2016 has seen the release of the long awaited changes to the lease accounting standards for companies reporting under International Financial Reporting Standards (IFRS) and US GAAP. This might sound like something only accountants need to worry about, but is more far-reaching.
The changes will have a bigger impact on charterers than owners, as lessor accounting will largely remain unchanged. As a general rule, bareboat and time charters will fall within the scope of the new standards, whilst voyage charters will not. The changes cover the lease of assets and therefore, for a time charter, an allocation will need to be made between hire paid for the use of the ship versus the services provided.
Until now, most time charters have been accounted for as operating leases, meaning that for charterers a single expense was recorded in the income statement and the total amounts due under the charter were simply disclosed in the notes to the financial statements. This is all set to change. Under both US and international requirements the present value of the total amount due under the charter will have to be brought onto the balance sheet together with a Right of Use asset.
While net assets may not be greatly affected, gross assets and gross liabilities will increase significantly for companies which currently have major operating leases. There will also be some effect on reported profit, although that will vary between companies.
Current operating leases are nearly always spread evenly over their life, so the charge is constant.
Under the new IFRS rules, the total charges will consist of two elements – the depreciation of the vessel and the interest charge arising due to the financing. The depreciation will normally continue to be on a straight line basis, but the interest charges will be weighted towards the earlier part of the lease period. So, whilst ultimately, the total lease charges over the charter period will be the same as before they will be more front-loaded, with higher charges in the earlier years and lower charges in the later years. Obviously, the effect of this will be greatest on companies with just a few substantial charters, or even just one – those with many charters at various stages may find that even though the charges on each one change, the overall charges remain broadly the same.
The new US GAAP rules will have less impact on profits. Expenses under the US standard will remain flatter than under IFRS and may be unchanged from current standards.
Originally it had been expected that the US and international standards would be identical, but there are instead now two standards which, although similar in many respects, contain significant differences. On inception of a lease, the balance sheet entries prepared under the two new standards will usually be similar, but they will then diverge as the basis of charging expense differs. There are also differences of detail dealing with matters such as subleases, and sale and leaseback transactions.
It will be a few years before the first financial statements are published which have to comply with the new standards, nevertheless, many companies in the offshore maritime sector will need to consider the effect on their financial statements quite soon. Some will see major changes to their balance sheets, and a certain amount of change to their reported profits. Companies will also need to consider the effect that the changes will have on compliance with the terms of financing which include covenants. And where breaches of covenants are likely, or reasonably possible, talking to lenders before the change hits the accounts will be crucial.
To discuss this and how it may affect your business, please get in touch.
This article was originally published in the Offshore Support Journal.