In the Registration Document 2018 including the annual financial report by AIR FRANCE KLM GROUP the Group implemented IFRS 16 and IFRS 15 and IFRS 9. Here are some excerpts from the document to illustrate the effects:
[Air France KLM – 2018 Registration document – page 220]
note 2. Restatement of 2017 Financial statements
Since January 1, 2018, the Air France – KLM Group has applied the following three new standards:
— IFRS 9 “Financial Instruments”
IFRS 15 “Revenue Recognition from Contracts with Customers”
This standard came into force on January 1, 2018.
In accordance with IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”, the standard has been applied retrospectively to each previous period in which financial information is presented. Within this framework, none of the simplification measures proposed in the standard has been used.
— IFRS 16 “Leases”
The Group opted for the early adoption of this standard as of January 1, 2018.
In accordance with IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”, it has been applied using the retrospective restatement to each prior reporting period detailed below.
The two capitalization exemptions proposed by the standard – lease contracts with a duration equal or less than 12 months and lease contracts for which the underlying asset has a low value in new which has been defined by the Group below US$5,000 have been used.
[Air France KLM – 2018 Registration document – page 221]
The main changes induced by IFRS 16 are the following:
— capitalization of aircraft lease contracts fulfilling the capitalization criteria defined by IFRS 16.
The lease term corresponds to the non- cancellable period of each contract except in cases where the Group is reasonably certain of exercising the renewal options contractually foreseen. For example, this may be the case if substantial cabin customization has taken place whereas the residual lease term is significantly shorter than the useful life of the cabins. The discount rate used to value the lease debt corresponds, for each aircraft, to the implicit rate mainly involved by the contractual elements.
Most of the aircraft lease contracts are denominated in US dollars. As from January 1, 2018, the Group put in place a cash- flow hedge relationship for its revenues in US dollars via the lease debt in US dollars in order to limit the volatility of the foreign exchange variation resulting from the revaluation of its lease debt. The effective portion of the foreign exchange revaluation of the lease debt in US dollar at the closing rate is recorded in “other comprehensive income”. This amount is recycled in turnover when the hedged item is recognized.
In accordance with IFRS9, the hedging relationship was designated prospectively and has been set up at Group level as from January 1, 2018. The comparative accounts, restated in 2017, are therefore impacted by the debt volatility in US dollar on the line “other financial income and expenses”.
— capitalization of real- estate lease contracts.
Based on its analysis, the Group has identified lease contracts within the meaning of the standard concerning surface areas rented in its hubs, rented building dedicated to the maintenance business, customized lounges in airports other than the hubs and rented office buildings. The lease term corresponds to the non- terminable period of the contract. Most of the contracts do not provide renewal options. The discount rate used to calculate the lease debt is determined, for each asset, according to the incremental borrowing rate at the commencement of the contract;
— capitalization of the other- asset leases.
As a result of the Group’s analysis, the main lease contracts identified correspond to company cars, pools of spare parts and engine lease contracts. The lease term corresponds to the non- terminable period of the contract. Most of the contracts do not provide renewal options. The discount rate used to calculate the right- of- use asset and the lease debt is determined, for each asset, according to the incremental borrowing rate at the commencement of the contract;
[Air France KLM – 2018 Registration document – page 222]
— accounting of the maintenance on leased aircraft.
The Group recognizes return obligation liabilities and provisions in respect of the required maintenance obligations within the framework of the lease of aircraft to lessors. The constitution of these return obligation liabilities and provisions depends on the type of maintenance obligations to fulfill before returning these aircraft to the lessors: overhaul and restoration work as well as airframe and engine potential reconstitution. These provisions also consist of compensation paid to lessors in respect of wear of the limited life parts in the engines;
– overhaul and restoration works (not depending on aircraft utilization).
Costs resulting from work required to be performed just before returning aircraft to the lessors, such as painting of the shell or aircraft overhaul (“C Check”) are recognized as provisions as of the inception of the contract. The counterpart of these provisions is booked as a complement through the initial book value of the aircraft right- of- use assets. This complement to the right- of- use asset is depreciated over the lease term,
– airframe and engine potentials reconstitution (depending on the utilization of the aircraft and its engines).
The airframe and the engine potentials are recognized as a complement to the right- of- use assets since they are considered as full-fledged components, as distinct from the physical components which are the engine and the airframe. These components are the counterparts of the return obligation liability, recognized in its totality at the inception of the contract. When maintenance events aimed at reconstituting these potentials take place, the costs incurred are capitalized. These potentials are depreciated over the period of use of the underlying assets (flight hours for the engine potentials component or straight- line for the airframe potentials component),
– compensation related to limited life parts (engine components).
As the component approach is not applicable for limited life parts, costs related to the lessor’s compensation are booked progressively as provisions as they are used during the lease term and based upon contractual data (e.g. cost of a limited life part).
For comparison purposes, the consolidated financial statements as of December 31, 2017 have been restated. The adjusted balance sheet as of January 1 and December 31, 2017 is also presented.
[Air France KLM – 2018 Registration document – page 223 – 226]
The capitalisation of operating leases in the balance sheet as of 1 January 2017 has the following overall impact:
|IFRS 16 impact – contracts capitalization||IFRS 16 impact – maintenance of leased aircraft||Total|
|Return obligation liability and other provisions||–||(1,164)||(1,164)|
This quite illustrates the reason business was not in favour of implementing IFRS 16. Balance sheet totals increase, equity is lower and ratios worsen.
The cash flow is bottom line the same, the great advantage of cash. But cash flow from operating activities improves significantly (41% improvement). So in comparing cash flow statements over longer periods into the past one might want to adjust the classification of cash between operating, investing and financing activities. Or consider using other concepts of cash flows (for example: free cash flow) in fair value measurements.