CFO’s guide: Which sectors and groups will be most impacted by IFRS 16 in the Middle East?
04/06/18
In the second article of this series we shall consider which sectors will be most impacted by IFRS 16, how the impact on the Middle East compares to other regions, and what other factors will drive complexity for groups under IFRS 16.
Quick recap of the IFRS 16 headlines…
From 1 January 2019 the new IFRS 16 Leases standard will become effective for all IFRS reporting groups in the region. This new standard represents a fundamental change to current lease accounting as it will now mean that all lease commitments should be recognised ‘on balance sheet’ by lessees. As a result operating leases that were previously ‘off balance sheet’ will need to be recognised as a ‘right of use’ asset and associated lease liability. Depreciation and interest will replace the current ‘rental expense’ and this will result in EBITDA increasing and a change in profit profiles.
Which sectors in the Middle East will be most impacted by IFRS 16?
PwC has undertaken a global study (the “PwC Study”) to assess the impact of IFRS 16 on the financial statements, key financial ratios and performance measures on a sample of 3,199 listed IFRS reporting organisations.
The PwC Study illustrated that the impact of the new IFRS 16 standard will vary significantly between different industries – with those industries such as retail, airlines, professional services, healthcare, textile/ apparel and wholesale anticipated to be most impacted because of their heavy use of operating lease models. At the same time, however, it is also apparent that there are significant differences between individual entities within the same industries, depending on their specific business models.
The table below shows a summary of the impact by industry and is based on median values as opposed to averages in order to mitigate the impact of outliers:
| Industry | Median increase in debt |
% entities with over 25% increase |
Median increase in EBITDA |
|---|---|---|---|
| Retail | +98% | 35% | +41% |
| Airlines | +47% | 50% | +33% |
| Professional services | +42% | 40% | +15% |
| Health Care | +36% | 62% | +24% |
| Textile and Apparel | +28% | 49% | +18% |
| Wholesale | +28% | 39% | +17% |
| Transport and Infrastructure | +24% | 43% | +20% |
| Entertainment | +23% | 67% | +15% |
| Telecommunication | +21% | 52% | +8% |
| Lodging | +16% | 50% | +9% |
| Industrial | +14% | 30% | +9% |
| Construction | +14% | 9% | +8% |
| Chemical | +13% | 61% | +6% |
| Food and Agriculture | +12% | 78% | +7% |
| Pharmaceutical | +8% | 48% | +5% |
| Broadcasting | +7% | 42% | +11% |
| Financial Services | +6% | 37% | +6% |
| Real Estate | +6% | 74% | +1% |
| Extractive Companies | +4% | 54% | +3% |
| Utilities | +2% | 59% | +2% |
How does the impact of IFRS 16 on the Middle East compare to other regions?
The PwC Study also shows that the impact on individual entities within an industry can be significantly different depending on its geographical location.
| Geography/region | Median increase in EBITDA |
Median increase in Debt |
|---|---|---|
| European Union | 11% | 21% |
| Africa | 11% | 21% |
| Australia and New Zealand | 10% | 22% |
| Middle East | 9% | 12% |
| Non – EU | 8% | 13% |
| North America (excl. USA) | 6% | 11% |
| South America | 6% | 5% |
| Asia | 4% | 6% |
What other factors will drive implementation complexity for groups under IFRS 16?
Whilst it is clear that the industry and geography of a group will be a key driver of the financial impact of IFRS 16, there are also other factors that will drive implementation complexity for groups under IFRS 16:
- Complex, multi entity group structures
IFRS 16 implementation is necessary at both an entity and consolidated level. Where a group has multiple legal entities across multiple jurisdictions, this creates complexity around ensuring implementation is undertaken appropriately and consistently across each entity - and the group as a whole. - Large population of ‘unique’ leases
Data collation and extraction is a key IFRS 16 implementation activity. A large volume of unique leases (i.e. with different lessors and different contractual terms) will create a greater implementation challenge compared to groups who have multiple leases with the same lessor, where a more standardised approach can be adopted for data extraction. - Subjective extension or renewal clauses
IFRS 16 requires lease extension or renewal periods to be included within the assessment of lease term where extension or renewal is reasonably certain. Groups with a high volume of contracts with extension of renewal clauses will therefore need to develop an appropriate approach for assessing lease term for each relevant lease. - Long dated leases
Groups with leases that were entered into a number of years ago may invariably face challenges in obtaining all relevant historic documentation and agreements for those leases. Where insufficient detail is available this can then influence the IFRS 16 transition choice adopted by that group. We are already aware of a number of groups in Europe that have decided they are not able to apply the full retrospective IFRS 16 transition approach because of a lack of available information for relevant long dated leases. - Groups with dedicated supplier arrangements
Where a group has a dedicated supplier, or similar arrangement, it is necessary to consider whether an embedded lease is held with that supplier – this could arise where a group indirectly controls the suppliers assets through the service contract arrangement.
The key takeaways for the Middle East CFO
- Certain industries will be more impacted than others by IFRS 16. At the same time however, the impact between entities within the same industry will vary depending on their business model.
- Other factors can also drive the impact and implementation complexity of IFRS 16 – such as large complex group structures, large population of unique leases, long dated leases and subjective extension or renewal options.
- A key starting point for IFRS 16 adoption for CFO’s is to undertake an IFRS 16 impact assessment to understand the potential impact of IFRS 16 on their group – this will help provide clarity on the key impact areas and enable the development of an appropriate implementation plan.
In the next article we shall consider what groups should be thinking about now and the key areas to be considered and addressed as part of an initial IFRS 16 impact assessment.
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