating
leases into account when valuing a company.
Despite the still popular theory of market efficiency, which implies that markets accurately process
information irrespectively of the positioning within the Financial Statements and therefore postulating
equivalence between recognition and disclosure, prior literature is unable to provide an unambiguous
answer. Given that the IASB estimated in 2015 that once IFRS 16 is applied, an estimated $2.8 trillion2
worth of lease commitments that are currently ‘off-balance sheet’ will be added to balance sheets
globally, it is of the essence to investigate whether Belgian and Luxembourgish investment and valuation
specialists are aware of the potential impact on the company’s Equity Value.
The respondents in the second category who received Financial Statements prepared in accordance with
IFRS 16, provided, on average, significantly lower Equity Values than their colleagues in the first
category who received the same Financial Statements but prepared under the current lease standard IAS
17. The results of this research suggest that, on average, Belgian and Luxembourgish analysts and
investors today do not take into account operating leases and consequentially seem to underestimate the
impact of operating leases on company valuation.
A vital feature of this research design was that by incorporating the participants’ opinions on IFRS 16 and
reasons why did not take into account the off-balance sheet information, I was able to get better insights
into the rationales underlying their calculated Equity Value. 58,8% of the questionnaires were identified
as positive towards the new lease treatment stating that it will improve the quality and transparency of the
Financial Statements. It turns out that a substantial part of the 41,2% questionnaires containing critiques,
can be countered using the ‘Short-Term’ of ‘Low-Value’ exemptions incorporated in IFRS 16 (IASB,
2016).
This research makes two main contributions. First and foremost, my results provide causal evidence that
investment professionals are currently unaware or underestimate the impact of operating leases on a
company’s financial situation. Besides that, this research provides insight into the reasoning of
professionals on this specific topic and whether they assess the intervention of the IASB as useful or not.
Second, this research helps understanding how professionals currently deal with operating leases and
whether the IASB made the right decision to revise the current accounting standard and eliminate the
existing accounting difference between operating and finance leases.
2 Based on a research conducted by the US SEC (2005) on 30.000 quoted companies; non-discounted base
3
This dissertation continues as follows: The next section discusses prior studies about lease capitalization
and off-balance sheet information. The third section provides a summary of IFRS 16. Section four
discusses the data collection and methodology. Section five contains an analysis of the impact of IFRS
16. The sixth section contains the sample selection whereas the seventh section contains the experimental
results of this research. Section eight and nine summarize the findings, discuss the paper and give
suggestions for future research.
2. Literature review
2.1. Analyst
A study by Imhoff, Libe and Wright (1991) indicates that the capitalization of leases leads to a significant
decline in the return on assets (hereafter ROA) for both intensive and less intensive lease users.
Additionally, the impact on the debt to earnings ratio is significantly higher for intensive lease users than
for less intensive users, 191% compared to 47%. Using the capitalization method designed by Imhoff et
al. (1991), the study of Beattie, Edwards and Goodacre (1998) assessed the impact of operating leases of
232 U.K. listed companies on their Financial Statements. They found that unrecorded lease assets make
up 6% of the total assets and the unrecorded long-term liabilities are on average 39% of the liabilities
reported. Consequentially there will be an impact on seven key financial ratios such as the Asset
Turnover, ROA, Debt-to-Equity ratio, …
A more recent research also made use of the capitalization method created by Imhoff et al. in 1991 and
further developed in 1999. The results of the study by Bennet and Bradbury (2003) confirm the potential
impact on the Financial Statements of ‘constructive capitalization’. Their evidence on 38 firms listed on
the New Zealand Stock Exchange suggests that ‘constructive capitalization’ will influence the balance
sheet tremendously since 22,9% of the liabilities and 8,8% of the assets are currently not reported.
Consequently, they found that the Leverage ratio increases whereas the Current ratio and ROA decreases.
Additionally, they provided evidence that standard rules of thumb, such as multiplying the rental
expenses, which are often used by US analysts, are inaccurate and unreliable in an international setting.
Another recent study of Durocher (2008) tested the impact of the transformation of operating leases,
belonging to 100 Canadian listed companies, on the financial indicators. The results indicate that the
capitalization will lead to the recognition of substantially more assets and liabilities on the balance sheet.
Consequentially, it will drastically increase the Debt-to-Asset ratio and significantly decrease the Current
ratio. Branswijck, Longueville and Everaert (2011) investigated the possible impact of implementing a
new lease standard, eliminating the difference between finance and operating leases, on listed companies
4
in the Netherlands and Belgium for 2008. Their results confirm Durocher’s (2008) results and indicate
that the Debt-to-Equity ratio will be positively influenced while ROA and the Current ratio are negatively
affected. Additionally, they state that the magnitude of the impact on the key ratios differs among sectors.
Similar conclusions were drawn by Durocher (2008). His study found evidence that three industry
segments: merchandising and lodging, oil and gas, and financial services will experience significant
impacts on ROA, Return On Equity (hereafter ROE) and earnings per share (hereafter EPS).
As this research is based on a case-based survey, the financial situation of the company will be assessed
using the ratios that were found significant in the papers mentioned above. Namely: Debt-to-Equity,
Debt-to-Assets, ROA and Current Ratio. Depending on the accountancy standard used to prepare the
Financial Statements, IAS 17 or IFRS 16, material differences in the four ratios mentioned above are
expected.
2.2. Investor
It has been a long lasting question whether investors adjust appropriately for the effects of accounting
methods and disclosure alternatives. Looking back on earlier literature, the answer to this question seems
to be ‘sometimes’. Dyckman (1964) suggested that the investment decision of investors is more often
influenced by the accounting procedures used to prepare the Financial Statements rather than the
underlying business reality. Consequentially, companies having identical economic circumstances are
judged differently due to their choice of accountancy policy (Dyckman, 1964; Maines, 1995).
Decades later, the answer to this question seems more ambiguous. Hirshleifer and Teoh (2003) state that
there is a significant disjunction in the existing literature between the experimental research and the
theoretical models of the Financial Statements processing. The experimental research provides an array of
evidence that both inexperienced and professional investors/analysts are biased in their interpretation of
Financial Statements. Consequentially, this bias influences the market prices (Hirshleifer & Teoh, 2003).
Analytical models of disclosure and reporting on the contrary, have almost uniformly assumed full
rationality of decisions and pricing (Libby et al, 2002). More generally, Breton and Taffler (1995) tested
a large sample of experienced investment analysts drawn from five of the top London houses whether
they were able to reveal window dressing. The participating analysts were not overly concerned about the
quality of the presented balance sheet. Therefore only a limited amount of analysts made adjustments to
the accounts. Breton and Taffler (1995) concluded that off-balance sheet obligations such as operating
lease liabilities could distort the fundamental analysis of the company. Similar conclusions were drawn
by Libby, Bloomfield and Nelson (2002). They claim that the information on which Financial Statement
users rely upon in their judgments is limited. The fact that those decision makers are aware of the
existence of cosmetic accounting differences does not guarantee full consideration of their consequences
5
on the company’s value. Professional Financial Statement users are even aware of the incentive managers
have to opportunistically apply ambiguous accounting standards to optimize the Financial Statements in
their favour. Even though the majority of the professionals have the ability, they fail or refuse to make the
necessary adjustments (Libby et al. 2002). Hirshleifer and Teoh (2003) suggested that the concern of the
regulators about the exploitation of the investor’s inattention by companies merits careful consideration.
There is only a limited amount of prior research dealing with the operating lease issue specifically.
Gallery and Imhoff (1998) conducted a research in Australia and failed to discover market corrections for
off-balance sheet leases. Davis-Friday, Folami, Liu and Mittelstaedt (1999) examined whether the market
values Financial Statement data differently if it is disclosed, instead of recognized in the body of the
financial statements. Although their study focused on the liability for retiree benefits and not operational
leasing, their results indicate how markets interpret off-balance information. They found some modest
evidence that the recognized liability receives more weight than the disclosed liability in market value
association tests. This has been confirmed by a more recent research conducted by Ge (2006). According
to his research, investors seem to incorrectly estimate the implications of off-balance-sheet lease activities
for future earnings. Therefore, a long-short investment strategy that exploits this miscalculation could
generate significant future abnormal stock returns. Ely (1995) created a model based on prior work from
Modigliani and Miller (1963) and applied it to the Financial Statements. The model investigated whether
information on operating leases is accurately reflected in the equity risk. Equity risk is measured as the
standard deviation of the stock price and is therefore related to the standard deviation of the ROA and the
Debt-to-Equity ratio. Her research provides evidence that capitalization of operating leases is not taken
into account in the equity risk. The empirical studies mentioned above, suggest that investors do not
capitalize operating leases and that they systematically underestimate the importance of off-balance sheet
information.
A more recent study by Chu, Levesque, Mathieu and Zhang (2007) examined whether credit departments
of banks use the leverage resulting from the capitalization of off-balance sheet obligations to assess credit
risk. Their evidence suggests that banks struggle to properly estimate the off-balance sheet obligations of
a firm. They conclude that capitalization of operating leases causes measurement difficulties and provide
strong support for changes in the accountancy policy.
6
As mentioned in the introduction, this research intends to discover whether Belgian and Luxembourgish
investment professionals are more aware of the importance of off-balance sheet information than their
international colleagues. Prior literature however is relatively clear whether investment professionals
successfully process all the available information, both disclosed and recognized, when taking an
investment decision. The studies by Bretton and Taffler (1995), Davis-Friday et al. (1999) and Ge (2006)
indicate that even experienced investors and analysts fail to realize the impact of off-balance sheet
information. Therefore the following hypothesis is expressed:
H1: The application of IFRS 16 leads to a decrease in the Equity Value perceived by the investment
professionals.
3. Lease standard
On January 13th, 2016, the IASB presented the IFRS 16 – Lease standard dealing with the recognition,
measurement and disclosure of lease contracts. Their American partner, the FASB launched their new
standard ASC 842 shortly after.
Lease accounting was a joint project of the IASB and the US-standard setter (FASB). The IASB and
FASB started working on their new lease standards in 2009. The Lease Accounting Working Group was
founded to guide and monitor the development of the new standard. In order to keep a tight relationship
with the business reality, three documents were released3 to gather feedback from the future users of the
standard. Over the years, adjustments were made based on the concerns of cost and complexity of
implementing the new standard.
The following paragraphs provide an overview of the scope, identification, recognition and transition of
the IFRS 16 standard. For a more detailed overview, I refer to the IFRS 16 sheet released by the IASB or
the Deloitte and Touche IFRS 16 Guide.
3 Discussion paper (2009); Exposure draft (2010); Revised exposure draft (2013)
7
3.1. Criticism IAS 17
“One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet”
(Sir Tweedie, D.)
One of the biggest critiques on IAS 17 mentioned by the Association of Chartered Certified Accountants
(ACCA) and the IASB is the significant difference in the accounting treatment of operating leases and
finance leases (ACCA, 2014). During an interview, the chairman of the IASB, protested against the fact
that two very similar transactions from an economic perspective could be reported very differently,
ultimately reducing the comparability between entities drastically (Hoogervorst, H., 2016). Some well-
known examples include fleets of aircraft or rolling stocks that apparently do not meet the criteria for
recognition as assets and liabilities (PWC, 2016). Sir David Tweedie, the previous Chairman of the IASB,
acknowledged during a speech in 2008 to the Empire Club of Canada that almost no one in the room has
ever flown in a plane that was actually on the balance sheet of the airline.
The relative flexibility in the recognition of leases as an operating lease under IAS 17 led to
misclassification on a large scale. Small contractual adjustments can change the classification of a lease
contract. Which results in a significant understatement of the company’s liabilities (IASB, 2010) and
ultimately, the manipulation of key ratios (IASB, 2016). The IASB stated in 2010 that as most companies
prefer operating to finance leases, the company’s judgment is often biased, resulting in leases with a clear
finance element being classified as operating leases.
Second, today’s model is too complex and not transparent enough according to the Financial Statement
users (IASB, 2010). The absence of detailed requirements concerning the disclosure in the Financial
Statements makes it hard for investors, bankers and analysts to assess the company’s financial situation
correctly (IASB, 2016). Marton et al. (2012) suggest that companies reporting their leases as operating
leases have better financial ratios than their competitors reporting finance leases. Which provides a strong
stimulus to companies to try to misclassify their lease contracts as operating leases. In an attempt to undo
these distortions, some analysts and investors make their own adjustments based on assumptions whereas
others do not, which ultimately leads to even bigger inconsistencies (Hoogervorst, H., 2016).
Third, IAS 17 does not comply with the core values of IASB’s conceptual framework (IASB, 2015). The
relative subjectivity of reporting as either an operating or finance lease under IAS 17 conflicts with item
2.28 of the conceptual framework: “Permitting alternative accounting methods for the same economic
phenomenon diminishes comparability.” And 2.29: “Verifiability helps assure users that information
faithfully represents the economic phenomena it purports to represent.” (Conceptual Framework; 2015)
Additionally, the framework provides detailed definitions for assets and liabilities. Companies who
8
desperately try to classify their contracts as operating leases in order to create an accountancy fiction,
understand improving the financial position, do not respect these definitions.
3.2. Scope of IFRS 16
IFRS 16 will be applied to virtually all lease contracts except those listed under IFRS 16.3 4 .
IFRS 16 defines a lease as a contract, or part of a contract, that conveys the right to use an asset (the
underlying asset) for a period of time in exchange for consideration (IFRS, 2016). In order to be allowed
to classify a contract as a lease contract at inception date, it has to contain a lease. The IASB created a
Flowchart to help determine whether a contract contains a lease (Annex 1: ‘Flowchart – IFRS 16’).
(IFRS 16:B13) states that an asset can be identified either explicitly (example: serial number) or
implicitly (asset not mentioned in the contract). If implicitly, the asset cannot be identified but there is
only one asset that is capable of being used to meet the contract terms. In both cases, there may be an
identified asset. For more information on identified asset, I refer to IFRS 16: B13 – B19.
The right to obtain substantially all of the economic benefits (IFRS 16:B21) and the right to direct the
how and for what purpose the asset is used (IFRS 16: B24) are seen as the right to control the identified
asset. Which is different from the right of use stated in IAS 17.
Figure 1: Definition of a lease
4 Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources; biological assets within the scope of IAS 41; Agriculture within the scope of IFRIC 12; Licences of intellectual property within the scope of IFRS 15; rights held by lessee under licensing agreements within the scope of IAS 38.
Lease
Right of control
lessee obtains substantially all
economic benefis lessee directs the
use
identified asset
explicitely/implicitely
9
The notion of ‘right of control’ is crucial to make a distinction between lease contracts and service
contracts. A lease contract provides a customer with the right to control the use of an identified asset for a
period of time in exchange for consideration (IFRS 16:9). Whereas in a service contract, the supplier
controls the use of any assets used to deliver the service (IFRS 16:BC105).
In theory, the distinction between the two types of contracts is clear. The reality however is often not
black-and-white. A vast amount of contracts combines a lease component with non-lease components.
Such as for example the lease of a fleet combined with maintenance (service).
IFRS 16 requires for those multi-element contracts to identify and account each component separately.
For an elaborate description of the identification, I refer to IFRS 16: B32.
As a practical expedient however, lessees are not forced to separate the contract and are allowed to
account the lease component and non-lease component as one single lease component. This accounting
policy choice however has to be made by class of underlying asset (IFRS 16:15). The IASB Board
expects that this exemption will only be used if the service component is negligible since it will increase
the lessee’s liabilities. (IFRS 16 - Board statement)
3.3. Lease term
Similar to IAS 17, the new standard defines the lease term as “the non-cancellable period of the lease plus
periods covered by an option to extend or an option to terminate if the lessee is reasonably certain to
exercise the extension option or not exercise the termination option” (IFRS 16:18).
Under IAS 17, the interpretation of the term ‘reasonably certain’ was a source of long and controversial
discussions since it led to diversity in practice. IFRS 16:B37 addresses this issue and states: “all facts and
circumstances creating an economic incentive for the lessee to exercise the option must be considered”
(IFRS 16: B37).
3.4. Recognition and Measurement
As mentioned before, the IASB tried to take into account the concerns of the future standard users as
much as possible. IFRS 16 includes two recognition and measurement exemptions (IFRS 16:5). Both
exemptions are optional and only apply to lessees. The application of these exemptions leads to the
accountancy treatment similar to the current operating lease accounting (IFRS 16:5). Which recognises
the payments on a straight-line basis.
10
• Short-term leases are defined as leases with a lease term of 12 months or less. Leases containing a
purchase option cannot be identified as a short-term lease (IFRS 16:8).
• Leases for which the underlying asset is of low value: Although the standard does not explicitly
define the term ‘low value’, the IASB had in mind assets of a value lower than USD 5,000 (IFRS
16:BC100). Examples of those small ticket items might be IT equipment or office furniture. The
exemption can be applied on a lease-by-lease basis (IFRS 16:8).
It is important to note that the analysis does not take into account whether the aggregated value is material
(IFRS 16:B7). Accordingly, although the aggregated value of the assets may be substantial, the
exemption is still applicable.
3.5. Lessee – Lessor accountancy
As mentioned before, the objective of this dissertation is not to provide a detailed accounting overview of
IFRS 16. The lessee and lessor accounting and the leaseback transaction are therefore not discussed.
3.6. Transition
IFRS 16 is effective for reporting periods beginning on or after 1 January 2019. Earlier application is
allowed, but only in conjunction with IFRS 15. The initial application date is the start of the annual
reporting period in which the entity applies IFRS 16 for the first time. (IFRS 16:C2)
The IASB acknowledges the potential impact of IFRS 16 on the lessee’s Financial Statements. Therefore,
it does not require a full retrospective application in accordance with IAS 8 but allows a ‘simplified
approach’. This allows entities to apply the new standard only to contracts entered into (or modified) on
or after the initial application date. Therefore, the entity is not required to reassess existing lease contracts
(IFRS 16:C4). As instead, at the date of initial application, the opening balance of retained earnings is
adjusted for the cumulative effect of applying IFRS 16 (IFRS 16:C7). Full retrospective application
however remains optional.
Although the transition period of three years seems long, the concerned companies started the transition
process early, as it requires a substantial amount of work. While conducting this research, several IFRS
experts from Mazars, Baker Tilly and BDO emphasized during informal interviews the difficulty and
workload of implementing the new standard since every lease contract has to be reprocessed, acceptable
discount rates have to be set, ...
11
It is important to note that although the European Financial Reporting Advisory Group (EFRAG)
submitted its Endorsed Advice to the European Commission in March 2017, the standard has not been
ratified yet.
3.7. IFRS vs. US GAAP
As mentioned in the introduction, lease accounting was a joint project of the IASB and the FASB.
Although initially the two Boards intended to develop a converged standard, ultimately only the guidance
on the definition of a lease and the principle of recognizing all leases on the lessee’s balance sheet are
aligned. In other areas, differences remain or even increase.
The biggest dissimilarity between the two standards concerns the accountancy treatment for lessees.
Although the overall guideline under IFRS 16 and ASC 842 requires all lease contracts to be recognized
on the balance sheet, US GAAP users still have to make use of the dual lease accounting model, which
means that entities need to determine the type of leases (operating or finance lease) they have in their
portfolio and account for them accordingly. IFRS 16 on the contrary, uses a single lease accounting
model, which eliminates the lease classification test for lessees. This distinction however will not have an
impact on the recognition on the balance sheet but solely on the expenses reported in the income
statement.
A second notable difference between the IFRS 16 and ASC 842 is their respective treatment of small
ticket assets. As mentioned in §3 (3.4. ‘Recognition and measurement’), IFRS 16 includes a small ticket
exemption for leases with a low value. Consequentially, they do not need to be recognized on the balance
sheet. The FASB however rejected the concept of excluding the small ticket items from the balance sheet.
In order to lower the cost of transition, the FASB standard contains existing accounting rules that allow
exclusion based on the significance to the user.
There exist other minor discrepancies between the two standards such as the date of implementation, rules
for early adoption and the classification for lessors. For a detailed overview, I refer to the KPMG: IFRS
16 manual (2016).
12
4. Data and methodology
This part of the paper elaborates the sample selection and data measurement of the research.
4.1. (Empirical) Strategy
In order to test the hypothesis, a field study was conducted based on questionnaires sent to investment
professionals active in Belgium and Luxemburg. The key objective of this case-based experiment was to
identify whether investment professionals adjust for operating leases when giving their vision on the
company’s Equity Value. Afterwards, the participants were asked to indicate whether they made any
adjustments to EBITDA. As explained in more detail below, each investment professional was randomly
assigned to one of two categories. The Financial Statements of the second category were manipulated to
imitate the effect of IFRS 16. In both categories, the investment professionals had to evaluate the Equity
Value of the same company but in compliance with respectively IAS 17 or IFRS 16.
The various items in the income statement and balance sheet from both categories were carefully selected
to ensure a low degree of estimation diversity.
Afterwards, the investment professionals were asked explicitly whether they took operating leases into
account and why. Followed by the question whether they perceive the new lease standard as an
improvement or a useless intervention by the IASB.
4.2. Experimental Design
This study examines the effect of IFRS 16 for analysts and investors. The target group of the
questionnaire referred to as investment professionals was defined as expert users of Financial Statements
who have experience in company valuation. During the sample selection process, the email addresses
from professional Financial Statement users active in the valuation and investment business were
collected. The sample consists of professional investors active in the Private Equity and Venture Capital
sector, Business Angels, fund managers and valuation experts who provide supporting services. Such as
M&A consultants and Corporate Finance experts. Most of the investment professionals were identified
with the assistance of the Business Angel Network (BAN), the Belgian Venture Capital and Private
Equity Association (BVA) and the Belgian Corporate Finance Association (B.C.F.A.), as well as by using
my own contacts.
The real objective of this dissertation was not mentioned to reduce the possibility of biased answers. In
the email sent to the investment professional, the stated intention of this research was to analyse how
13
professionals value Financial Statements. Enclosed in the email, they could find a small case containing
the simplified Financial Statements of an existing company accompanied by four open questions dealing
with Equity Value, adjustments and their opinion on IFRS 16.
The simplified Financial Statements were derived from a large quoted Italian manufacturer of car parts5.
The document included a summary of the balance sheet and the annual income statement (Annex 2 –
section 3: ‘Financial Statements’ and Annex 3 – section 3: ‘Financial Statements’ for details). A summary
of crucial IFRS accounting policies was provided along with key issues on the measurement and
recognition of Financial Statement items where managerial judgment was required.
Depending on the category the professional was assigned to, they received slightly different Financial
Statements. Subjects assigned to category one, receiving the Financial Statements prepared under IAS 17,
obtained the following information regarding the operating leases of the firm:
Accountancy policy: Assets held under finance lease are recognized and recorded at inception
under PPE. Leases, where the lessor retains substantially all the risks and rewards incident to ownership,
are classified as operating leases and are therefore not recognized on the balance sheet. Lease payments
are recognized in the statement of income under other expenses.
Notes: The company has outstanding lease agreements for several production facilities and
headquarters. The company concluded that not all significant risks and rewards were transferred to the
company. Therefore these contracts are considered to be operating leases. The effective annual interest
rate for the finance lease obligations is 6%.
Minimum future rental payments: ‘000 €
‘000 € 31/Dec/15 31/Dec/14
< 1 year 22 19
1-2 years 19 15
2-3 years 19 15
3-4 years 19 15
4-5 years 19 15
>5 years 108 96
Total 206 175
Table 1: Minimum future rental payments (lease payments) 5 A large public company was chosen to assure that the investment professional did not incorporate illiquidity discounts in the calculated equity value.
14
Participants assigned to the second category, with the Financial Statements prepared under IFRS 16
however, received the following information:
Accountancy policy: The firm chose to adopt the new lease standard IFRS 16 early, which erases
the distinction between operating and finance leases. All lease obligations are therefore recognized on the
balance sheet and no longer incorporated in the income statement.
Afterwards, the participants were informed that a leading audit firm audited the company and since the
company is publicly quoted, the corporate governance is considered of high quality.
Before the respondents answered the valuation section, some questions were asked about their personal
background. The age, sex, professional occupation, professional experience and the IFRS knowledge of
the participant were recorded to have an overview of the composition of the two categories.
Once the investment professional gave his/her vision on the Equity Value, EBITDA adjustments and the
operating lease issues, they were asked to give their opinion on the new lease standard. The professionals
were asked whether they think that eliminating the difference between operating and finance leasing will
be an improvement of the current situation (hence improved visibility and comparability) or not and why.
In order to counter the high level of subjectivity inherent to the interpretation of the opinions and to
improve the internal validity of the research, the respondents who could be identified afterwards were
contacted and asked to quantify their opinion using a 5 point Likert item ranging from 1=strongly
disagree to 5=strongly agree.
Finally, the questionnaire ended with a multiple-choice question where the participant had to indicate
which valuation tool they would normally use. The last line of the questionnaire left room for any
remarks or questions.
The entire cases and questionnaires are presented in the Appendix [Annex 2: ‘Questionnaire category 1
(IAS 17)’ & Annex 3: ‘Questionnaire category 2 (IFRS 16)’].
15
4.3. Measurement method
As mentioned before, one category of investment professionals received the Financial Statements in
compliance with IFRS 16. Since IFRS 16 has not been launched yet, the effect had to be imitated using a
capitalization method.
4.3.1. Lease Capitalization Method
The research in this study applied the lease capitalization method designed by Palepu, Healy and Peek in
their book: Business analysis and valuation: IFRS edition (fourth edition).
This method is similar to the constructive capitalization method designed by Imhoff et al. in 1991. This
method has been used several times in previous studies such as Beattie et al. (1998) and Branswijck et al.
(2011), examining the effect of capitalization on Financial Statements and key ratios. The capitalization
method designed by Palepu, Healy and Peek however is specifically targeting Financial Statements
prepared under IFRS and was therefore used in this research.
There exists another method of lease capitalization called the heuristic method. The study of Bennet and
Bradbury (2003) indicated however that applying the heuristic method leads to significantly higher
unrecorded lease assets and liabilities, which are often overstated.
4.3.2. Estimating unrecorded Assets and Liabilities
The capitalization method, designed by Palepu, Healy and Peek (2016), consists of 6 consecutive steps.
First, the present value of the operating lease expenses was calculated as of January 1, 2014. The
operating lease payments were extracted from an existing quoted company’s Financial Statements for the
years 2014 and 2015 together with the non-cancellable future operating lease payments for the following
years. As it is not the objective of this paper to investigate the exact effect of capitalization on the balance
sheet, the Financial Statements of the company were simplified. The minimum future rental payments are
provided below. In order to calculate the present value, assumptions were made concerning the interest
rate of the financial leases. The assumptions used in this research are in line with the requirements of
Palepu, Healy and Peek (2016).
Assumptions:
• discount rate equals the effective annual interest rate for finance lease obligations: 6%
• lump sum values >5y: lower of rental payment in year 5 or lump sum value
16
Minimum future rental payments
‘000 € 31/Dec/15 31/Dec/14
< 1 year 22 19
1-2 years 19 15
2-3 years 19 15
3-4 years 19 15
4-5 years 19 15
>5 years 108 96
Total 206 175
Table 2: Minimum future rental payments
Using the discount rate on the lease expenses resulted in the estimated unrecorded assets and liabilities
shown in Table 3.
‘000 € 31/Dec/15 31/Dec/14 31/Dec/15 31/Dec/14
Year Discount factor Raw values Raw values Discounted value Discounted value
<1 1,060 22 19 20,8 17,9
2 1,124 19 15 16,9 13,3
3 1,191 19 15 16,0 12,6
4 1,262 19 15 15,0 11,9
5 1,338 19 15 14,2 11,2
6 1,419 19 15 13,4 10,6
7 1,504 19 15 12,6 10,0
8 1,594 19 15 11,9 9,4
9 1,689 19 15 11,2 8,9
10 1,791 19 15 10,6 8,4
11 1,898 13 15 6,8 7,9
12 2,012 6 0,0 3,0
Total 206 175 149,5 125,1
Within 1 year 20,8 17,9
Over 1 year 128,8 107,1
Total 149,5 125,1
Table 3: Present Value of minimum rental payments
17
Table 4 incorporates the second step, the change in lease assets and liabilities during the year 2015 from
new lease transactions.
‘000 €
Expectations for 2015
Lease expense for 2015 19
(=17,9*1,06)
Lease commitments 2015 and beyond 113,5
(=107,1*1,06)
Actual values for 2015
Lease expense for 2015 22
Lease commitments 2016 and beyond 149,5
Difference 39,0
Table 4: Change in lease assets and liabilities from new lease transactions
On December 31, 2014, the company’s liability for lease commitments in 2015 and beyond was
€107.100. Assuming there were no changes in these commitments, they would have been valued at
€113.500 on December 31, 2015. The company’s actual lease commitment at the end of 2015 however
was €149.500. The difference between the actual and the anticipated lease expense suggests a change in
their lease commitments.
The sum of the actual values supersedes the sum of the expectations. This points to an increase in lease
commitments expressed as an increase in non-current tangible assets and non-current debt by € 39.0006
during 2015.
4.3.3. Estimating Interest Expenses and Depreciation Expense
During the third step, the operating lease expenses (€22.000) are added back to the income statement,
included in Other Expenses. The fourth step substitutes the lease payment into an interest expense part
and a repayment of non-current debt part similar to the finance lease accounting method. The calculated
interest expense is the interest rate multiplied by the beginning lease liability plus the interest on the
increased lease liability in 2015. The interest expense for 2015 is therefore €8.7007. As we do not know
when the new leases were incorporated or when the first interest payment was made, we assume that the
average of all the contracts combined is 6 months (pro rata temporis principle). The calculated non-
6 €149.500 - €113.500 + €22.000 - €19.000 7 6% * €125.100 + (6% * 0,5 * €39.000)
18
current debt repayment (€13.300) is the difference between the operating lease expense of 2015 (€22.000)
and the calculated interest expense (€8.700).
In order to determine the depreciation expense (step 5), the weighted average lease term (WALT) had to
be calculated (infra Table 5). Several assumptions were made according to Palepu, Healy and Peek:
• Each payment was split into 12 different contracts with different remaining lease terms. The
maximum remaining lease term equals the number of years over which future lease payments
were allocated to compute the present value of future rental payments.
• The present value of the lease obligation equals the book value.
• The number of the contact equals the number of payments and the remaining lease term.
• The amount of payments related to a specific contract reflects the decrease in value of the
minimum rental payments from one year to the other.
A higher value of each contract leads to higher weights and therefore a higher weighted average lease
term.
The depreciation expense is calculated using the depreciation rate of !!"#$
. The depreciation expense is
!!!,!
∗ 125,1 + !!!,!
∗ 0,5 ∗ 39 ∗ 1000 = €13.000
The new lease contracts are depreciated using the pro rata temporis method. Because we do not know
when the company obtained the assets, we assume that the average is 6 months.
19
Year
Lease
payment Contracts
1 2 3 4 5 6 7 8 9 10 11 12
1 19 4 0 0 0 0 0 0 0 0 0 9 6
2 15
0 0 0 0 0 0 0 0 0 9 6
3 15
0 0 0 0 0 0 0 0 9 6
4 15
0 0 0 0 0 0 0 9 6
5 15
0 0 0 0 0 0 9 6
6 15
0 0 0 0 0 9 6
7 15
0 0 0 0 9 6
8 15
0 0 0 9 6
9 15
0 0 9 6
10 15
0 9 6
11 15
9 6
12 6
6
Remaining lease
term of each
contract 1 2 3 4 5 6 7 8 9 10 11 12
Value of each
contract 3,8 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 71,0 50,3
Weights 0,0302 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,5676 0,4022
Weights *
remaining lease
term of each
contract 0,0302 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 6,2435 4,8268
Weighted average lease term
=
11,1005
Table 5: Weighted average lease term
4.3.4. Estimating Net Profit
The sixth step calculates the deferred tax liability and eventually the net profit.
The expense under finance lease (€21.700) is the sum of the depreciation expense (€13.000) and the
interest expense (€8.700). The expense under the operating lease method is the lease payment of €22.000.
Under the finance lease method, we see an increase in profit of €300. The tax books of the company
cannot be changed, but for financial reporting purposes it will report higher earnings before tax and thus a
20
higher tax expense through deferred taxes. Assuming a tax rate of 25%, the increased tax expense is €758.
The deferred tax liabilities increase by the same amount (€75).
Income Statement 2015
Cost of sales ‘000 €
Lease expense - 22
Depreciation expense + 13,0
Interest expense + 8,7
P/L before tax + 0,3
Tax + 0,075
P/L after tax + 0,225
Table 6: Simplified Income Statement 2015
4.3.5. Adjusted ending Balance Sheet
Table 7 presents the adjustments that have been made to the balance sheet of the second category.
Assets Liabilities
Non-current tangible assets Non-current debt
Beginning capital 125,0 Beginning debt 125,0
New leases 39,0 New leases 39,0
Annual depreciation -13,0 Debt repayment -13,3
Deferred tax liability 0,075
SE 0,225
Total 151,0 Total 151,0
Table 7: Adjustments to ending Balance Sheet 2015
4.4. Manipulation Check
To check how and whether the respondents calculated the Equity Value of the company correctly, the
respondents were asked to write down the adjustments they made to EBTIDA. For the test dealing with
the Equity Value, questionnaires that failed the manipulation check were omitted.
8 25% * €19.000 - €18.700
21
4.5. Coding Strategy
Before the questionnaires were transcribed to SPSS, they were checked for accuracy. Questionnaires who
failed the manipulation check were transcribed into the database but eliminated for the relevant test. The
analysis of the open questions where the rationales for the adjustments or the opinions were discussed is
based on personal interpretation and is therefore subject to individual bias.
5. Analysis
Prior research from Branswijck et al. (2011) and Öztürk & Serçemeli (2016) analysed the potential
impact of the new lease standard on the Financial Statements. IFRS 16 has a significant influence on the
balance sheet, the income statement and the key financial ratios. As stated in the literature review, this
research applied the same key financial indicators as the papers mentioned above.
5.1. Effect on Balance Sheet
Table 8 provides an overview of key balance sheet items prepared in compliance with respectively IAS
17 and IFRS 16 for the year 2015.
2015 Reported 2015 Adjusted Difference (%)
Total Assets 1.556 1.707 9,70%
Total Liabilities 870 1.021 17,36%
Equity 686 686 ≈
Table 8: Financial Statement summary
Annex 2 (section 3: ‘Financial Statements’) contains the initial balance sheet prepared under IAS 17
whereas annex 3 (section 3: ‘Financial Statements’) includes the adjusted balance sheet prepared under
IFRS 16.
The liabilities of the company increased by 17,36% whereas the total assets increased by only 9,70%.
These case-based findings are in line with the results found by Beattie et al. (1998) and Bennet &
Bradbury (2003). In order to evaluate the financial position of the company correctly, it is useful to do a
financial ratio analysis to measure the performance of the company. An overview of the most important
key financial ratios according to Branswijck et al. (2011), Öztürk & Serçemeli (2016) and Durocher
(2008) is provided and tested in §5 (5.4. ‘Effect on ratios’).
22
5.2. Effect on Income Statement
Statement of Income (€ thousand)
2015 2015 Adjusted
Revenue 2.073 2.073
Cost of sales (1.410) (1.410)
Other expenses (338) (316)
Investment income 9 9
EBITDA 334 356
Depreciation & amortization (109) (122)
EBIT 225 234
Net interest cost (8) (17)
Taxes (58) (58)
Net Income 159 159
Table 9: Income Statement
Under IAS 17, the lease expenses were accounted as an operating cost. Under IFRS 16 however, the lease
payments are subtracted from the operating expenses and split up in a depreciation cost (€13.000) and a
financial cost (€8.700). Although the operating situation of the company did not change, it will report a
significantly higher EBITDA. The increase in EBIT is lower than the increase in EBITDA because of the
higher depreciation cost. In this particular case, the net income does not change significantly (€225) due
to the new lease standard and the assumed discount rate of 6%. Depending on the used discount rate and
the lease term, minor differences are possible. It is important to notice that the annual cost reported in the
income statement remained the same under IAS 17 (straight-line lease expense) whereas, over the years,
the expense under IFRS decreases because of the lower depreciation cost (front-loaded expense).
5.3. Effect on Cash flow(s)
Applying IFRS 16 does not change the original transaction between the lessor and the lessee. As a
consequence, the net cash flow does not change. On one hand, the operating cash flow will increase
because a part of the operating lease payments is removed. On the other hand, the finance cash flow will
decrease with the same amount.
23
5.4. Effect on ratios
As expected the ratios changed using the adjusted Financial Statements. The change in the financial ratios
presented in table 10 is in line with the results found by Durocher (2008) and Branswijck et al. (2011).
Table 10: Ratio analysis
The D/E ratio as a proxy for financial leverage increased drastically from 52,04% to 74,05% leading to
higher potential bankruptcy costs and reduced flexibility. A higher leverage could lead to debt holders
restricting the firm’s operating, investment and financing decisions due to their covenants imposed on the
firm (Palepu, et al., 2016). The Debt-to-Asset ratio increased from 22,94% to 29,76% which implies that
there are now more claims on the company’s assets. The increased financial risk of the firm along with a
deteriorated solvability leads to a higher probability of being credit constrained in the future (Kaplan &
Zingales, 1995). The ROA decreased slightly from 10,21% to 9,31%. As the revenue of the company did
not change, the net profit margin13 did not change in this case. The decreased ROA is caused by a lower
asset turnover suggesting that the management of the company uses the assets less effective to generate
sales. The liquidity of the company measured by the current ratio of the company decreased from 1,26 to
1,19. As long as the ratio remains above 1 however, the company does not have liquidity issues.
It is important to note that the magnitude of the impact of IFRS 16 will vary depending on whether the
company is lease intensive or not. Although the company used in this case-based survey is not
uncommonly lease-intensive, the impact on the ratios cannot be neglected.
5.5. Conclusion
The results of this case-based research are in line with the results of prior literature. Although
operationally the situation of the company did not change, its Financial Statements suggest otherwise.
Figure 2 provides a visual overview of the key financial ratios commonly used by professional Financial 9 (Current + Non-Current Debt) / Shareholders’ Equity 10 (Current + Non-Current Debt) / Total Assets 11 Net Income / Total Assets 12 Current Assets / Current Liabilities 13 ROA= Net Profit Margin x Asset Turnover
Debt/Equity9 Debt/Asset10 ROA11 Current ratio12
Initial 52,04% 22,94% 10,21% 1,26
Adjusted 74,05% 29,76% 9,31% 1,19
24
Statement users (Branswijck et al., 2011). The management teams of the companies will have to
communicate clearly with the Financial Statement users to justify the overnight changes to their Financial
Statements. Loan covenants for example often incorporate leverage clauses. Due to the increased
leverage, the covenants could be breached which could have severe consequences (freeze of dividends,
forced asset sale, …) for the company. Financial institutions will have to adapt their financial models and
renegotiate the terms of their contracts to adjust for the new situation.
Figure 2: Ratio Analysis
It is important to note that the impact of implementing IFRS 16 on this particular firm is material but not
exceptional. The report of Europe Economics 2017 expects a linear relationship between the size of the
lease portfolio and the magnitude of the consequences. The retail, aviation and transportation sector, who
are traditionally very lease intensive, are expected to experience the biggest effects. (Europe Economics,
2017)
6. Sampling and Results
6.1. Sample Description
The Full Sample consists of 58 investment professionals and excludes 4 questionnaires from the test
phase. The test phase was used to improve the design and content of the questionnaire.
In order to maximize the amount of questionnaires in each individual test, varying sample sizes were
used. Annex 4 presents a detailed overview of the sample selection and composition.
52,04%
22,94%
10,21%
74,05%
29,76%
9,31%
Debt/Equity Debt/Asset ROA
Ratio Analysis 2015 Adjusted 2015
25
In the test based on the Equity Value, two questionnaires were eliminated because of failed manipulation
checks. The sample used for the Equity Value analysis therefore comprises 56 investment professionals.
The Likert item Sample is a sub-sample of the Full Sample of 58. The sample excludes 45 questionnaires
lacking Likert Scores and comprises therefore 13 questionnaires. The written Response Sample, which
was used in the descriptive of the rationales, is a sub-sample of the Full Sample of 58. The sample
excludes 7 questionnaires that did not provide rationales or unclear rationales. As a result, the sample was
reduced to 51 questionnaires.
Figure 3 and 4 provide the descriptive statistics for the Full Sample.
Figure 3 reports the personal demographics by age and sex. The Full Sample is predominantly composed
of male investment professionals (Figure 3, Panel 1). This raises the question whether this sample is
biased or whether the proportion of women in the investment business is significantly lower. The
composition of the sample is in line with evidence from Gompers et al. (2014) claiming that over 90% of
the VC investors are men and that many areas of finance are still largely dominated by men. The most
frequently appearing age group is 41-50 (40%), shortly followed by >51 (33%). The age groups 20-30
and 31-40 represent respectively 8% and 19% of the Full Sample (Figure 3, Panel 2).
Figure 3: Sex and Age group
26
Figure 4 provides more detail on the professional demographics of the Full Sample.
The sample consists of roughly the same amount of professional investors (47%) as others (53%) (infra
Figure 4, Panel 1). Panel 2 describes the professional experience of the respondents. 39% of the
respondents have less than 10 years of experience. The majority of the sample (61%) consists of people
who appear to be very experienced professionals. 40% of the respondents have more than 10 but less than
20 years of professional experience. The remaining 21% of the respondent have between 21 and 30 years
of experience.
Panel 3 gives an overview of the IFRS knowledge of the participants. A sizable portion of the sample
indicates that they either have an average level (48%) or a limited level (48%), whereas only 4% of the
respondents claim to have advanced IFRS knowledge.
Figure 4: Professional demographics for the Full Sample
27
Several tests were conducted to analyse whether the composition of category 1 and 2 are not significantly
different from each other.
In order to test whether the proportion of professional investors in category 1 and 2 are not significantly
different, two binomial tests were conducted. As the proportion of the overall population is unknown,
empirical proportions were used when conducting the test. The empirical proportions of professional
investors in the first and second category are 0,49 respectively 0,44. The significance probability (0,390)
found when conduction the binomial test for category 2 using the empirical proportion of category 1
(0,49) was superior to the conventional 1,5 and 10% levels. The significance probability (0,376) found
when conducting the binomial test for category 1 using the empirical proportion of category 2 (0,44) was
superior to the conventional 1,5 and 10% levels. The null hypothesis that the proportion of professional
investors in category 1 and 2 is not significantly different can therefore not be rejected at these levels.
Two additional binomial tests were conducted to verify whether the proportion of men and women in
each category was not significantly different. As the probability of having a man in the population is
unknown, the proportion was defined calculating the probability in each category. For the first category,
the empirical proportion of finding a man was 0,94. For the second category, the empirical proportion
was 0,89. The significance probability (0,219) found when conducting a binomial test for category 2
using the calculated proportion of category 1 was superior to conventional 1,5 and 10% levels. The
significance probability (0,322) found after conducting the binomial test for category 1 using the
calculated proportion of category 2 was superior to the conventional 1,5 and 10% significance levels. The
null hypothesis that the proportion of males in both categories is not significantly different cannot be
rejected at these levels.
As the distribution of the population for age, experience and IFRS knowledge are unknown, Chi-Square
tests were conducted to verify whether there are no significant differences in distribution for the two
categories. The significance probability of the Chi-Square test for age (0,208) does not reject the null
hypothesis that the distribution of category 1 is not significantly different from the distribution of
category 2 at the conventional levels of 1,5 and 10%.
The significance probability of the Chi-Square test for experience (0,172) does not reject the null
hypothesis that the distribution of category 1 is not significantly different from the distribution of
category 2 at the conventional levels of 1,5 and 10%.
The significance probability of the Chi-Square test for IFRS knowledge (0,645) does not reject the null
hypothesis that the distribution of category 1 is not significantly different from the distribution of
category 2 at the conventional levels of 1,5 and 10%.
28
None of the tests above indicate a significant difference between category 1 and 2. Therefore I assume
that the results found in this research are not significantly biased by the category the participants were
assigned to.
6.2. Univariate Descriptive Evidence on Equity Value
Table 11 provides the descriptive statistics for the Equity Values calculated by category 1 and 2. Two
questionnaires were discarded from the sample because of failed manipulation checks. The mean and
median Equity Value of category 2 are substantially lower than the Equity Value’s of category 1, which
could be an early indication of a potentially significant difference between category 1 and 2.
Variable Obs. Mean SD P25 Median P75
Equity Value
Category 1 30 1139,83 46,79 1119,75 1145 1181
Category 2 26 1064,15 49,32 1023,75 1056 1118
Table 11: Equity value
Figure 5 provides a graphic overview of the expected and observed effects. As stated in the hypothesis,
we expected that, on average, the Equity Value calculated by the investment professional would be lower
when assigned to category 2 (IFRS 16) than to category 1 (IAS 17).
Figure 5: Expected vs. Empirical Equity Value
1000
1040
1080
1120
1160
1200
IAS 17 IFRS 16
Equ
ity V
alue
Accountingstandard
Equity Value
Expectations Experimental
29
As mentioned above, both Table 11 and Figure 5 reveal a decrease in Equity Value when shifting from
IAS 17 to IFRS 16, which is in line with our null hypothesis. Whether this difference in valuation is
significant will be tested and discussed in §7 (7. ‘Experimental Results’).
6.3. Descriptive Evidence on Lease Treatments
Figure 6 provides the descriptive statistics of the lease adjustments made by the investment professionals
in category 1. 65% of the respondents declared they did not make any adjustments because the operating
leases are already incorporated in EBITDA and therefore having a sufficient impact on the value of the
firm. 26% of the respondents excluded the operating leases from the Income Statement and used a
capitalization method to convert the operating expense to a financial debt. 3% indicated that they would
consider capitalizing the lease expenses if it would be an extraordinary lease intensive company. The
remaining 6% indicated that they needed more information to be able to make adjustments. The
additional information they required however was not specified.
Figure 6: Lease treatment
6.4. Descriptive Evidence on Perceived Usefulness of IFRS 16
The written responses of the investment professionals were analysed to reveal the rationales underlying
their opinion on IFRS 16. In order to augment the validity of the conclusions drawn from the rationales, a
5-point Likert item was added to the research.
65%
26%
3% 6%
0,00% 10,00% 20,00% 30,00% 40,00% 50,00% 60,00% 70,00%
Incorporated in EBITDA
Capitalized Partial Capitalisation
Lack of Information
Lease Treatment
Category 1
30
Figure 7: Opinion IFRS 16
Figure 7 and Table 12 provide the descriptive of the 5-point Likert item gauging the respondent’s position
on the new lease standard and whether according to them, it will improve the quality and transparency of
the Financial Statements. 53,85% of the respondents indicated to support the statement and therefore the
new lease standard, whereas 38,46% opposes. The majority seems to believe that IFRS 16 will provide a
solution for the often criticized flexibility of IAS 17.
Variable Obs. Mean Std. Dev. P25 Median P75
Opinion IFRS 16 13 3,23 1,641 1,5 4 5
By Category
Category 1 8 3,13 1,642 1,25 3,5 4,75
Category 2 5 3,4 1,817 1,5 4 5
Table 12: Descriptive 5-point Likert item (1: Strongly disagree – 5: Strongly agree)
A Chi-Square test was conducted to verify whether the ‘Opinion on IFRS 16’ is independent from the
category the participant belonged to. The test provided a p-value of 0,905, which tells us that there is no
statistically significant association between the category the respondent was assigned to and his or her
opinion on IFRS at the conventional 1,5 and 10% levels. 100% of the cells however have an expected
count lower than 5 with a minimum expected count of only 0,38. Therefore, the result found by the Chi-
Square test should be handled with extreme care.
23,08%
15,38%
7,69%
23,08%
30,77%
0,00%
10,00%
20,00%
30,00%
40,00%
Stronghly disagree
Disagree Neutral Agree Stronghly agree
Improved quality and transaprency
31
6.5. Descriptive evidence preferred valuation tool
Figure 8 gives an overview of the preferred valuation tool of the Full Sample. 67% declared that if this
case would be a real life valuation question, they would use a multiple (in combination with DCF) to
value the company. 29% of the professionals would rely on Discounted Cash Flow whereas only a
minority would use the Dividend Discount Model or the Adjusted Book Value. Figure 8 confirms the
popularity of a Multiple as a valuation method among investment specialists and as an adequate valuation
tool for this case-based study.
Figure 8: Preferred Valuation Tool
7. Experimental Results
To test whether the valuation difference visible in Table 11 is statistically significant, the two means were
compared using a t-test. Given the relatively small sample sizes (<50), a Shapiro Wilk test was executed
to check normality. For category 1, a significance probability of 0,086 was found. The hypothesis that
Category 1 comes from a normally distributed population cannot be rejected at conventional 1% and 5%
but it can be at the 10% level. The significance of category 2 (0,171) is superior to the conventional 1,5
and 10% levels. Therefore we cannot reject the null hypothesis that both categories come from a normally
distributed population. Consequentially, a paired t-test was executed to compare the means of the two
categories. As a t-test assumes equal variances between the two paired samples, a Levene test was
conducted to verify. The Levene’s Test for equal variances provides a probability significance of 0,341,
DCF 29%
Multiple 52%
Adjusted Book Value 2%
Dividend Discount Model
2% DCF & Multiple
15%
Valuation Tool
DCF
Multiple
Adjusted Book Value
Dividend Discount Model
DCF & Multiple
32
which is superior to the conventional 1,5 and 10% levels. The null hypothesis of equal variances of
category 1 and 2 is therefore not rejected at those levels.
The paired t-test provides us a t-value of -6,034 (infra Table 13). Given our hypothesis that applying
IFRS 16 will lead to a lower perceived Equity Value by the investment professionals, a one-tailed test
was necessary. Given the one-tailed critical values at the conventional significance levels of 1,5 and 10 %
respectively -2,492; -1,711 and -1,318, we reject the null hypothesis that both means are equal in favour
of the alternative hypothesis stating that the mean of category 2 is significantly lower.
Pairs Mean df T Sig.
EV 14 Category 2
– EV category 1 -73,52 24 -6,034 0,000
Table 13: Paired sample t-test
Two additional tests were conducted to examine whether there exists a significant difference between
early and late respondents and whether there exists a relationship between the respondent’s opinion on the
new lease standard and the calculated Equity Value.
The cut-off for the first test was set at seven working days. Respondents who completed and sent back the
questionnaire within seven working days were identified as early respondents. The others were identified
as late respondents. Since the date of reception from the questionnaires received with the help of
B.C.F.A., BVA and BAN is unknown, only the questionnaires sent and received by myself are taken into
account. The Full Sample of 58 is therefore reduced to 26 participants. 16 questionnaires from category 1
and 10 questionnaires from category 2 were included in the test. A significance probability15 of 0,175 was
found for category 1. The null hypothesis that the average Equity Value of the late respondents is not
significantly different from the early respondents cannot be rejected at the conventional 1,5 and 10%
levels. A significance probability16 of 0,554 was found for category 2. The null hypothesis that the
average Equity Value of an early respondent is not significantly different from the Equity Value of a late
respondent cannot be rejected at the conventional 1,5 and 10% levels.
In order to analyse whether the ‘opinion on IFRS 16’ measured by the 5-point Likert item had an
influence on the calculated Equity Value, two one-way ANOVA’s were conducted. For the first category,
the analysis of variance showed that the effect of ‘the opinion on IFRS 16’ on the calculated Equity Value 14 EV= Equity Value 15 Levene’s test for equal variances superior to conventional 1 and 5% levels. 16 Levene’s test for equal variances superior to conventional 1,5 and 10% levels.
33
was not statistically significant at the conventional 1,5 and 10% levels with a p-value of 0,666. For the
second category, the analysis of variance showed that the effect of the ‘opinion on IFRS 16’ on the
calculated Equity Value was not found statistically significant at the conventional 1,5 and 10% levels
with a p-value of 0,870. It is important to note that for both ANOVA’s, that the Levene’s test for equal
variances could not be calculated because of the extremely small amount of respondents in the category
‘opinion on IFRS 16’.
A factorial analysis of variance (ANOVA) was conducted to analyse the influence of five independent
variables (Age, Sex, Experience, Professional Investor, IFRS knowledge) on the calculated Equity Value
of the firm for both the first and second category. All effects were statistically insignificant for the first
category at the conventional 1,5 and 10% levels except for the IFRS Knowledge factor. The main effect
for IFRS Knowledge yielded an F-ratio of F(2,9)= 3,491 and a p-value of 0,075, indicating a significant
difference between investment professionals having limited (estimated mean: 1129,6 ; SD: 14,8), average
(estimated mean: 1159,8 ; SD: 14,7) and advanced IFRS Knowledge (estimated mean: 1181 ; SD: 51,5) at
the 10% level. As only one respondent claimed to have an advanced level, a post-hoc analysis could not
be executed because not every category contains the required minimum of two elements. Although the
result appears to be statistically significant, the result is most likely not economically significant.
Conclusions drawn from a test based on a category containing only one respondent are most likely not
meaningful and should be handled with care.
As for the second category, none of the effects were statistically significant at the conventional 1,5 and
10% levels.
Table 13 represents the top 5 rationales given by the respondents for both the positive (Panel 1) and
negative opinions (Panel 2). The table is based on the Full Sample but 7 questionnaires were excluded
because of unclear or missing opinions. The sample was therefore reduced to 51 questionnaires. 58,8% of
the questionnaires were identified as positive towards mandatory lease capitalization, whereas 41,2% was
identified as negative towards the new lease standard. This number is in line with the 5-point Likert item
which shows that 53,85% of the respondents perceive IFRS 16 as an improvement of the current
situation.
34
Opinion Full Sample Category 1 Category 2
Rank % Rank % Rank %
Improved valuation
because of visibility
liabilities 1 28,57% 1 29,41% 3 23,08%
Off-balance sheet items
decrease 2 25,00% 3 17,65% 1 30,77%
Financial liabilities are
more visible 3 21,43% 2 23,53% 4 15,38%
Convergence accounting
and economic reality 3 21,43% 3 17,65% 2 23,08%
Ratio manipulation
decreases 4 3,57% 4 5,88% NA NA
Panel 1: Top 5 Rationales supporting improvement
Opinion Full Sample Category 1 Category 2
Rank % Rank % Rank %
Risk profile is different 1 30,00% 1 33,33% 2 25,00%
Only long term or
substantial liabilities
should be visible
1 30,00% 2 22,22% 1 33,33%
No influence on
valuation 2 20,00% 2 22,22% 3 16,67%
Economic difference
between operating and
finance leases
3 15,00% 3 11,11% 3 16,67%
Operating lease is still a
cash movement but does
not appear in EBITDA
4 5,00% 3 11,11% NA NA
Panel 2: Rationales supporting deteriorating situation
Table 14: Raised rationales overall and by category (panel 1 & panel 2)
Panel 1 shows the most frequently mentioned rationales supporting the new lease standard. Interestingly,
the increased visibility of former off-balance sheet liabilities and the improved valuation score very high
in both categories. Which indicates that investment professionals are aware of the existence of off-
35
balance sheet obligations and their potential impact on valuation. Even though they seem to be aware of
this distortion, evidence found in Figure 6 and Table 13 shows that although there exist methods to undo
the distortion (cfr. Capitalization), the professional investors do not take the ‘hidden’ liabilities into
account when valuing a company. Which raises the question why not? Potentially, they are not aware of
the existence of such capitalization methods or they perceive them as inadequate or inefficient.
Panel 2 shows the rationales provided by the participants protesting against the new lease standard. The
most frequently mentioned rationale claims that the risk profiles of an operating or finance lease are
substantially different, therefore they should not be treated the same way. An important part of the
respondents (30%) indicate that only the substantial operating lease contracts should be visible. A more
profound analysis of this rationale shows that most of them acknowledge the fact that the current
flexibility in the lease standard IAS 17 is being exploited. The intervention of the IASB however is
sometimes perceived both by supporters and opponents of IFRS 16 as too far-reaching. The short-term
and low-value exemptions embodied in the lease standard, were designed to simplify the transformation
process and lower the implementation cost for the companies. Unintentionally however, these exemptions
could solve some of the most often mentioned objections towards IFRS 16.
8. Conclusion and discussion
In January 2016, the IASB published the long expected new lease standard: IFRS 16, which ends the
difference in accountancy treatment between operating and finance leases. In order to augment the
transparency and comparability of the Financial Statements, capitalization of virtually all lease contracts
will be required. The objective of this dissertation was to reveal whether the investment professionals in
Belgium and Luxemburg will experience significant valuation consequences when IFRS 16 becomes
mandatory the 1st of January 2019. Prior literature suggests that, on average, the capitalization of lease
contracts will result in higher financial liabilities appearing on the Balance Sheet, which affects the
calculated Equity Value of the company directly. In this case-based survey, the impact of implementing
IFRS 16 on the key financial indicators is in line with prior literature. The results indicate that mandatory
capitalization of operating leases, remarkably influences the Debt-to-Equity ratio, Debt-to-Asset ratio,
Current ratio and ROA of the company. The expected impact of IFRS 16 however will vary depending on
the industry and the lease intensity of the company. The retail and airline sector are expected to suffer the
most.
The results of this dissertation support the hypothesis that the implementation of IFRS 16 will lead to a
lower perceived Equity Value. Despite the strong valuation incentive for the investment professional and
the existence of effective models (e.g. capitalization method) to imitate the effect of IFRS 16, the
36
investment professionals in Belgium and Luxembourg neglect to benefit from their existence.
Surprisingly however, the majority of the respondents voted in favour of the mandatory capitalization,
claiming that IFRS 16 will improve the quality and transparency of the Financial Statements.
Consequentially, the investment professionals seem aware of the existence of off-balance sheet liabilities
and their consequences on valuation but neglect or refuse to undo these distortions. Future research could
investigate why this is the case. Perhaps the capitalization method is not mastered by the investment
professional or not perceived effective enough.
This dissertation tried to capture the rationales and the opinions of the respondents. Although the majority
of the respondents, based on the 5-point Likert item, support IFRS 16, 38,64%17 of the professionals
oppose. The 41,2%18 of rationales containing negative feedback or remarks on the new lease standard
cannot be ignored. The question whether the drastic intervention of the IASB demanding capitalization of
virtually all lease contracts is justified cannot be answered unambiguously. In an ultimate attempt to
improve the transparency of the Financial Statements, IFRS 16 will eliminate IAS 17’s often-criticized
relative subjectivity where lessees could choose almost arbitrarily between operating and finance lease.
The magnitude of the impact of IFRS 16 can however be minimized using the unintentionally created
flexibility in the definition of a lease (or a service contract) and the short-term lease exemption. In the
end, the effect of IFRS 16 might not have the far-reaching consequences expected by the investment
professionals (and standard setters) today.
The results of this dissertation are relevant to the IASB and other standard setters as it gives insight in
how investment professionals deal with off-balance sheet items (operating leases). The significant
valuation difference between the two categories, based on respectively IAS 17 and IFRS 16, provides
empirical evidence that the concerns and the intervention of the IASB are merited even though it is not
always perceived as such by the investment professionals themselves.
9. Limitations
The results of this dissertation are naturally limited by data deficiencies and various assumptions. Even
though I allowed for varying sample sizes in the different tests, in order to deal with these issues, the
amount of respondents remains often limited. The additional test analysing whether the early respondents
are significantly different from the late respondent is based on a reduced sample due to the unknown date
of reception from the various associations. Therefore, the sample consisted solely of questionnaires sent
17 Based on the sample used in the Likert score analysis. 18 Based on the sample used in the ‘Opinion on IFRS 16’ analysis
37
and received by myself. Tests such as for example the Factorial ANOVA who provide statistically
significant results are not necessarily significant from an economic point of view. Conclusions drawn
from tests based on limited samples should be analysed carefully before generalizing it to the overall
population.
As the Likert item was initially not incorporated in the questionnaire sent to the investment professionals,
only the respondents who could be identified afterwards were contacted to quantify their opinion on IFRS
16 with a 5-point Likert item. The open question gauging the opinion on IFRS 16 itself was interpreted by
myself and is therefore subject to personal interpretation. Future research could use the top five rationales
both pro and contra IFRS 16 mentioned by the respondents in this dissertation and convert them into
multiple-choice questions. This way, a larger sample could be addressed, which could test the validity of
my results. This dissertation focussed at Belgian and Luxembourgish investors and analysts. The topic
IFRS 16 can and should however be explored from different points of view. A similar research could be
conducted to test whether creditors interpret the Financial Statements differently or if IFRS 16 will
impact the credit analysis as significantly as it influences company valuation.
To my knowledge, there has not been a research yet that investigated the impact for the leasing
companies. IFRS 16 will most likely cause a shockwave through the leasing industry. Analysing and
anticipating how the lessors will deal with the new standard or how the lease market will evolve should
be researched as leasing remains a popular way of financing in Europe. (Leaseurope – European Leasing,
2015)
VIII
10. References
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Statement Recognition vs. Disclosure: Evidence from SFAS No. 106. Accounting Review, (74), p. 403–
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XII
11. Appendix
Annex 1
Annex 1: Flowchart – IFRS 16
Source: IFRS 16 In depth, PWC
XIII
Annex 2
Annex 2: Questionnaire Category 1 (IAS 17)
Section 1: Personal background I would like to ask you some questions about your demographics and professional occupation. For the next questions, please highlight your answer or elaborate if necessary. The entire survey should not take longer than 15 minutes.
• Are you a professional investor as an occupation?
• Characterize your occupation briefly please (e.g. Private Equity, Venture Capital, Bank,…)
• Number of years of experience in current occupation: 0-10 11-20 21-30 Over 30
• Age: 20-30 31-40 41-50 Over 51
• Sex:
• Level of accounting knowledge IFRS: None Limited Average Advanced
Yes No
M F
XIV
Section 2: Valuation In the second section, I will ask you to do a valuation of the company, based on the Financial Statements I provided below. 1) Using the EV/EBITDA multiple of 4 and the information provided in the document, what is the
calculated equity value of the firm? 2) Did you make any adjustments to EBITDA?
a. If yes, which one?
b. If no, why not?
3) Did you take into account operating leases?
c. If yes, how?
d. If no, why?
4) Please give your opinion on the elimination of the difference between operating and finance leases. Do you think it improved the quality and transparency of the Financial Statements?
e. If yes, why?
f. If no, why?
5) How would you normally calculate a quick estimate of the (equity) value of the company? (pick only one)
a. DCF method b. Multiple (e.g. EV/EBITDA, P/E) c. Adjusted book value d. Dividend Discount model e. Other
6) If you have any questions or remarks, please write them below.
XV
7) Post-questionnaire addendum: In addition to your answer provided in question 4, how would you assess the statement: “eliminating the difference between operating and finance leases will improve the quality and transparency of the Financial Statements”, on a 5-point Likert scale ranging from 1= strongly disagree, to 5= strongly agree?
1 2 3 4 5 Section 3: Financial Statements Introduction: Company X is a manufacturer of car parts. It was founded 20 years ago and is considered to be a solid company. The Balance Sheet and Income Statement have been stable over the last couple of years. SummaryBalanceSheet(€thousand)
PPE 600 Equity 686Developmentcosts 41 Long-termdebt 210
Goodwill 44 Provisions 43Otherintangibleassets 15 Deferredtaxliabilities 13
Shareholdings 25 TOTALnon-currentliabilities 264Otherfinancialassets 12 Short-termdebt 147
Deferredtaxassets 56 Tradepayables 350
TOTALnon-currentassets 793 Othercurrentpayables 107Inventory 250 TOTALcurrentliabilities 604
Tradereceivables 311 Cash 202 TOTALcurrentassets 763
TOTALASSETS 1.556 TOTALEQUITYANDLIABILITIES 1.556 StatementofIncome(€thousand)
Revenue 2.073Costofsales (1.410)Otherexpenses (338)Investmentincome 9EBITDA 334Depreciation&amortization (109)EBIT 225Netinterestcost (8)Taxes (58)NetIncome 159
XVI
Accounting Policy: The consolidated Financial Statements are prepared in compliance with IFRS. The firm uses a historical cost basis unless stated otherwise below. Crucial accounting policies:
• PPE are carried at cost, net of accumulated depreciation and any impairment in value. • Assets held under finance lease are recognised and recorded at inception under PPE. Leases
where the lessor retains substantially all the risks and rewards incident to ownership are classified as operating leases and are therefore not recognised on the balance sheet. Lease payments are recognised in the statement of income under other expenses.
• Goodwill is measured at cost and annually tested for impairment. • Development costs and other intangible assets are measured at cost less
amortization if the necessary criteria are met. • Inventories are stated at the lower of cost or market value. • Shareholdings are valued using the equity method. • Other financial assets are measured at amortised cost, using the effective interest rate method,
less impairment cost. • Provisions for employee benefits are the net of the present value of the obligations to the defined
benefit plan and external plan assets. Discretionary valuations and significant accounting estimates:
• Recognition, measurement and impairment of intangible assets required management judgement. • The present value of the defined benefit obligation is determined according to annual actuarial
assessment. • The company holds a limited number of minority investments in unlisted firms. Managerial
estimates were used to determine the Fair Value of these investments.. • Deferred tax assets are recognised for all unused tax losses. The company’s management had to
estimate the amount of deferred tax assets that could be recognised based on the amount of future taxable profit.
• Impairment of assets is based on the assumptions used to calculate the recoverable amount. Notes and additional information:
• The tax percentage is 25%.
• A leading audit firm has audited the company. The corporate governance is therefore of high standard.
XVII
• Inventories In € ‘000 31.12.15 31.12.14 raw materials 102 96 work in progress 48 44 finished products 82 77 goods in transit 18 14 TOTAL 250 231 In € ‘000 31.12.14 Provis-
ions Use/release Exchange
rate fluctuation
change in consolidation area
31.12.15
write down provision 33 13 -9 0,6 -1,6 36
• Trade receivables
Expired receivables mainly refer to leading car manufacturers.
• Financial Debt & Derivatives
Summary € ‘000 Liquidity 202 Current financial debt 147 Net current financial debt -55 Non-current financial debt 210 Net financial debt 155
• Leases The company has outstanding lease agreements for several production facilities and headquarters. The company concluded that not all significant risks and rewards were transferred to the company. Therefore these contracts are considered to be operating leases. Theeffective annual interest rate for the finance lease obligations is 6%
MinimumFuturerentalpayments:€‘000 31/12/15 31/12/14<1year 22 191-2years 19 152-3years 19 153-4years 19 154-5years 19 15>5years 108 96Total 206 175
XVIII
• Provision for Employee Benefits
In € ‘000 31.12.14 Provisions Use/release Interest expense
Exchange rate fluctuations
change in consolidation area
actuarial gain/loss
31.12.15
employees' leaving entitlement
23 0 -1 0,4 0 -0,2 -1,2 21
defined benefit plans
9 0,3 -0,7 0,4 0,5 0 -0,5 9
defined contribution plans
1 0,6 -0,6 0 0 0 0 1
total 33 0,9 -2,3 0,8 0,5 -0,2 -1,7 31
• Valuation
A company with similar characteristics (growth potential, seize, industry,…) was recently valued 4 times its EBITDA.
XIX
Annex: 3 Annex 3: Questionnaire Category 2 (IFRS 16)
Section 1: Personal background
I would like to ask you some questions about your demographics and professional occupation. For the next questions, please highlight your answer or elaborate if necessary. The entire survey should not take longer than 15 minutes.
• Are you a professional investor as an occupation?
• Characterize your occupation briefly please (e.g. Private Equity, Venture Capital, Bank,…)
• Number of years of experience in current occupation: 0-10 11-20 21-30 Over 30
• Age: 20-30 31-40 41-50 Over 51
• Sex:
• Level of accounting knowledge IFRS: None Limited Average Advanced
Yes No
M F
XX
Section 2: Valuation In the second section, I will ask you to do a valuation of the company, based on the Financial Statements I provided below. 1) Using the EV/EBITDA multiple of 4 and the information provided in the document, what is the
calculated equity value of the firm? 2) Did you make any adjustments to EBITDA?
g. If yes, which one?
h. If no, why not?
3) Please give your opinion on the elimination of the difference between operating and finance leases.
Do you think it improved the quality and transparency of the Financial Statements?
i. If yes, why?
j. If no, why?
4) How would you normally calculate a quick estimate of the (equity) value of the company?
(Pick only one)
f. DCF method g. Multiple (e.g. EV/EBITDA, P/E) h. Adjusted book value i. Dividend Discount model j. Other
5) If you have any questions or remarks, please write them below. 6) Post-questionnaire addendum: In addition to your answer provided in question 3, how would you assess the statement: “eliminating the difference between operating and finance leases will improve the quality and transparency of the Financial Statements”, on a 5-point Likert scale ranging from 1= strongly disagree, to 5= strongly agree? 1 2 3 4 5
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Section 3: Financial Statements Introduction: Company X is a manufacturer of car parts. It was founded 20 years ago and is considered to be a solid company. The Balance Sheet and Income Statement have been stable over the last couple of years. SummaryBalanceSheet(€thousand) PPE 751 Equity 686Developmentcosts 41 Long-termdebt 322Goodwill 44 Provisions 43Otherintangibleassets 15 Deferredtaxliabilities 13Shareholdings 25 TOTALnon-currentliabilities 378Otherfinancialassets 12 Short-termdebt 186Deferredtaxassets 56 Tradepayables 350TOTALnon-currentassets 944 Othercurrentpayables 107Inventory 250 TOTALcurrentliabilities 643Tradereceivables 311
Cash 202 TOTALcurrentassets 763
TOTALASSETS 1.707 TOTALEQUITYANDLIABILITIES 1.707 StatementofIncome(€thousand)
Revenue 2.073Costofsales (1.410)Otherexpenses (316)Investmentincome 9EBITDA 356Depreciation&amortization (122)EBIT 234Netinterestcost (17)Taxes (58)NetIncome 159
Accounting Policy: The consolidated Financial Statements are prepared in compliance with IFRS. The firm uses a historical cost basis unless stated otherwise below. Crucial accounting policies:
• PPE are carried at cost, net of accumulated depreciation and any impairment in value.
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The firm chose to adopt the new lease standard IFRS 16 early, which erases the distinction between operating and finance leases. All lease obligations are therefore recognised on the balance sheet and no longer incorporated in the income statement.
• Goodwill is measured at cost and annually tested for impairment. • Development costs and other intangible assets are measured at cost less
amortization if the necessary criteria are met. • Inventories are stated at the lower of cost or market value. • Shareholdings are valued using the equity method. • Other financial assets are measured at amortised cost, using the effective interest rate method,
less impairment cost. • Provisions for employee benefits are the net of the present value of the obligations to the defined
benefit plan and external plan assets. Discretionary valuations and significant accounting estimates:
• Recognition, measurement and impairment of intangible assets required management judgement. • The present value of the defined benefit obligation is determined according to annual actuarial
assessment. • The company holds a limited number of minority investments in unlisted firms. Managerial
estimates were used to determine the Fair Value of these investments. • Deferred tax assets are recognised for all unused tax losses. The company’s management had to
estimate the amount of deferred tax assets that could be recognised based on the amount of future taxable profit.
• Impairment of assets is based on the assumptions used to calculate the recoverable amount. Notes and additional information:
• The company has been audited by a leading audit firm. The corporate governance is therefore of high standard.
• The tax percentage is 25% and the interest percentage 6%.
• Inventories In € ‘000 31.12.15 31.12.14 raw materials 102 96 work in progress 48 44 finished products 82 77 goods in transit 18 14 TOTAL 250 231 In € ‘000 31.12.14 Provis-
ions Use/release Exchange
rate fluctuation
change in consolidation area
31.12.15
write down provision 33 13 -9 0,6 -1,6 36
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• Trade receivables
Expired receivables mainly refer to leading car manufacturers.
• Financial Debt & Derivatives
Summary € ‘000 Liquidity 202 Current financial debt 186 Net current financial debt -16 Non-current financial debt 322 Net financial debt 306
• Leases The company chose to apply IFRS 16 early. The new standard eliminates the difference between operating and finance leases. All lease contracts are therefore recognized as a financial debt on the balance sheet. As a consequence, operating lease payments have been eliminated from the income statement.
• Provision for Employee Benefits
In € ‘000 31.12.14 Provisions Use/release Interest expense
Exchange rate fluctuations
change in consolidation area
actuarial gain/loss
31.12.15
employees' leaving entitlement
23 0 -1 0,4 0 -0,2 -1,2 21
defined benefit plans
9 0,3 -0,7 0,4 0,5 0 -0,5 9
defined contribution plans
1 0,6 -0,6 0 0 0 0 1
total 33 0,9 -2,3 0,8 0,5 -0,2 -1,7 31
• Valuation A company with similar characteristics (growth potential, seize, industry,…) was recently valued 4 times its EBITDA.
XXIV
Annex 4
Annex 4: Sample Selection and Composition
Sample Description Obs.
1) Full Sample 58
This sample is based on all the questionnaires and excludes:
-4 questionnaires from the test phase
This sample consists of:
-Respondents Category 1 31
-Respondents Category 2 27
2) Sample used in Equity Value analysis 56
Sub-sample of the Full Sample excluding:
- 2 questionnaires with failed manipulation checks
3) Sample used in descriptive Lease Treatment 29
Sub-sample of the Full Sample excluding:
- 27 questionnaires from the 2nd category
- 2 missing answers from category 1
4) Sample used in Likert score analysis 13
Sub-sample of the Full Sample excluding:
- 45 questionnaires with no Likert scores.
5) Sample used in ‘opinion IFRS 16’ analysis 51
Sub-sample of the Full Sample excluding:
- 7 questionnaires with incomplete or unclear answers
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