IFRS 16 and Weighted average cost of capital: Difference between pages

From ACT Wiki
(Difference between pages)
Jump to navigationJump to search
imported>Doug Williamson
(Add link to IAS Plus)
 
imported>Doug Williamson
No edit summary
 
Line 1: Line 1:
International Financial Reporting Standard 16, dealing with leases.
(WACC).  


IFRS 16 replaces IAS 17: Leases.
'''1.'''


IFRS 16 is mandatory - for companies reporting under international financial reporting standards - from 1 January 2019.  
The average cost of capital of a firm, taking into account all sources of capital, weighted by their current market values.




IFRS 16 requires most lease liabilities to be accounted for 'on balance sheet'.
For a firm with both equity and debt capital, the WACC would be calculated as:


This change removes the former distinction between [[operating lease]]s and [[finance lease]]s.


WACC = Ke x E/[D+E] + Kd(1-t) x D/[D+E]


Broadly speaking, IFRS 16 requires all leases to be recognised on the balance sheet, other than short term leases or those for low value assets.


The leases to be brought 'on balance sheet' under IFRS 16 include most operating leases that were 'off balance sheet' under IAS 17.
Where:


IFRS 16 leads to increased transparency and improved comparability between companies that lease and companies that borrow to buy assets.  
Ke = cost of equity.


Kd(1-t) = after tax cost of debt.


However, for many companies IFRS 16 results in material restatements of their balance sheets and - to a lesser extent - income statements.
E = market value of equity.


The main balance sheet impact is to 'gross up' both assets and liabilities by the capital amounts of the leases.
D = market value of debt.


The main income statement impact is to recognise a greater proportion of total costs in the earlier years of the lease. In other words, cost recognition is 'front-end loaded' under IFRS 16.




These restatements will normally impact any financial covenant ratios that include ‘debt’, ‘net worth’ or similar indicators, subject to any 'frozen GAAP' provisions.
'''''Example'''''


EBITDA and the interest cover ratio are also likely to be impacted.
For example where:


Ke = cost of equity = 10%


==See also==
Kd(1-t) = after tax cost of debt = 3.6%
*[[ASU 2016-02 Leases (Topic 842)]]
*[[Debt]]
*[[DIA]]
*[[EBITDA]]
*[[Finance lease]]
*[[Frozen GAAP]]
*[[IAS 17]]
*[[Incremental borrowing rate]]
*[[Interest cover]]
*[[Interest rate implicit in a lease]]
*[[Lease]]
*[[Operating lease]]
*[[Off balance sheet]]
*[[Residual value]]
*[[Right of Use]]


E = market value of equity = $100m


==Other links==
D = market value of debt = $100m
[https://www.treasurers.org/thetreasurer/definitive-guide-to-deriving-ifrs-16-discount-rates Definitive guide to deriving IFRS 16 discount rates: The Treasurer]




==External link==
WACC = Ke x E/[D+E] + Kd(1-t) x D/[D+E]
*[https://www.https://www.iasplus.com/en-gb/standards/ifrs-en-gb/ifrs-16 IFRS 16


[[Category:Accounting,_tax_and_regulation]]
= 10% x 100/[100+100=200] + 3.6% x 100/[100+100=200]
[[Category:Compliance_and_audit]]
 
= 5% + 1.8%
 
= '''6.8%'''
 
 
This weighted average is exactly mid-way between the cost of equity and the after-tax cost of debt, because the proportions of equity and debt are exactly equal in this example.
 
 
'''2.'''
 
In order to create or add shareholder value, the managers of this firm would need to earn an after-tax rate of return on their investment projects of <u>more than</u> the WACC of 6.8%.
 
 
== See also ==
* [[Cost of capital]]
* [[Cost of debt]]
* [[Cost of equity]]
* [[Optimal capital structure]]
* [[Shareholder value]]

Revision as of 16:48, 11 June 2013

(WACC).

1.

The average cost of capital of a firm, taking into account all sources of capital, weighted by their current market values.


For a firm with both equity and debt capital, the WACC would be calculated as:


WACC = Ke x E/[D+E] + Kd(1-t) x D/[D+E]


Where:

Ke = cost of equity.

Kd(1-t) = after tax cost of debt.

E = market value of equity.

D = market value of debt.


Example

For example where:

Ke = cost of equity = 10%

Kd(1-t) = after tax cost of debt = 3.6%

E = market value of equity = $100m

D = market value of debt = $100m


WACC = Ke x E/[D+E] + Kd(1-t) x D/[D+E]

= 10% x 100/[100+100=200] + 3.6% x 100/[100+100=200]

= 5% + 1.8%

= 6.8%


This weighted average is exactly mid-way between the cost of equity and the after-tax cost of debt, because the proportions of equity and debt are exactly equal in this example.


2.

In order to create or add shareholder value, the managers of this firm would need to earn an after-tax rate of return on their investment projects of more than the WACC of 6.8%.


See also

Retrieved from ‘https://wiki.treasurers.org/w/index.php?title=IFRS_16&oldid=50753’