09 December 2015

EFRAG: Findings from the public survey on the expected effects of the introduction of IFRS 16 Leases on financial covenants in loan agreemen

EFRAG published a report that summarises the findings from the public survey on the effects of the introduction of IFRS 16 Leases on financial covenants in loan agreements. The public survey was carried out by EFRAG in association with the National Standard Setters (AAT, ANC, DRSC, FRC, and OIC).

In July 2015, EFRAG and the National Standard Setters AAT, ANC, ASCG, FRC, and OIC launched a public survey. The IASB also participated in this consultation.

The objective of the survey was to consult with European constituents to understand their expectations of the effects of the introduction of IFRS 16 Leases on financial covenants in loan agreements.

IFRS 16 Leases is expected to be issued at the beginning of 2016 and will require the recognition of all identified leases on a lessee's balance sheet with only limited exceptions. Under the current requirements, operating leases are not recognised on a lessee’s statement of financial position; operating lease commitments are disclosed in the notes.

Loan agreements may include financial covenants that require an entity to meet specified ratios based on accounting data. Concerns have been raised that the recognition of operating lease commitments as lease liabilities on a lessee’s statement of financial position will affect financial covenants and may result in entities breaching those covenants.  However, the impact of these new requirements may not occur or be mitigated if agreements include clauses (a) such as use of 'frozen GAAP or (b) that require or allow renegotiation of covenants when accounting standards are changed.

Lenders

The responses show mixed practice; some lenders reported that they apply different types of covenants for different clients, i.e. covenants are often tailored for the particular client. Nevertheless, a large majority of respondents stated that their loan agreements included at least one of the following features:

(a) automatic renegotiation clauses in the case of a change to accounting principles, at least for some of their agreements;

(b) ‘frozen GAAP’ provisions; or

(c) adjustments for operating lease commitments in determining covenants.

For loan agreements containing any of the above-mentioned features, the requirements of IFRS 16 are not expected, in isolation, to cause a breach of covenants. Furthermore, a large majority of lender respondents noted that they will reconsider the terms and conditions of covenants when IFRS 16 is effective, although it was not clear if those comments referred to new agreements or existing agreements.

Some respondents also reported that some of their covenants use non-accounting based measures2.

Non-lenders

Non-lenders that responded were almost all preparers, with the exception of one professional consultant and one user.

The large majority of non-lender respondents (35) reported that their covenants were based on accounting data. Based on the replies and the available information, the covenants of the majority of non-lender respondents (27) either (a) are not expected to be impacted or (b) are expected to be renegotiated if IFRS 16 affects covenant ratios. 

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