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

RBI minutes show MPC members flagged upside risks to inflation

RBI minutes show MPC members flagged upside risks to inflation Concerns about economic growth and easing inflation prompted five of the six monetary policy committee (MPC) members to call for a cut in the repo rate, but most warned that prices could start accelerating, show the minutes of the panel’s last meeting, released on Wednesday. The comments reflected a tone of caution and flagged upside risks to inflation from farm loan waivers, rise in food prices, especially vegetables, price revisions withheld ahead of the goods and services tax, implementation of house rent allowance under the 7th pay commission and fading of favourable base effect, among others. On 2 August, the panel chose to cut the repurchase rate—the rate at which the central bank infuses liquidity in the banking system—by 25 basis points to 6%. One basis point is one-hundredth of a percentage point. Pami Dua, professor at the Delhi School of Economics, wrote that her analysis showed “a fading economic growth outlook, as …

Shrinking footprints of foreign banks in India

Shrinking footprints of foreign banks in India Foreign banks are increasingly shrinking their presence in India and are also becoming more conservative than private and public sector counterparts. While many of them have sold some of their businesses in India as part of their global strategy, some are trying to keep their core expertise intact. Others are branching out to newer areas to continue business momentum.For example, HSBC and Barclays Bank in India have got out of the retail business, whereas corporate-focused Standard Chartered Bank is now trying to increase its focus on retail “Building a retail franchise is a huge exercise and takes a long time. You cannot afford to lose it,” said Shashank Joshi, Bank of Tokyo-Mitsubishi UFJ’s India head.According to the Reserve Bank of India (RBI) data, foreign banks’ combined loan book shrunk nearly 10 per cent from Rs 3.78 trillion in fiscal 2015-16 to Rs 3.42 trillion last financial year. The banking industry, which includes foreign banks…

Differential Tax Levy under GST: Food Firms May De-Register Trademarks

Differential Tax Levy under GST:Food Firms May De-Register Trademarks The government’s decision to charge an enhanced tax rate on trademark food brands is leading several rice, wheat and cereal manufacturers to consider de-registering their product trademarks. Irked by the June 28 central government notification fixing a 5 per cent goods and services tax (GST) rate on food items packaged in unit containers and bearing registered brand names, the industry has made several representations to the government to reconsider the differential tax levy, which these players say is creating an unlevel playing field within these highly-competitive and low-margin industries. Sources say that the move has affected the packaged rice industry the hardest and allowed the un-registered market leaders, India Gate and Daawat, to gain advantage as compared to other registered brands such as Kohinoor and Lal Qilla. Smaller players are even more worried with this enhanced rate of tax (against the otherwise …