The new leases standard requires a lessee to recognise right-of-use (ROU) assets and lease liabilities for the majority of leases. A lessee applies AASB 136 Impairment of Assets to determine whether the ROU asset is impaired. Here we respond to common questions on the impact of ROU assets and lease liabilities when performing impairment assessments under AASB 136.
Let’s pose a scenario that at 31 December 2019 Company X performs an impairment assessment of its store. The store is considered a cash generating unit (CGU). Company X calculates the recoverable amount of the CGU using a value in use* approach. Cash flows are discounted using a weighted average cost of capital (WACC) of 8.0 percent.
The CGU includes the leased premises, and other assets including goodwill. The lease was previously accounted for as an operating lease under the superseded leasing standard AASB 117 Leases.
The lease was recognised at 1 January 2019 on transition to the new leases standard using an incremental borrowing rate of 4.5 percent.
At 31 December 2019, the ROU asset is $1,054,000 and the lease liability is $1,076,000. Leasehold improvements (capitalised as fixed assets) total $1,010,000 and goodwill is $300,000.
On disposal of the CGU, a buyer would not assume the lease liability**.
Question 1: Is the carrying amount of the CGU impacted by AASB 16?
Interpretive response: Yes. ROU assets are required to be assessed for impairment under AASB 136. At 31 December 2019, Company X includes the ROU asset in the carrying amount of the CGU. This results in an increase in the carrying amount by $1,054,000.
|CGU carrying amount ($’000)|
Question 2: Is recoverable amount impacted by AASB 16?
Interpretive response: Yes. For on balance sheet leases***, the nature of the expenses are no longer operating in nature. Instead they are recognised as depreciation and interest, thereby increasing EBITDA and free cash flows compared to AASB 117.
Question 3: Is the increase in recoverable amount equal to the increase in carrying amount?
No. Both the carrying amount** and recoverable amount of the CGU increase applying AASB 16 compared to the old leases standard. Absent a change in WACC, the carrying amount of the CGU increases more than the recoverable amount. This is due to the difference between the incremental borrowing rate (of 4.5 percent), used to determine the leased asset included in the CGU carrying amount and WACC (of 8.0 percent), used to discount the free cash flows. Assuming no other adjustments, this will result in a decrease in headroom.
*Recoverable amount is the higher of value in use and fair value less costs of disposal.
**If a buyer would assume the lease liability on disposal of the CGU, the carrying amount and recoverable amount must both be decreased by the carrying amount of the lease liability where the VIU model is used to assess for impairment [AASB 136:78]. The assessment of whether a buyer would assume the lease liability will depend on the facts and circumstances of the scenario.
***Lease payments for short-term leases, leases of low value items and variable lease payments that do not depend on an index or rate for which no lease liability is recognised continue to be included in EBITDA and therefore in recoverable amount free cash flows.
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