Skip to main content

New accounting standards likely to create turbulence for airlines


India’s aviation industry might be flying into a debt cloud when new accounting standards come into force in 2019. Carriers may see their loans liability soar by more than Rs 50,000 crore, with the latest set of rules calling time on the established practice of aircraft leasing. 
The biggest impact of the switch would be on low-fare, asset-light airlines, especially IndiGo, which rely on lease-rentals for their operations. The new global accounting norms – IFRS 16 – would also affect legacy carriers such as Jet AirwaysBSE 0.13 % and Air India, which have adopted the industry best practice to lower their upfront costs. Net cash outgo for carriers, however, may not increase after the change over. 
A spokesperson at IndiGo declined to comment, saying the airline is in a silent period as its April-June earnings are to be announced shortly. A senior executive at Jet said there would “definitely be an impact” but didn’t elaborate. 
"It weighs down the balance sheet with representative debt more than actual debt," rued a senior executive at SpiceJet, saying that since there are assets backing the debt, the switch wouldn’t change valuations of an airline based on net worth.
Lease Rentals to Asset Ownership
From January 2019, the total rental obligation across the lease duration of an aircraft will be counted as debt. For instance, if a plane is leased for eight years, the current value of the total lease rental payments to be made across those eight years will be added to the outstanding debt. Since the aircraft is leased, the "right to use" the aircraft will be counted as the asset underlying the debt. 
“In other words, lessees will appear to become more asset-rich, but also more heavily indebted,” according to Kimber Bascom, KPMG’s global IFRS leasing standards leader. 
In the profit and loss account, this will contribute to the depreciation plus interest, thereby, hitting margins and net earnings. 
To be sure, it remains to be seen how promptly India would adopt these changes to its own accounting standard. India adopted IFRS on April 1, 2016. 
PWC estimates that the new accounting standard would impact at least 20 industries, ranging from retail to utilities. But the second biggest impact, after retail, will be on airlines, for which average debt would rise up to 47%. 
"It is a massive shift and there appears to be no way to avoid the impact,” said Sumit Seth, partner and IFRS leader at PwC. "For years, airlines have entered into voluminous leases of planes without having to recognize them on their balance sheet, historically classified as operating lease with only off-balance sheet disclosures.” 
Seth added: “The new standard is being brought to fix such anomalies, by now reflecting the substance of the transaction and bringing on to the balance sheet both the right-of-use asset and a corresponding lease obligation.” 
SpiceJet, Jet, AI: Industry-Wide Practice 
In India, the total lease rental obligations for three publicly listed airlines—InterGlobe Aviation (IndiGo), Jet Airways and SpiceJet - was Rs 13,000 crore by end- FY16, mostly on narrow-bodied planes and their engines, according to disclosures in their balance sheets. 
A senior Air India executive pegged the state-run flag carrier’s own lease rental obligations in FY16 for 21 wide-bodied Boeing Dreamliner 787 planes at another Rs 13,000 crore. (The lease rental on a wide-bodied plane can be three times that of a narrow-bodied plane). 
Sydney-based consultant CAPA Centre for Aviation estimates 400 aircraft deliveries by FY22 to Indian carriers—mostly to IndiGo--with 70%-80% of them either on direct lease or sale and leaseback transactions, wherein a purchased plane is sold to a lessor and leased back. 
“Given these figures, it is fairly easy to assume the industry burden in the next few years would be more that Rs 50,000 crore,” said a senior airline executive, who didn’t want to be named. 
Some global airlines already post lease rental adjusted net debt and the numbers are staggering. For instance, Air France-KLM's reported net debt, as of December 2016, is 3.7 billion euros (Rs 27,750 crore), according to a Bloomberg report. But its lease rental-adjusted net debt is more than three-fold higher at 11.2 billion euros (Rs 84,000 crore). 
Significant EBITDA Impact
In 2016, Air France-KLM's EBITDA was EUR2.7 billion (Rs 20,250 crore), compared with EUR2.4 billion (Rs 18,000 crore) in 2015. In 2016, EBITDAR (factoring in lease rentals) was EUR3.8 billion (Rs 28,500 crore), compared with EUR3.4 billion (Rs25,500 crore) in 2015.
To be sure, the Air France-KLM group had 552 aircraft in its fleet at the end of December 2016, more than the current combined fleet of all the scheduled carriers in India. 
The solution for airlines would be to shift to other models - a finance lease or the outright purchase of an aircraft. Kapil Kaul, CEO South Asia at CAPA, said that IndiGo will shift more planes to finance leases, adding however that lessors won't be so easily convinced to make that shift.
An operating lease is a transaction at the end of which the aircraft goes back the lessor. At the end of a finance lease, the airline or lessee takes ownership of the plane. The latter is a balance-sheet transaction. 
A senior SpiceJet executive quoted above added that the switch "defeats the operating lease concept, which allows low fare airlines an asset-light model." 
At present, airlines are exempted from GST liability on leased aircraft. 
“We are the front-runners in the adoption of IFRS 9 dealing with financial instruments. We have, however, not yet finalized the formal date of adoption of IFRS 15, which deals with new revenue recognition rules. IFRS 16 on leases is the next such large accounting project in response to which the Institute of Chartered Accountants of India has come up with an exposure draft Ind AS 116, mirroring the IFRS 16. The exposure draft has proposed an effective date beginning April 1, 2019, but we have to wait and watch whether India will adopt the new standard around the same time as other countries do globally,” said Seth of PwC.
The Economic Times , New Delhi, 26th July 2017

Comments

Popular posts from this blog

At 18%, GST Rate to be Less Taxing for Most Goods

About 70% of all goods and some consumer durables likely to cost less

A number of goods such as cosmetics, shaving creams, shampoo, toothpaste, soap, plastics, paints and some consumer durables could become cheaper under the proposed goods and services tax (GST) regime as most items are likely to be subject to the rate of 18% rather than the higher one of 28%.

India is likely to rely on the effective tax rate currently applicable on a commodity to get a fix on the GST slab, said a government official, allowing most goods to make it to the lower bracket.

For instance, if an item comes within the 12% excise slab but the effective tax is 8% due to abatement, then the latter will be considered for GST fitment.

Going by this formulation, about 70% of all goods could fall in the 18% bracket.

The GST Council has finalised a four-tier tax structure of 5%, 12%, 18% and 28% but has left room for the highest slab to be pegged at 40%. A committee of officials will work out the fitment and the council…

Coffee-Toffee, the GST Debate Continues

Hundreds of crores of rupees in the form of taxes ride on the exact categorisation of products Is Parachute hair oil or edible oil? Is KitKat a chocolate or a biscuit? Is a Vicks tablet medicament or confectionery? For the taxpayer and the tax collector, this is much more than an exercise in semantics -hundreds of crores of rupees ride on the exact categorisation.
As the government moves closer to rolling out the goods and services tax (GST) on July 1, many such distinctions are being debated so that no ambiguity remains. Not just that, the government is revisiting old tax cases that were lost over product categorisation, according to people with knowledge of the matter, presumably with a view to making sure that revenue collections can be maximised. “In the past, several tax officers had challenged some of the product categorisations, including those in the retail segment, but lost out in court or at appellate level,“ said one of the persons. “Now we have a chance to go ahead with speci…

Deposit gush:-CA Institute Bats for Special Audit