IFRS 16 - LEASES: IMPLICATIONS FOR

ANALYSTS AND INVESTORS

Aantal woorden/ Word count: 15.878

Sébastien Rulmont Stamnummer/student number: 01305593

Promotor/ Supervisor: Prof. Dr. Heidi Vander Bauwhede

Masterproef voorgedragen tot het bekomen van de graad van:

Master’s Dissertation submitted to obtain the degree of:

Master of Science in Business Economics

Academiejaar/ Academic year: 2016 - 2017

IFRS 16 – LEASES: IMPLICATIONS

FOR ANALYSTS AND INVESTORS

Aantal woorden/ Word count: 15.878

Sébastien Rulmont Stamnummer/student number: 01305593

Promotor/ Supervisor: Prof. Dr. Heidi Vander Bauwhede

Masterproef voorgedragen tot het bekomen van de graad van:

Master’s Dissertation submitted to obtain the degree of:

Master of Science in Business Economics

Academiejaar/ Academic year: 2016 - 2017

I

Permission

I declare that the content of this Master’s Dissertation may be consulted and/or reproduced, provided that

the source is referenced.

Sébastien Rulmont

Signature:

II

Abstract

In January 2016, the IASB published IFRS 16, the new lease standard that will supersede IAS 17 on the

1st of January 2019. IFRS 16 will eliminate the relative recognition flexibility and requires the

capitalization of virtually all lease contracts on the lessees’ balance sheets. The IASB is convinced that

the recognition of both operating and finance leases will increase the transparency and comparability of

the Financial Statements (IASB, 2016). A limited amount of prior literature however (Libby et al., 2002),

claims equivalence between recognition and disclosure in the notes, implying that IFRS 16 will not have

any impact on company valuation and is therefore considered a useless intervention by the IASB. This

dissertation documents how and whether Belgian and Luxembourgish investment professionals

incorporate operating leases when valuing a company. The findings suggest that, on average, these

professionals do not incorporate off-balance sheet information in their valuation. The results of this

dissertation provide support for the IASB’s intervention and confirm their concerns of misled Financial

Statement users (IASB, 2016), although it is not always perceived as such by the investment professionals

themselves.

Keywords: IFRS 16, IAS 17, Lease Accounting, Lease Capitalization, Company Valuation, Market

Efficiency

III

Foreword

This research is the fruit of my labour at the Faculty of Economics and Business Administration at the

University of Ghent over the academic year 2016 - 2017. My master’s dissertation was written to obtain

the degree of Master of Science in Business Economics: Corporate Finance.

Several persons have contributed both academically and practically to my master thesis. First of all, I

would like to thank my head supervisor Professor Dr. Heidi Vander Bauwhede and the co-supervisor

Frederik Verplancke for their valuable input, feedback and support throughout the entire year.

Furthermore, I would like to thank the associations B.C.F.A., BVA and BAN for their help identifying

and contacting potential respondents. I am particularly grateful to Mr. Edwig Tanghe who introduced me

to the associations mentioned above and who has been a big help throughout the entire process.

I would also like to thank Mr. Jan Van Robaeys for his constructive comments to my dissertation. Last

but not least I would like to thank my friends and family for being supportive throughout the year.

I hope you will enjoy reading this thesis.

Sébastien Rulmont

Ghent, August 2017

IV

Table of contents

Permission..............................................................................................................................................................I

Abstract...................................................................................................................................................................II

Foreword..............................................................................................................................................................III

Tableofcontents...............................................................................................................................................IV

List–abbreviations...........................................................................................................................................VI

List–figures,tables,annexes.......................................................................................................................VII

1. Introduction..................................................................................................................................................1

2. Literaturereview........................................................................................................................................32.1. Analyst.........................................................................................................................................................................32.2. Investor.......................................................................................................................................................................4

3. Leasestandard.............................................................................................................................................63.1. CriticismIAS17.......................................................................................................................................................73.2. ScopeofIFRS16......................................................................................................................................................83.3. Leaseterm..................................................................................................................................................................93.4. RecognitionandMeasurement.........................................................................................................................93.5. Lessee–Lessoraccountancy..........................................................................................................................103.6. Transition................................................................................................................................................................103.7. IFRSvs.USGAAP..................................................................................................................................................11

4. Dataandmethodology............................................................................................................................124.1. (Empirical)Strategy...........................................................................................................................................124.2. ExperimentalDesign..........................................................................................................................................124.3. Measurementmethod........................................................................................................................................154.3.1. LeaseCapitalizationMethod...................................................................................................................154.3.2. EstimatingunrecordedAssetsandLiabilities.................................................................................154.3.3. EstimatingInterestExpensesandDepreciationExpense.........................................................174.3.4. EstimatingNetProfit..................................................................................................................................194.3.5. AdjustedendingBalanceSheet.............................................................................................................20

4.4. ManipulationCheck............................................................................................................................................204.5. CodingStrategy.....................................................................................................................................................21

V

5. Analysis........................................................................................................................................................215.1. EffectonBalanceSheet.....................................................................................................................................215.2. EffectonIncomeStatement.............................................................................................................................225.3. EffectonCashflow(s)........................................................................................................................................225.4. Effectonratios......................................................................................................................................................235.5. Conclusion...............................................................................................................................................................23

6. SamplingandResults..............................................................................................................................246.1. SampleDescription.............................................................................................................................................246.2. UnivariateDescriptiveEvidenceonEquityValue.................................................................................286.3. DescriptiveEvidenceonLeaseTreatments.............................................................................................296.4. DescriptiveEvidenceonPerceivedUsefulnessofIFRS16................................................................296.5. Descriptiveevidencepreferredvaluationtool.......................................................................................31

7. ExperimentalResults..............................................................................................................................31

8. Conclusionanddiscussion....................................................................................................................35

9. Limitations.................................................................................................................................................36

10. References..............................................................................................................................................VIII

11. Appendix...................................................................................................................................................XII

VI

List – abbreviations

ACCA Association of Chartered Certified Accountants

ASC Accounting Standards Codification

BAN Business Angel Network

BCFA Belgian Corporate Finance Association

BVA

DCF

Belgian Venture Capital and Private Equity Association

Discounted Cash Flow

D/E Debt to Equity

EBIT Earnings Before Interest and Taxes

EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization

EFRAG

EPS

European Financial Reporting Advisory Group

Earnings per Share

FASB Financial Accounting Standards Board

IAS International Accounting Standards

IASB International Accounting Standards Board

IFRIC International Financial Reporting Interpretation Committee

IFRS International Financial Reporting Standards

M&A Merger and Acquisition

PPE Property, Plant and Equipment

ROA Return on Assets

ROE

SD

Return on Equity

Standard Deviation

US GAAP United States General Accepted Accounting Principles

VC Venture Capitalist

WALT Weighted Average Lease Term

VII

List – figures, tables, annexes

Figure 1: Definition of a lease ....................................................................................................................... 8Figure 2: Ratio Analysis .............................................................................................................................. 24Figure 3: Sex and Age group ....................................................................................................................... 25Figure 4: Professional demographics for the Full Sample .......................................................................... 26Figure 5: Expected vs. Empirical Equity Value .......................................................................................... 28Figure 6: Lease treatment ............................................................................................................................ 29Figure 7: Opinion IFRS 16 .......................................................................................................................... 30Figure 8: Preferred Valuation Tool ............................................................................................................. 31

Table 1: Minimum future rental payments (lease payments) ...................................................................... 13Table 2: Minimum future rental payments .................................................................................................. 16Table 3: Present Value of minimum rental payments ................................................................................. 16Table 4: Change in lease assets and liabilities from new lease transactions ............................................... 17Table 5: Weighted average lease term ......................................................................................................... 19Table 6: Simplified income statement 2015 ................................................................................................ 20Table 7: Adjustments to ending Balance Sheet 2015 .................................................................................. 20Table 8: Financial Statement summary ....................................................................................................... 21Table 9: Income Statement .......................................................................................................................... 22Table 10: Ratio analysis .............................................................................................................................. 23Table 11: Equity value ................................................................................................................................. 28Table 12: Descriptive 5-point Likert item (1: Strongly disagree – 5: Strongly agree) ................................ 30Table 13: Paired sample t-test ..................................................................................................................... 32Table 14: Raised rationales overall and by category (panel 1 & panel 2) ................................................... 34

Annex 1: Flowchart – IFRS 16 .................................................................................................................. XIIAnnex 2: Questionnaire Category 1 (IAS 17) .......................................................................................... XIIIAnnex 3: Questionnaire Category 2 (IFRS 16) ........................................................................................ XIXAnnex 4: Sample Selection and Composition ....................................................................................... XXIV

1

1. Introduction

The reliability and transparency of Financial Statements have been long lasting issues under the IAS 17

lease standard (IASB, 2016). Due to the distinction between operating and finance leasing, respectively

off- and on-balance sheet, the Financial Statements do not always reflect the underlying business reality

(ACCA, 2014).

Due to the new lease standard, IFRS 16, promulgated in February 2016 by the IASB in close

collaboration with the FASB, capitalization of the majority of all lease contracts will become mandatory

(IASB, 2016). Under IFRS 16, the substantially different accountancy treatment of operating leases and

finance leases will be eliminated, therefore clearing the Financial Statements of the lessee from potential

asset and liability distortions (IASB, 2016). As of 1 January 2019, when IFRS 16 will supersede IAS 17,

the regularly criticized off-balance sheet treatment of operating leases (Chu et al., 2007) will be

prohibited.

According to the IASB, the recognition of assets and liabilities for all types of leases provides a more

genuine image of the financial position of a company and will lead to greater transparency and therefore

comparability (IASB – Effect Analysis, 2016). The past decade, standard setters have been placing more

and more emphasis on designing accounting information facilitating the valuation objective (Murphy et

al., 2013; Pelger, 2015). The IASB states that this will enable analysts and investors to improve their

assessment of the financial performance of a company hence their valuation. Contrary to the pre-IFRS 16

era when companies applied IAS 17 accounting requirements, some investors adjusted for off-balance

sheet leases whereas others did not (Hoogervorst, H., 2016). Given that today, 85 per cent1 of all leases

(IASB, 2016) are estimated to be off-balance sheet, the IASB is convinced that the augmented

transparency will lead to superior investment decisions.

This dissertation intends to discover whether analysts and investors today incorporate equally (or at all)

items that are currently only disclosed in the notes versus those that have been recognized in the Financial

Statements. A field study was conducted involving 58 questionnaires completed by Belgian and

Luxembourgish investment professionals. The focus of this research on investment professionals reflects

their importance both as target users of Financial Statements and as major capital providers (Cascino et

al., 2016). The participating investment professionals received a short case containing the abridged

Financial Statements from an existing quoted company. Depending on the category they were randomly

1 Based on a research conducted by the US SEC (2005) on 30.000 quoted companies

2

assigned to, the professionals received Financial Statements in compliance with either IAS 17 or IFRS 16.

This allowed me to test my main research question whether (and how) valuation experts take operating

leases into account when valuing a company.

Despite the still popular theory of market efficiency, which implies that markets accurately process

information irrespectively of the positioning within the Financial Statements and therefore postulating

equivalence between recognition and disclosure, prior literature is unable to provide an unambiguous

answer. Given that the IASB estimated in 2015 that once IFRS 16 is applied, an estimated $2.8 trillion2

worth of lease commitments that are currently ‘off-balance sheet’ will be added to balance sheets

globally, it is of the essence to investigate whether Belgian and Luxembourgish investment and valuation

specialists are aware of the potential impact on the company’s Equity Value.

The respondents in the second category who received Financial Statements prepared in accordance with

IFRS 16, provided, on average, significantly lower Equity Values than their colleagues in the first

category who received the same Financial Statements but prepared under the current lease standard IAS

17. The results of this research suggest that, on average, Belgian and Luxembourgish analysts and

investors today do not take into account operating leases and consequentially seem to underestimate the

impact of operating leases on company valuation.

A vital feature of this research design was that by incorporating the participants’ opinions on IFRS 16 and

reasons why did not take into account the off-balance sheet information, I was able to get better insights

into the rationales underlying their calculated Equity Value. 58,8% of the questionnaires were identified

as positive towards the new lease treatment stating that it will improve the quality and transparency of the

Financial Statements. It turns out that a substantial part of the 41,2% questionnaires containing critiques,

can be countered using the ‘Short-Term’ of ‘Low-Value’ exemptions incorporated in IFRS 16 (IASB,

2016).

This research makes two main contributions. First and foremost, my results provide causal evidence that

investment professionals are currently unaware or underestimate the impact of operating leases on a

company’s financial situation. Besides that, this research provides insight into the reasoning of

professionals on this specific topic and whether they assess the intervention of the IASB as useful or not.

Second, this research helps understanding how professionals currently deal with operating leases and

whether the IASB made the right decision to revise the current accounting standard and eliminate the

existing accounting difference between operating and finance leases.

2 Based on a research conducted by the US SEC (2005) on 30.000 quoted companies; non-discounted base

3

This dissertation continues as follows: The next section discusses prior studies about lease capitalization

and off-balance sheet information. The third section provides a summary of IFRS 16. Section four

discusses the data collection and methodology. Section five contains an analysis of the impact of IFRS

16. The sixth section contains the sample selection whereas the seventh section contains the experimental

results of this research. Section eight and nine summarize the findings, discuss the paper and give

suggestions for future research.

2. Literature review

2.1. Analyst

A study by Imhoff, Libe and Wright (1991) indicates that the capitalization of leases leads to a significant

decline in the return on assets (hereafter ROA) for both intensive and less intensive lease users.

Additionally, the impact on the debt to earnings ratio is significantly higher for intensive lease users than

for less intensive users, 191% compared to 47%. Using the capitalization method designed by Imhoff et

al. (1991), the study of Beattie, Edwards and Goodacre (1998) assessed the impact of operating leases of

232 U.K. listed companies on their Financial Statements. They found that unrecorded lease assets make

up 6% of the total assets and the unrecorded long-term liabilities are on average 39% of the liabilities

reported. Consequentially there will be an impact on seven key financial ratios such as the Asset

Turnover, ROA, Debt-to-Equity ratio, …

A more recent research also made use of the capitalization method created by Imhoff et al. in 1991 and

further developed in 1999. The results of the study by Bennet and Bradbury (2003) confirm the potential

impact on the Financial Statements of ‘constructive capitalization’. Their evidence on 38 firms listed on

the New Zealand Stock Exchange suggests that ‘constructive capitalization’ will influence the balance

sheet tremendously since 22,9% of the liabilities and 8,8% of the assets are currently not reported.

Consequently, they found that the Leverage ratio increases whereas the Current ratio and ROA decreases.

Additionally, they provided evidence that standard rules of thumb, such as multiplying the rental

expenses, which are often used by US analysts, are inaccurate and unreliable in an international setting.

Another recent study of Durocher (2008) tested the impact of the transformation of operating leases,

belonging to 100 Canadian listed companies, on the financial indicators. The results indicate that the

capitalization will lead to the recognition of substantially more assets and liabilities on the balance sheet.

Consequentially, it will drastically increase the Debt-to-Asset ratio and significantly decrease the Current

ratio. Branswijck, Longueville and Everaert (2011) investigated the possible impact of implementing a

new lease standard, eliminating the difference between finance and operating leases, on listed companies

4

in the Netherlands and Belgium for 2008. Their results confirm Durocher’s (2008) results and indicate

that the Debt-to-Equity ratio will be positively influenced while ROA and the Current ratio are negatively

affected. Additionally, they state that the magnitude of the impact on the key ratios differs among sectors.

Similar conclusions were drawn by Durocher (2008). His study found evidence that three industry

segments: merchandising and lodging, oil and gas, and financial services will experience significant

impacts on ROA, Return On Equity (hereafter ROE) and earnings per share (hereafter EPS).

As this research is based on a case-based survey, the financial situation of the company will be assessed

using the ratios that were found significant in the papers mentioned above. Namely: Debt-to-Equity,

Debt-to-Assets, ROA and Current Ratio. Depending on the accountancy standard used to prepare the

Financial Statements, IAS 17 or IFRS 16, material differences in the four ratios mentioned above are

expected.

2.2. Investor

It has been a long lasting question whether investors adjust appropriately for the effects of accounting

methods and disclosure alternatives. Looking back on earlier literature, the answer to this question seems

to be ‘sometimes’. Dyckman (1964) suggested that the investment decision of investors is more often

influenced by the accounting procedures used to prepare the Financial Statements rather than the

underlying business reality. Consequentially, companies having identical economic circumstances are

judged differently due to their choice of accountancy policy (Dyckman, 1964; Maines, 1995).

Decades later, the answer to this question seems more ambiguous. Hirshleifer and Teoh (2003) state that

there is a significant disjunction in the existing literature between the experimental research and the

theoretical models of the Financial Statements processing. The experimental research provides an array of

evidence that both inexperienced and professional investors/analysts are biased in their interpretation of

Financial Statements. Consequentially, this bias influences the market prices (Hirshleifer & Teoh, 2003).

Analytical models of disclosure and reporting on the contrary, have almost uniformly assumed full

rationality of decisions and pricing (Libby et al, 2002). More generally, Breton and Taffler (1995) tested

a large sample of experienced investment analysts drawn from five of the top London houses whether

they were able to reveal window dressing. The participating analysts were not overly concerned about the

quality of the presented balance sheet. Therefore only a limited amount of analysts made adjustments to

the accounts. Breton and Taffler (1995) concluded that off-balance sheet obligations such as operating

lease liabilities could distort the fundamental analysis of the company. Similar conclusions were drawn

by Libby, Bloomfield and Nelson (2002). They claim that the information on which Financial Statement

users rely upon in their judgments is limited. The fact that those decision makers are aware of the

existence of cosmetic accounting differences does not guarantee full consideration of their consequences

5

on the company’s value. Professional Financial Statement users are even aware of the incentive managers

have to opportunistically apply ambiguous accounting standards to optimize the Financial Statements in

their favour. Even though the majority of the professionals have the ability, they fail or refuse to make the

necessary adjustments (Libby et al. 2002). Hirshleifer and Teoh (2003) suggested that the concern of the

regulators about the exploitation of the investor’s inattention by companies merits careful consideration.

There is only a limited amount of prior research dealing with the operating lease issue specifically.

Gallery and Imhoff (1998) conducted a research in Australia and failed to discover market corrections for

off-balance sheet leases. Davis-Friday, Folami, Liu and Mittelstaedt (1999) examined whether the market

values Financial Statement data differently if it is disclosed, instead of recognized in the body of the

financial statements. Although their study focused on the liability for retiree benefits and not operational

leasing, their results indicate how markets interpret off-balance information. They found some modest

evidence that the recognized liability receives more weight than the disclosed liability in market value

association tests. This has been confirmed by a more recent research conducted by Ge (2006). According

to his research, investors seem to incorrectly estimate the implications of off-balance-sheet lease activities

for future earnings. Therefore, a long-short investment strategy that exploits this miscalculation could

generate significant future abnormal stock returns. Ely (1995) created a model based on prior work from

Modigliani and Miller (1963) and applied it to the Financial Statements. The model investigated whether

information on operating leases is accurately reflected in the equity risk. Equity risk is measured as the

standard deviation of the stock price and is therefore related to the standard deviation of the ROA and the

Debt-to-Equity ratio. Her research provides evidence that capitalization of operating leases is not taken

into account in the equity risk. The empirical studies mentioned above, suggest that investors do not

capitalize operating leases and that they systematically underestimate the importance of off-balance sheet

information.

A more recent study by Chu, Levesque, Mathieu and Zhang (2007) examined whether credit departments

of banks use the leverage resulting from the capitalization of off-balance sheet obligations to assess credit

risk. Their evidence suggests that banks struggle to properly estimate the off-balance sheet obligations of

a firm. They conclude that capitalization of operating leases causes measurement difficulties and provide

strong support for changes in the accountancy policy.

6

As mentioned in the introduction, this research intends to discover whether Belgian and Luxembourgish

investment professionals are more aware of the importance of off-balance sheet information than their

international colleagues. Prior literature however is relatively clear whether investment professionals

successfully process all the available information, both disclosed and recognized, when taking an

investment decision. The studies by Bretton and Taffler (1995), Davis-Friday et al. (1999) and Ge (2006)

indicate that even experienced investors and analysts fail to realize the impact of off-balance sheet

information. Therefore the following hypothesis is expressed:

H1: The application of IFRS 16 leads to a decrease in the Equity Value perceived by the investment

professionals.

3. Lease standard

On January 13th, 2016, the IASB presented the IFRS 16 – Lease standard dealing with the recognition,

measurement and disclosure of lease contracts. Their American partner, the FASB launched their new

standard ASC 842 shortly after.

Lease accounting was a joint project of the IASB and the US-standard setter (FASB). The IASB and

FASB started working on their new lease standards in 2009. The Lease Accounting Working Group was

founded to guide and monitor the development of the new standard. In order to keep a tight relationship

with the business reality, three documents were released3 to gather feedback from the future users of the

standard. Over the years, adjustments were made based on the concerns of cost and complexity of

implementing the new standard.

The following paragraphs provide an overview of the scope, identification, recognition and transition of

the IFRS 16 standard. For a more detailed overview, I refer to the IFRS 16 sheet released by the IASB or

the Deloitte and Touche IFRS 16 Guide.

3 Discussion paper (2009); Exposure draft (2010); Revised exposure draft (2013)

7

3.1. Criticism IAS 17

“One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet”

(Sir Tweedie, D.)

One of the biggest critiques on IAS 17 mentioned by the Association of Chartered Certified Accountants

(ACCA) and the IASB is the significant difference in the accounting treatment of operating leases and

finance leases (ACCA, 2014). During an interview, the chairman of the IASB, protested against the fact

that two very similar transactions from an economic perspective could be reported very differently,

ultimately reducing the comparability between entities drastically (Hoogervorst, H., 2016). Some well-

known examples include fleets of aircraft or rolling stocks that apparently do not meet the criteria for

recognition as assets and liabilities (PWC, 2016). Sir David Tweedie, the previous Chairman of the IASB,

acknowledged during a speech in 2008 to the Empire Club of Canada that almost no one in the room has

ever flown in a plane that was actually on the balance sheet of the airline.

The relative flexibility in the recognition of leases as an operating lease under IAS 17 led to

misclassification on a large scale. Small contractual adjustments can change the classification of a lease

contract. Which results in a significant understatement of the company’s liabilities (IASB, 2010) and

ultimately, the manipulation of key ratios (IASB, 2016). The IASB stated in 2010 that as most companies

prefer operating to finance leases, the company’s judgment is often biased, resulting in leases with a clear

finance element being classified as operating leases.

Second, today’s model is too complex and not transparent enough according to the Financial Statement

users (IASB, 2010). The absence of detailed requirements concerning the disclosure in the Financial

Statements makes it hard for investors, bankers and analysts to assess the company’s financial situation

correctly (IASB, 2016). Marton et al. (2012) suggest that companies reporting their leases as operating

leases have better financial ratios than their competitors reporting finance leases. Which provides a strong

stimulus to companies to try to misclassify their lease contracts as operating leases. In an attempt to undo

these distortions, some analysts and investors make their own adjustments based on assumptions whereas

others do not, which ultimately leads to even bigger inconsistencies (Hoogervorst, H., 2016).

Third, IAS 17 does not comply with the core values of IASB’s conceptual framework (IASB, 2015). The

relative subjectivity of reporting as either an operating or finance lease under IAS 17 conflicts with item

2.28 of the conceptual framework: “Permitting alternative accounting methods for the same economic

phenomenon diminishes comparability.” And 2.29: “Verifiability helps assure users that information

faithfully represents the economic phenomena it purports to represent.” (Conceptual Framework; 2015)

Additionally, the framework provides detailed definitions for assets and liabilities. Companies who

8

desperately try to classify their contracts as operating leases in order to create an accountancy fiction,

understand improving the financial position, do not respect these definitions.

3.2. Scope of IFRS 16

IFRS 16 will be applied to virtually all lease contracts except those listed under IFRS 16.3 4 .

IFRS 16 defines a lease as a contract, or part of a contract, that conveys the right to use an asset (the

underlying asset) for a period of time in exchange for consideration (IFRS, 2016). In order to be allowed

to classify a contract as a lease contract at inception date, it has to contain a lease. The IASB created a

Flowchart to help determine whether a contract contains a lease (Annex 1: ‘Flowchart – IFRS 16’).

(IFRS 16:B13) states that an asset can be identified either explicitly (example: serial number) or

implicitly (asset not mentioned in the contract). If implicitly, the asset cannot be identified but there is

only one asset that is capable of being used to meet the contract terms. In both cases, there may be an

identified asset. For more information on identified asset, I refer to IFRS 16: B13 – B19.

The right to obtain substantially all of the economic benefits (IFRS 16:B21) and the right to direct the

how and for what purpose the asset is used (IFRS 16: B24) are seen as the right to control the identified

asset. Which is different from the right of use stated in IAS 17.

Figure 1: Definition of a lease

4 Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources; biological assets within the scope of IAS 41; Agriculture within the scope of IFRIC 12; Licences of intellectual property within the scope of IFRS 15; rights held by lessee under licensing agreements within the scope of IAS 38.

Lease

Right of control

lessee obtains substantially all

economic benefis lessee directs the

use

identified asset

explicitely/implicitely

9

The notion of ‘right of control’ is crucial to make a distinction between lease contracts and service

contracts. A lease contract provides a customer with the right to control the use of an identified asset for a

period of time in exchange for consideration (IFRS 16:9). Whereas in a service contract, the supplier

controls the use of any assets used to deliver the service (IFRS 16:BC105).

In theory, the distinction between the two types of contracts is clear. The reality however is often not

black-and-white. A vast amount of contracts combines a lease component with non-lease components.

Such as for example the lease of a fleet combined with maintenance (service).

IFRS 16 requires for those multi-element contracts to identify and account each component separately.

For an elaborate description of the identification, I refer to IFRS 16: B32.

As a practical expedient however, lessees are not forced to separate the contract and are allowed to

account the lease component and non-lease component as one single lease component. This accounting

policy choice however has to be made by class of underlying asset (IFRS 16:15). The IASB Board

expects that this exemption will only be used if the service component is negligible since it will increase

the lessee’s liabilities. (IFRS 16 - Board statement)

3.3. Lease term

Similar to IAS 17, the new standard defines the lease term as “the non-cancellable period of the lease plus

periods covered by an option to extend or an option to terminate if the lessee is reasonably certain to

exercise the extension option or not exercise the termination option” (IFRS 16:18).

Under IAS 17, the interpretation of the term ‘reasonably certain’ was a source of long and controversial

discussions since it led to diversity in practice. IFRS 16:B37 addresses this issue and states: “all facts and

circumstances creating an economic incentive for the lessee to exercise the option must be considered”

(IFRS 16: B37).

3.4. Recognition and Measurement

As mentioned before, the IASB tried to take into account the concerns of the future standard users as

much as possible. IFRS 16 includes two recognition and measurement exemptions (IFRS 16:5). Both

exemptions are optional and only apply to lessees. The application of these exemptions leads to the

accountancy treatment similar to the current operating lease accounting (IFRS 16:5). Which recognises

the payments on a straight-line basis.

10

• Short-term leases are defined as leases with a lease term of 12 months or less. Leases containing a

purchase option cannot be identified as a short-term lease (IFRS 16:8).

• Leases for which the underlying asset is of low value: Although the standard does not explicitly

define the term ‘low value’, the IASB had in mind assets of a value lower than USD 5,000 (IFRS

16:BC100). Examples of those small ticket items might be IT equipment or office furniture. The

exemption can be applied on a lease-by-lease basis (IFRS 16:8).

It is important to note that the analysis does not take into account whether the aggregated value is material

(IFRS 16:B7). Accordingly, although the aggregated value of the assets may be substantial, the

exemption is still applicable.

3.5. Lessee – Lessor accountancy

As mentioned before, the objective of this dissertation is not to provide a detailed accounting overview of

IFRS 16. The lessee and lessor accounting and the leaseback transaction are therefore not discussed.

3.6. Transition

IFRS 16 is effective for reporting periods beginning on or after 1 January 2019. Earlier application is

allowed, but only in conjunction with IFRS 15. The initial application date is the start of the annual

reporting period in which the entity applies IFRS 16 for the first time. (IFRS 16:C2)

The IASB acknowledges the potential impact of IFRS 16 on the lessee’s Financial Statements. Therefore,

it does not require a full retrospective application in accordance with IAS 8 but allows a ‘simplified

approach’. This allows entities to apply the new standard only to contracts entered into (or modified) on

or after the initial application date. Therefore, the entity is not required to reassess existing lease contracts

(IFRS 16:C4). As instead, at the date of initial application, the opening balance of retained earnings is

adjusted for the cumulative effect of applying IFRS 16 (IFRS 16:C7). Full retrospective application

however remains optional.

Although the transition period of three years seems long, the concerned companies started the transition

process early, as it requires a substantial amount of work. While conducting this research, several IFRS

experts from Mazars, Baker Tilly and BDO emphasized during informal interviews the difficulty and

workload of implementing the new standard since every lease contract has to be reprocessed, acceptable

discount rates have to be set, ...

11

It is important to note that although the European Financial Reporting Advisory Group (EFRAG)

submitted its Endorsed Advice to the European Commission in March 2017, the standard has not been

ratified yet.

3.7. IFRS vs. US GAAP

As mentioned in the introduction, lease accounting was a joint project of the IASB and the FASB.

Although initially the two Boards intended to develop a converged standard, ultimately only the guidance

on the definition of a lease and the principle of recognizing all leases on the lessee’s balance sheet are

aligned. In other areas, differences remain or even increase.

The biggest dissimilarity between the two standards concerns the accountancy treatment for lessees.

Although the overall guideline under IFRS 16 and ASC 842 requires all lease contracts to be recognized

on the balance sheet, US GAAP users still have to make use of the dual lease accounting model, which

means that entities need to determine the type of leases (operating or finance lease) they have in their

portfolio and account for them accordingly. IFRS 16 on the contrary, uses a single lease accounting

model, which eliminates the lease classification test for lessees. This distinction however will not have an

impact on the recognition on the balance sheet but solely on the expenses reported in the income

statement.

A second notable difference between the IFRS 16 and ASC 842 is their respective treatment of small

ticket assets. As mentioned in §3 (3.4. ‘Recognition and measurement’), IFRS 16 includes a small ticket

exemption for leases with a low value. Consequentially, they do not need to be recognized on the balance

sheet. The FASB however rejected the concept of excluding the small ticket items from the balance sheet.

In order to lower the cost of transition, the FASB standard contains existing accounting rules that allow

exclusion based on the significance to the user.

There exist other minor discrepancies between the two standards such as the date of implementation, rules

for early adoption and the classification for lessors. For a detailed overview, I refer to the KPMG: IFRS

16 manual (2016).

12

4. Data and methodology

This part of the paper elaborates the sample selection and data measurement of the research.

4.1. (Empirical) Strategy

In order to test the hypothesis, a field study was conducted based on questionnaires sent to investment

professionals active in Belgium and Luxemburg. The key objective of this case-based experiment was to

identify whether investment professionals adjust for operating leases when giving their vision on the

company’s Equity Value. Afterwards, the participants were asked to indicate whether they made any

adjustments to EBITDA. As explained in more detail below, each investment professional was randomly

assigned to one of two categories. The Financial Statements of the second category were manipulated to

imitate the effect of IFRS 16. In both categories, the investment professionals had to evaluate the Equity

Value of the same company but in compliance with respectively IAS 17 or IFRS 16.

The various items in the income statement and balance sheet from both categories were carefully selected

to ensure a low degree of estimation diversity.

Afterwards, the investment professionals were asked explicitly whether they took operating leases into

account and why. Followed by the question whether they perceive the new lease standard as an

improvement or a useless intervention by the IASB.

4.2. Experimental Design

This study examines the effect of IFRS 16 for analysts and investors. The target group of the

questionnaire referred to as investment professionals was defined as expert users of Financial Statements

who have experience in company valuation. During the sample selection process, the email addresses

from professional Financial Statement users active in the valuation and investment business were

collected. The sample consists of professional investors active in the Private Equity and Venture Capital

sector, Business Angels, fund managers and valuation experts who provide supporting services. Such as

M&A consultants and Corporate Finance experts. Most of the investment professionals were identified

with the assistance of the Business Angel Network (BAN), the Belgian Venture Capital and Private

Equity Association (BVA) and the Belgian Corporate Finance Association (B.C.F.A.), as well as by using

my own contacts.

The real objective of this dissertation was not mentioned to reduce the possibility of biased answers. In

the email sent to the investment professional, the stated intention of this research was to analyse how

13

professionals value Financial Statements. Enclosed in the email, they could find a small case containing

the simplified Financial Statements of an existing company accompanied by four open questions dealing

with Equity Value, adjustments and their opinion on IFRS 16.

The simplified Financial Statements were derived from a large quoted Italian manufacturer of car parts5.

The document included a summary of the balance sheet and the annual income statement (Annex 2 –

section 3: ‘Financial Statements’ and Annex 3 – section 3: ‘Financial Statements’ for details). A summary

of crucial IFRS accounting policies was provided along with key issues on the measurement and

recognition of Financial Statement items where managerial judgment was required.

Depending on the category the professional was assigned to, they received slightly different Financial

Statements. Subjects assigned to category one, receiving the Financial Statements prepared under IAS 17,

obtained the following information regarding the operating leases of the firm:

Accountancy policy: Assets held under finance lease are recognized and recorded at inception

under PPE. Leases, where the lessor retains substantially all the risks and rewards incident to ownership,

are classified as operating leases and are therefore not recognized on the balance sheet. Lease payments

are recognized in the statement of income under other expenses.

Notes: The company has outstanding lease agreements for several production facilities and

headquarters. The company concluded that not all significant risks and rewards were transferred to the

company. Therefore these contracts are considered to be operating leases. The effective annual interest

rate for the finance lease obligations is 6%.

Minimum future rental payments: ‘000 €

‘000 € 31/Dec/15 31/Dec/14

< 1 year 22 19

1-2 years 19 15

2-3 years 19 15

3-4 years 19 15

4-5 years 19 15

>5 years 108 96

Total 206 175

Table 1: Minimum future rental payments (lease payments) 5 A large public company was chosen to assure that the investment professional did not incorporate illiquidity discounts in the calculated equity value.

14

Participants assigned to the second category, with the Financial Statements prepared under IFRS 16

however, received the following information:

Accountancy policy: The firm chose to adopt the new lease standard IFRS 16 early, which erases

the distinction between operating and finance leases. All lease obligations are therefore recognized on the

balance sheet and no longer incorporated in the income statement.

Afterwards, the participants were informed that a leading audit firm audited the company and since the

company is publicly quoted, the corporate governance is considered of high quality.

Before the respondents answered the valuation section, some questions were asked about their personal

background. The age, sex, professional occupation, professional experience and the IFRS knowledge of

the participant were recorded to have an overview of the composition of the two categories.

Once the investment professional gave his/her vision on the Equity Value, EBITDA adjustments and the

operating lease issues, they were asked to give their opinion on the new lease standard. The professionals

were asked whether they think that eliminating the difference between operating and finance leasing will

be an improvement of the current situation (hence improved visibility and comparability) or not and why.

In order to counter the high level of subjectivity inherent to the interpretation of the opinions and to

improve the internal validity of the research, the respondents who could be identified afterwards were

contacted and asked to quantify their opinion using a 5 point Likert item ranging from 1=strongly

disagree to 5=strongly agree.

Finally, the questionnaire ended with a multiple-choice question where the participant had to indicate

which valuation tool they would normally use. The last line of the questionnaire left room for any

remarks or questions.

The entire cases and questionnaires are presented in the Appendix [Annex 2: ‘Questionnaire category 1

(IAS 17)’ & Annex 3: ‘Questionnaire category 2 (IFRS 16)’].

15

4.3. Measurement method

As mentioned before, one category of investment professionals received the Financial Statements in

compliance with IFRS 16. Since IFRS 16 has not been launched yet, the effect had to be imitated using a

capitalization method.

4.3.1. Lease Capitalization Method

The research in this study applied the lease capitalization method designed by Palepu, Healy and Peek in

their book: Business analysis and valuation: IFRS edition (fourth edition).

This method is similar to the constructive capitalization method designed by Imhoff et al. in 1991. This

method has been used several times in previous studies such as Beattie et al. (1998) and Branswijck et al.

(2011), examining the effect of capitalization on Financial Statements and key ratios. The capitalization

method designed by Palepu, Healy and Peek however is specifically targeting Financial Statements

prepared under IFRS and was therefore used in this research.

There exists another method of lease capitalization called the heuristic method. The study of Bennet and

Bradbury (2003) indicated however that applying the heuristic method leads to significantly higher

unrecorded lease assets and liabilities, which are often overstated.

4.3.2. Estimating unrecorded Assets and Liabilities

The capitalization method, designed by Palepu, Healy and Peek (2016), consists of 6 consecutive steps.

First, the present value of the operating lease expenses was calculated as of January 1, 2014. The

operating lease payments were extracted from an existing quoted company’s Financial Statements for the

years 2014 and 2015 together with the non-cancellable future operating lease payments for the following

years. As it is not the objective of this paper to investigate the exact effect of capitalization on the balance

sheet, the Financial Statements of the company were simplified. The minimum future rental payments are

provided below. In order to calculate the present value, assumptions were made concerning the interest

rate of the financial leases. The assumptions used in this research are in line with the requirements of

Palepu, Healy and Peek (2016).

Assumptions:

• discount rate equals the effective annual interest rate for finance lease obligations: 6%

• lump sum values >5y: lower of rental payment in year 5 or lump sum value

16

Minimum future rental payments

‘000 € 31/Dec/15 31/Dec/14

< 1 year 22 19

1-2 years 19 15

2-3 years 19 15

3-4 years 19 15

4-5 years 19 15

>5 years 108 96

Total 206 175

Table 2: Minimum future rental payments

Using the discount rate on the lease expenses resulted in the estimated unrecorded assets and liabilities

shown in Table 3.

‘000 € 31/Dec/15 31/Dec/14 31/Dec/15 31/Dec/14

Year Discount factor Raw values Raw values Discounted value Discounted value

<1 1,060 22 19 20,8 17,9

2 1,124 19 15 16,9 13,3

3 1,191 19 15 16,0 12,6

4 1,262 19 15 15,0 11,9

5 1,338 19 15 14,2 11,2

6 1,419 19 15 13,4 10,6

7 1,504 19 15 12,6 10,0

8 1,594 19 15 11,9 9,4

9 1,689 19 15 11,2 8,9

10 1,791 19 15 10,6 8,4

11 1,898 13 15 6,8 7,9

12 2,012 6 0,0 3,0

Total 206 175 149,5 125,1

Within 1 year 20,8 17,9

Over 1 year 128,8 107,1

Total 149,5 125,1

Table 3: Present Value of minimum rental payments

17

Table 4 incorporates the second step, the change in lease assets and liabilities during the year 2015 from

new lease transactions.

‘000 €

Expectations for 2015

Lease expense for 2015 19

(=17,9*1,06)

Lease commitments 2015 and beyond 113,5

(=107,1*1,06)

Actual values for 2015

Lease expense for 2015 22

Lease commitments 2016 and beyond 149,5

Difference 39,0

Table 4: Change in lease assets and liabilities from new lease transactions

On December 31, 2014, the company’s liability for lease commitments in 2015 and beyond was

€107.100. Assuming there were no changes in these commitments, they would have been valued at

€113.500 on December 31, 2015. The company’s actual lease commitment at the end of 2015 however

was €149.500. The difference between the actual and the anticipated lease expense suggests a change in

their lease commitments.

The sum of the actual values supersedes the sum of the expectations. This points to an increase in lease

commitments expressed as an increase in non-current tangible assets and non-current debt by € 39.0006

during 2015.

4.3.3. Estimating Interest Expenses and Depreciation Expense

During the third step, the operating lease expenses (€22.000) are added back to the income statement,

included in Other Expenses. The fourth step substitutes the lease payment into an interest expense part

and a repayment of non-current debt part similar to the finance lease accounting method. The calculated

interest expense is the interest rate multiplied by the beginning lease liability plus the interest on the

increased lease liability in 2015. The interest expense for 2015 is therefore €8.7007. As we do not know

when the new leases were incorporated or when the first interest payment was made, we assume that the

average of all the contracts combined is 6 months (pro rata temporis principle). The calculated non-

6 €149.500 - €113.500 + €22.000 - €19.000 7 6% * €125.100 + (6% * 0,5 * €39.000)

18

current debt repayment (€13.300) is the difference between the operating lease expense of 2015 (€22.000)

and the calculated interest expense (€8.700).

In order to determine the depreciation expense (step 5), the weighted average lease term (WALT) had to

be calculated (infra Table 5). Several assumptions were made according to Palepu, Healy and Peek:

• Each payment was split into 12 different contracts with different remaining lease terms. The

maximum remaining lease term equals the number of years over which future lease payments

were allocated to compute the present value of future rental payments.

• The present value of the lease obligation equals the book value.

• The number of the contact equals the number of payments and the remaining lease term.

• The amount of payments related to a specific contract reflects the decrease in value of the

minimum rental payments from one year to the other.

A higher value of each contract leads to higher weights and therefore a higher weighted average lease

term.

The depreciation expense is calculated using the depreciation rate of !!"#$

. The depreciation expense is

!!!,!

∗ 125,1 + !!!,!

∗ 0,5 ∗ 39 ∗ 1000 = €13.000

The new lease contracts are depreciated using the pro rata temporis method. Because we do not know

when the company obtained the assets, we assume that the average is 6 months.

19

Year

Lease

payment Contracts

1 2 3 4 5 6 7 8 9 10 11 12

1 19 4 0 0 0 0 0 0 0 0 0 9 6

2 15

0 0 0 0 0 0 0 0 0 9 6

3 15

0 0 0 0 0 0 0 0 9 6

4 15

0 0 0 0 0 0 0 9 6

5 15

0 0 0 0 0 0 9 6

6 15

0 0 0 0 0 9 6

7 15

0 0 0 0 9 6

8 15

0 0 0 9 6

9 15

0 0 9 6

10 15

0 9 6

11 15

9 6

12 6

6

Remaining lease

term of each

contract 1 2 3 4 5 6 7 8 9 10 11 12

Value of each

contract 3,8 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 71,0 50,3

Weights 0,0302 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,5676 0,4022

Weights *

remaining lease

term of each

contract 0,0302 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 6,2435 4,8268

Weighted average lease term

=

11,1005

Table 5: Weighted average lease term

4.3.4. Estimating Net Profit

The sixth step calculates the deferred tax liability and eventually the net profit.

The expense under finance lease (€21.700) is the sum of the depreciation expense (€13.000) and the

interest expense (€8.700). The expense under the operating lease method is the lease payment of €22.000.

Under the finance lease method, we see an increase in profit of €300. The tax books of the company

cannot be changed, but for financial reporting purposes it will report higher earnings before tax and thus a

20

higher tax expense through deferred taxes. Assuming a tax rate of 25%, the increased tax expense is €758.

The deferred tax liabilities increase by the same amount (€75).

Income Statement 2015

Cost of sales ‘000 €

Lease expense - 22

Depreciation expense + 13,0

Interest expense + 8,7

P/L before tax + 0,3

Tax + 0,075

P/L after tax + 0,225

Table 6: Simplified Income Statement 2015

4.3.5. Adjusted ending Balance Sheet

Table 7 presents the adjustments that have been made to the balance sheet of the second category.

Assets Liabilities

Non-current tangible assets Non-current debt

Beginning capital 125,0 Beginning debt 125,0

New leases 39,0 New leases 39,0

Annual depreciation -13,0 Debt repayment -13,3

Deferred tax liability 0,075

SE 0,225

Total 151,0 Total 151,0

Table 7: Adjustments to ending Balance Sheet 2015

4.4. Manipulation Check

To check how and whether the respondents calculated the Equity Value of the company correctly, the

respondents were asked to write down the adjustments they made to EBTIDA. For the test dealing with

the Equity Value, questionnaires that failed the manipulation check were omitted.

8 25% * €19.000 - €18.700

21

4.5. Coding Strategy

Before the questionnaires were transcribed to SPSS, they were checked for accuracy. Questionnaires who

failed the manipulation check were transcribed into the database but eliminated for the relevant test. The

analysis of the open questions where the rationales for the adjustments or the opinions were discussed is

based on personal interpretation and is therefore subject to individual bias.

5. Analysis

Prior research from Branswijck et al. (2011) and Öztürk & Serçemeli (2016) analysed the potential

impact of the new lease standard on the Financial Statements. IFRS 16 has a significant influence on the

balance sheet, the income statement and the key financial ratios. As stated in the literature review, this

research applied the same key financial indicators as the papers mentioned above.

5.1. Effect on Balance Sheet

Table 8 provides an overview of key balance sheet items prepared in compliance with respectively IAS

17 and IFRS 16 for the year 2015.

2015 Reported 2015 Adjusted Difference (%)

Total Assets 1.556 1.707 9,70%

Total Liabilities 870 1.021 17,36%

Equity 686 686 ≈

Table 8: Financial Statement summary

Annex 2 (section 3: ‘Financial Statements’) contains the initial balance sheet prepared under IAS 17

whereas annex 3 (section 3: ‘Financial Statements’) includes the adjusted balance sheet prepared under

IFRS 16.

The liabilities of the company increased by 17,36% whereas the total assets increased by only 9,70%.

These case-based findings are in line with the results found by Beattie et al. (1998) and Bennet &

Bradbury (2003). In order to evaluate the financial position of the company correctly, it is useful to do a

financial ratio analysis to measure the performance of the company. An overview of the most important

key financial ratios according to Branswijck et al. (2011), Öztürk & Serçemeli (2016) and Durocher

(2008) is provided and tested in §5 (5.4. ‘Effect on ratios’).

22

5.2. Effect on Income Statement

Statement of Income (€ thousand)

2015 2015 Adjusted

Revenue 2.073 2.073

Cost of sales (1.410) (1.410)

Other expenses (338) (316)

Investment income 9 9

EBITDA 334 356

Depreciation & amortization (109) (122)

EBIT 225 234

Net interest cost (8) (17)

Taxes (58) (58)

Net Income 159 159

Table 9: Income Statement

Under IAS 17, the lease expenses were accounted as an operating cost. Under IFRS 16 however, the lease

payments are subtracted from the operating expenses and split up in a depreciation cost (€13.000) and a

financial cost (€8.700). Although the operating situation of the company did not change, it will report a

significantly higher EBITDA. The increase in EBIT is lower than the increase in EBITDA because of the

higher depreciation cost. In this particular case, the net income does not change significantly (€225) due

to the new lease standard and the assumed discount rate of 6%. Depending on the used discount rate and

the lease term, minor differences are possible. It is important to notice that the annual cost reported in the

income statement remained the same under IAS 17 (straight-line lease expense) whereas, over the years,

the expense under IFRS decreases because of the lower depreciation cost (front-loaded expense).

5.3. Effect on Cash flow(s)

Applying IFRS 16 does not change the original transaction between the lessor and the lessee. As a

consequence, the net cash flow does not change. On one hand, the operating cash flow will increase

because a part of the operating lease payments is removed. On the other hand, the finance cash flow will

decrease with the same amount.

23

5.4. Effect on ratios

As expected the ratios changed using the adjusted Financial Statements. The change in the financial ratios

presented in table 10 is in line with the results found by Durocher (2008) and Branswijck et al. (2011).

Table 10: Ratio analysis

The D/E ratio as a proxy for financial leverage increased drastically from 52,04% to 74,05% leading to

higher potential bankruptcy costs and reduced flexibility. A higher leverage could lead to debt holders

restricting the firm’s operating, investment and financing decisions due to their covenants imposed on the

firm (Palepu, et al., 2016). The Debt-to-Asset ratio increased from 22,94% to 29,76% which implies that

there are now more claims on the company’s assets. The increased financial risk of the firm along with a

deteriorated solvability leads to a higher probability of being credit constrained in the future (Kaplan &

Zingales, 1995). The ROA decreased slightly from 10,21% to 9,31%. As the revenue of the company did

not change, the net profit margin13 did not change in this case. The decreased ROA is caused by a lower

asset turnover suggesting that the management of the company uses the assets less effective to generate

sales. The liquidity of the company measured by the current ratio of the company decreased from 1,26 to

1,19. As long as the ratio remains above 1 however, the company does not have liquidity issues.

It is important to note that the magnitude of the impact of IFRS 16 will vary depending on whether the

company is lease intensive or not. Although the company used in this case-based survey is not

uncommonly lease-intensive, the impact on the ratios cannot be neglected.

5.5. Conclusion

The results of this case-based research are in line with the results of prior literature. Although

operationally the situation of the company did not change, its Financial Statements suggest otherwise.

Figure 2 provides a visual overview of the key financial ratios commonly used by professional Financial 9 (Current + Non-Current Debt) / Shareholders’ Equity 10 (Current + Non-Current Debt) / Total Assets 11 Net Income / Total Assets 12 Current Assets / Current Liabilities 13 ROA= Net Profit Margin x Asset Turnover

Debt/Equity9 Debt/Asset10 ROA11 Current ratio12

Initial 52,04% 22,94% 10,21% 1,26

Adjusted 74,05% 29,76% 9,31% 1,19

24

Statement users (Branswijck et al., 2011). The management teams of the companies will have to

communicate clearly with the Financial Statement users to justify the overnight changes to their Financial

Statements. Loan covenants for example often incorporate leverage clauses. Due to the increased

leverage, the covenants could be breached which could have severe consequences (freeze of dividends,

forced asset sale, …) for the company. Financial institutions will have to adapt their financial models and

renegotiate the terms of their contracts to adjust for the new situation.

Figure 2: Ratio Analysis

It is important to note that the impact of implementing IFRS 16 on this particular firm is material but not

exceptional. The report of Europe Economics 2017 expects a linear relationship between the size of the

lease portfolio and the magnitude of the consequences. The retail, aviation and transportation sector, who

are traditionally very lease intensive, are expected to experience the biggest effects. (Europe Economics,

2017)

6. Sampling and Results

6.1. Sample Description

The Full Sample consists of 58 investment professionals and excludes 4 questionnaires from the test

phase. The test phase was used to improve the design and content of the questionnaire.

In order to maximize the amount of questionnaires in each individual test, varying sample sizes were

used. Annex 4 presents a detailed overview of the sample selection and composition.

52,04%

22,94%

10,21%

74,05%

29,76%

9,31%

Debt/Equity Debt/Asset ROA

Ratio Analysis 2015 Adjusted 2015

25

In the test based on the Equity Value, two questionnaires were eliminated because of failed manipulation

checks. The sample used for the Equity Value analysis therefore comprises 56 investment professionals.

The Likert item Sample is a sub-sample of the Full Sample of 58. The sample excludes 45 questionnaires

lacking Likert Scores and comprises therefore 13 questionnaires. The written Response Sample, which

was used in the descriptive of the rationales, is a sub-sample of the Full Sample of 58. The sample

excludes 7 questionnaires that did not provide rationales or unclear rationales. As a result, the sample was

reduced to 51 questionnaires.

Figure 3 and 4 provide the descriptive statistics for the Full Sample.

Figure 3 reports the personal demographics by age and sex. The Full Sample is predominantly composed

of male investment professionals (Figure 3, Panel 1). This raises the question whether this sample is

biased or whether the proportion of women in the investment business is significantly lower. The

composition of the sample is in line with evidence from Gompers et al. (2014) claiming that over 90% of

the VC investors are men and that many areas of finance are still largely dominated by men. The most

frequently appearing age group is 41-50 (40%), shortly followed by >51 (33%). The age groups 20-30

and 31-40 represent respectively 8% and 19% of the Full Sample (Figure 3, Panel 2).

Figure 3: Sex and Age group

26

Figure 4 provides more detail on the professional demographics of the Full Sample.

The sample consists of roughly the same amount of professional investors (47%) as others (53%) (infra

Figure 4, Panel 1). Panel 2 describes the professional experience of the respondents. 39% of the

respondents have less than 10 years of experience. The majority of the sample (61%) consists of people

who appear to be very experienced professionals. 40% of the respondents have more than 10 but less than

20 years of professional experience. The remaining 21% of the respondent have between 21 and 30 years

of experience.

Panel 3 gives an overview of the IFRS knowledge of the participants. A sizable portion of the sample

indicates that they either have an average level (48%) or a limited level (48%), whereas only 4% of the

respondents claim to have advanced IFRS knowledge.

Figure 4: Professional demographics for the Full Sample

27

Several tests were conducted to analyse whether the composition of category 1 and 2 are not significantly

different from each other.

In order to test whether the proportion of professional investors in category 1 and 2 are not significantly

different, two binomial tests were conducted. As the proportion of the overall population is unknown,

empirical proportions were used when conducting the test. The empirical proportions of professional

investors in the first and second category are 0,49 respectively 0,44. The significance probability (0,390)

found when conduction the binomial test for category 2 using the empirical proportion of category 1

(0,49) was superior to the conventional 1,5 and 10% levels. The significance probability (0,376) found

when conducting the binomial test for category 1 using the empirical proportion of category 2 (0,44) was

superior to the conventional 1,5 and 10% levels. The null hypothesis that the proportion of professional

investors in category 1 and 2 is not significantly different can therefore not be rejected at these levels.

Two additional binomial tests were conducted to verify whether the proportion of men and women in

each category was not significantly different. As the probability of having a man in the population is

unknown, the proportion was defined calculating the probability in each category. For the first category,

the empirical proportion of finding a man was 0,94. For the second category, the empirical proportion

was 0,89. The significance probability (0,219) found when conducting a binomial test for category 2

using the calculated proportion of category 1 was superior to conventional 1,5 and 10% levels. The

significance probability (0,322) found after conducting the binomial test for category 1 using the

calculated proportion of category 2 was superior to the conventional 1,5 and 10% significance levels. The

null hypothesis that the proportion of males in both categories is not significantly different cannot be

rejected at these levels.

As the distribution of the population for age, experience and IFRS knowledge are unknown, Chi-Square

tests were conducted to verify whether there are no significant differences in distribution for the two

categories. The significance probability of the Chi-Square test for age (0,208) does not reject the null

hypothesis that the distribution of category 1 is not significantly different from the distribution of

category 2 at the conventional levels of 1,5 and 10%.

The significance probability of the Chi-Square test for experience (0,172) does not reject the null

hypothesis that the distribution of category 1 is not significantly different from the distribution of

category 2 at the conventional levels of 1,5 and 10%.

The significance probability of the Chi-Square test for IFRS knowledge (0,645) does not reject the null

hypothesis that the distribution of category 1 is not significantly different from the distribution of

category 2 at the conventional levels of 1,5 and 10%.

28

None of the tests above indicate a significant difference between category 1 and 2. Therefore I assume

that the results found in this research are not significantly biased by the category the participants were

assigned to.

6.2. Univariate Descriptive Evidence on Equity Value

Table 11 provides the descriptive statistics for the Equity Values calculated by category 1 and 2. Two

questionnaires were discarded from the sample because of failed manipulation checks. The mean and

median Equity Value of category 2 are substantially lower than the Equity Value’s of category 1, which

could be an early indication of a potentially significant difference between category 1 and 2.

Variable Obs. Mean SD P25 Median P75

Equity Value

Category 1 30 1139,83 46,79 1119,75 1145 1181

Category 2 26 1064,15 49,32 1023,75 1056 1118

Table 11: Equity value

Figure 5 provides a graphic overview of the expected and observed effects. As stated in the hypothesis,

we expected that, on average, the Equity Value calculated by the investment professional would be lower

when assigned to category 2 (IFRS 16) than to category 1 (IAS 17).

Figure 5: Expected vs. Empirical Equity Value

1000

1040

1080

1120

1160

1200

IAS 17 IFRS 16

Equ

ity V

alue

Accountingstandard

Equity Value

Expectations Experimental

29

As mentioned above, both Table 11 and Figure 5 reveal a decrease in Equity Value when shifting from

IAS 17 to IFRS 16, which is in line with our null hypothesis. Whether this difference in valuation is

significant will be tested and discussed in §7 (7. ‘Experimental Results’).

6.3. Descriptive Evidence on Lease Treatments

Figure 6 provides the descriptive statistics of the lease adjustments made by the investment professionals

in category 1. 65% of the respondents declared they did not make any adjustments because the operating

leases are already incorporated in EBITDA and therefore having a sufficient impact on the value of the

firm. 26% of the respondents excluded the operating leases from the Income Statement and used a

capitalization method to convert the operating expense to a financial debt. 3% indicated that they would

consider capitalizing the lease expenses if it would be an extraordinary lease intensive company. The

remaining 6% indicated that they needed more information to be able to make adjustments. The

additional information they required however was not specified.

Figure 6: Lease treatment

6.4. Descriptive Evidence on Perceived Usefulness of IFRS 16

The written responses of the investment professionals were analysed to reveal the rationales underlying

their opinion on IFRS 16. In order to augment the validity of the conclusions drawn from the rationales, a

5-point Likert item was added to the research.

65%

26%

3% 6%

0,00% 10,00% 20,00% 30,00% 40,00% 50,00% 60,00% 70,00%

Incorporated in EBITDA

Capitalized Partial Capitalisation

Lack of Information

Lease Treatment

Category 1

30

Figure 7: Opinion IFRS 16

Figure 7 and Table 12 provide the descriptive of the 5-point Likert item gauging the respondent’s position

on the new lease standard and whether according to them, it will improve the quality and transparency of

the Financial Statements. 53,85% of the respondents indicated to support the statement and therefore the

new lease standard, whereas 38,46% opposes. The majority seems to believe that IFRS 16 will provide a

solution for the often criticized flexibility of IAS 17.

Variable Obs. Mean Std. Dev. P25 Median P75

Opinion IFRS 16 13 3,23 1,641 1,5 4 5

By Category

Category 1 8 3,13 1,642 1,25 3,5 4,75

Category 2 5 3,4 1,817 1,5 4 5

Table 12: Descriptive 5-point Likert item (1: Strongly disagree – 5: Strongly agree)

A Chi-Square test was conducted to verify whether the ‘Opinion on IFRS 16’ is independent from the

category the participant belonged to. The test provided a p-value of 0,905, which tells us that there is no

statistically significant association between the category the respondent was assigned to and his or her

opinion on IFRS at the conventional 1,5 and 10% levels. 100% of the cells however have an expected

count lower than 5 with a minimum expected count of only 0,38. Therefore, the result found by the Chi-

Square test should be handled with extreme care.

23,08%

15,38%

7,69%

23,08%

30,77%

0,00%

10,00%

20,00%

30,00%

40,00%

Stronghly disagree

Disagree Neutral Agree Stronghly agree

Improved quality and transaprency

31

6.5. Descriptive evidence preferred valuation tool

Figure 8 gives an overview of the preferred valuation tool of the Full Sample. 67% declared that if this

case would be a real life valuation question, they would use a multiple (in combination with DCF) to

value the company. 29% of the professionals would rely on Discounted Cash Flow whereas only a

minority would use the Dividend Discount Model or the Adjusted Book Value. Figure 8 confirms the

popularity of a Multiple as a valuation method among investment specialists and as an adequate valuation

tool for this case-based study.

Figure 8: Preferred Valuation Tool

7. Experimental Results

To test whether the valuation difference visible in Table 11 is statistically significant, the two means were

compared using a t-test. Given the relatively small sample sizes (<50), a Shapiro Wilk test was executed

to check normality. For category 1, a significance probability of 0,086 was found. The hypothesis that

Category 1 comes from a normally distributed population cannot be rejected at conventional 1% and 5%

but it can be at the 10% level. The significance of category 2 (0,171) is superior to the conventional 1,5

and 10% levels. Therefore we cannot reject the null hypothesis that both categories come from a normally

distributed population. Consequentially, a paired t-test was executed to compare the means of the two

categories. As a t-test assumes equal variances between the two paired samples, a Levene test was

conducted to verify. The Levene’s Test for equal variances provides a probability significance of 0,341,

DCF 29%

Multiple 52%

Adjusted Book Value 2%

Dividend Discount Model

2% DCF & Multiple

15%

Valuation Tool

DCF

Multiple

Adjusted Book Value

Dividend Discount Model

DCF & Multiple

32

which is superior to the conventional 1,5 and 10% levels. The null hypothesis of equal variances of

category 1 and 2 is therefore not rejected at those levels.

The paired t-test provides us a t-value of -6,034 (infra Table 13). Given our hypothesis that applying

IFRS 16 will lead to a lower perceived Equity Value by the investment professionals, a one-tailed test

was necessary. Given the one-tailed critical values at the conventional significance levels of 1,5 and 10 %

respectively -2,492; -1,711 and -1,318, we reject the null hypothesis that both means are equal in favour

of the alternative hypothesis stating that the mean of category 2 is significantly lower.

Pairs Mean df T Sig.

EV 14 Category 2

– EV category 1 -73,52 24 -6,034 0,000

Table 13: Paired sample t-test

Two additional tests were conducted to examine whether there exists a significant difference between

early and late respondents and whether there exists a relationship between the respondent’s opinion on the

new lease standard and the calculated Equity Value.

The cut-off for the first test was set at seven working days. Respondents who completed and sent back the

questionnaire within seven working days were identified as early respondents. The others were identified

as late respondents. Since the date of reception from the questionnaires received with the help of

B.C.F.A., BVA and BAN is unknown, only the questionnaires sent and received by myself are taken into

account. The Full Sample of 58 is therefore reduced to 26 participants. 16 questionnaires from category 1

and 10 questionnaires from category 2 were included in the test. A significance probability15 of 0,175 was

found for category 1. The null hypothesis that the average Equity Value of the late respondents is not

significantly different from the early respondents cannot be rejected at the conventional 1,5 and 10%

levels. A significance probability16 of 0,554 was found for category 2. The null hypothesis that the

average Equity Value of an early respondent is not significantly different from the Equity Value of a late

respondent cannot be rejected at the conventional 1,5 and 10% levels.

In order to analyse whether the ‘opinion on IFRS 16’ measured by the 5-point Likert item had an

influence on the calculated Equity Value, two one-way ANOVA’s were conducted. For the first category,

the analysis of variance showed that the effect of ‘the opinion on IFRS 16’ on the calculated Equity Value 14 EV= Equity Value 15 Levene’s test for equal variances superior to conventional 1 and 5% levels. 16 Levene’s test for equal variances superior to conventional 1,5 and 10% levels.

33

was not statistically significant at the conventional 1,5 and 10% levels with a p-value of 0,666. For the

second category, the analysis of variance showed that the effect of the ‘opinion on IFRS 16’ on the

calculated Equity Value was not found statistically significant at the conventional 1,5 and 10% levels

with a p-value of 0,870. It is important to note that for both ANOVA’s, that the Levene’s test for equal

variances could not be calculated because of the extremely small amount of respondents in the category

‘opinion on IFRS 16’.

A factorial analysis of variance (ANOVA) was conducted to analyse the influence of five independent

variables (Age, Sex, Experience, Professional Investor, IFRS knowledge) on the calculated Equity Value

of the firm for both the first and second category. All effects were statistically insignificant for the first

category at the conventional 1,5 and 10% levels except for the IFRS Knowledge factor. The main effect

for IFRS Knowledge yielded an F-ratio of F(2,9)= 3,491 and a p-value of 0,075, indicating a significant

difference between investment professionals having limited (estimated mean: 1129,6 ; SD: 14,8), average

(estimated mean: 1159,8 ; SD: 14,7) and advanced IFRS Knowledge (estimated mean: 1181 ; SD: 51,5) at

the 10% level. As only one respondent claimed to have an advanced level, a post-hoc analysis could not

be executed because not every category contains the required minimum of two elements. Although the

result appears to be statistically significant, the result is most likely not economically significant.

Conclusions drawn from a test based on a category containing only one respondent are most likely not

meaningful and should be handled with care.

As for the second category, none of the effects were statistically significant at the conventional 1,5 and

10% levels.

Table 13 represents the top 5 rationales given by the respondents for both the positive (Panel 1) and

negative opinions (Panel 2). The table is based on the Full Sample but 7 questionnaires were excluded

because of unclear or missing opinions. The sample was therefore reduced to 51 questionnaires. 58,8% of

the questionnaires were identified as positive towards mandatory lease capitalization, whereas 41,2% was

identified as negative towards the new lease standard. This number is in line with the 5-point Likert item

which shows that 53,85% of the respondents perceive IFRS 16 as an improvement of the current

situation.

34

Opinion Full Sample Category 1 Category 2

Rank % Rank % Rank %

Improved valuation

because of visibility

liabilities 1 28,57% 1 29,41% 3 23,08%

Off-balance sheet items

decrease 2 25,00% 3 17,65% 1 30,77%

Financial liabilities are

more visible 3 21,43% 2 23,53% 4 15,38%

Convergence accounting

and economic reality 3 21,43% 3 17,65% 2 23,08%

Ratio manipulation

decreases 4 3,57% 4 5,88% NA NA

Panel 1: Top 5 Rationales supporting improvement

Opinion Full Sample Category 1 Category 2

Rank % Rank % Rank %

Risk profile is different 1 30,00% 1 33,33% 2 25,00%

Only long term or

substantial liabilities

should be visible

1 30,00% 2 22,22% 1 33,33%

No influence on

valuation 2 20,00% 2 22,22% 3 16,67%

Economic difference

between operating and

finance leases

3 15,00% 3 11,11% 3 16,67%

Operating lease is still a

cash movement but does

not appear in EBITDA

4 5,00% 3 11,11% NA NA

Panel 2: Rationales supporting deteriorating situation

Table 14: Raised rationales overall and by category (panel 1 & panel 2)

Panel 1 shows the most frequently mentioned rationales supporting the new lease standard. Interestingly,

the increased visibility of former off-balance sheet liabilities and the improved valuation score very high

in both categories. Which indicates that investment professionals are aware of the existence of off-

35

balance sheet obligations and their potential impact on valuation. Even though they seem to be aware of

this distortion, evidence found in Figure 6 and Table 13 shows that although there exist methods to undo

the distortion (cfr. Capitalization), the professional investors do not take the ‘hidden’ liabilities into

account when valuing a company. Which raises the question why not? Potentially, they are not aware of

the existence of such capitalization methods or they perceive them as inadequate or inefficient.

Panel 2 shows the rationales provided by the participants protesting against the new lease standard. The

most frequently mentioned rationale claims that the risk profiles of an operating or finance lease are

substantially different, therefore they should not be treated the same way. An important part of the

respondents (30%) indicate that only the substantial operating lease contracts should be visible. A more

profound analysis of this rationale shows that most of them acknowledge the fact that the current

flexibility in the lease standard IAS 17 is being exploited. The intervention of the IASB however is

sometimes perceived both by supporters and opponents of IFRS 16 as too far-reaching. The short-term

and low-value exemptions embodied in the lease standard, were designed to simplify the transformation

process and lower the implementation cost for the companies. Unintentionally however, these exemptions

could solve some of the most often mentioned objections towards IFRS 16.

8. Conclusion and discussion

In January 2016, the IASB published the long expected new lease standard: IFRS 16, which ends the

difference in accountancy treatment between operating and finance leases. In order to augment the

transparency and comparability of the Financial Statements, capitalization of virtually all lease contracts

will be required. The objective of this dissertation was to reveal whether the investment professionals in

Belgium and Luxemburg will experience significant valuation consequences when IFRS 16 becomes

mandatory the 1st of January 2019. Prior literature suggests that, on average, the capitalization of lease

contracts will result in higher financial liabilities appearing on the Balance Sheet, which affects the

calculated Equity Value of the company directly. In this case-based survey, the impact of implementing

IFRS 16 on the key financial indicators is in line with prior literature. The results indicate that mandatory

capitalization of operating leases, remarkably influences the Debt-to-Equity ratio, Debt-to-Asset ratio,

Current ratio and ROA of the company. The expected impact of IFRS 16 however will vary depending on

the industry and the lease intensity of the company. The retail and airline sector are expected to suffer the

most.

The results of this dissertation support the hypothesis that the implementation of IFRS 16 will lead to a

lower perceived Equity Value. Despite the strong valuation incentive for the investment professional and

the existence of effective models (e.g. capitalization method) to imitate the effect of IFRS 16, the

36

investment professionals in Belgium and Luxembourg neglect to benefit from their existence.

Surprisingly however, the majority of the respondents voted in favour of the mandatory capitalization,

claiming that IFRS 16 will improve the quality and transparency of the Financial Statements.

Consequentially, the investment professionals seem aware of the existence of off-balance sheet liabilities

and their consequences on valuation but neglect or refuse to undo these distortions. Future research could

investigate why this is the case. Perhaps the capitalization method is not mastered by the investment

professional or not perceived effective enough.

This dissertation tried to capture the rationales and the opinions of the respondents. Although the majority

of the respondents, based on the 5-point Likert item, support IFRS 16, 38,64%17 of the professionals

oppose. The 41,2%18 of rationales containing negative feedback or remarks on the new lease standard

cannot be ignored. The question whether the drastic intervention of the IASB demanding capitalization of

virtually all lease contracts is justified cannot be answered unambiguously. In an ultimate attempt to

improve the transparency of the Financial Statements, IFRS 16 will eliminate IAS 17’s often-criticized

relative subjectivity where lessees could choose almost arbitrarily between operating and finance lease.

The magnitude of the impact of IFRS 16 can however be minimized using the unintentionally created

flexibility in the definition of a lease (or a service contract) and the short-term lease exemption. In the

end, the effect of IFRS 16 might not have the far-reaching consequences expected by the investment

professionals (and standard setters) today.

The results of this dissertation are relevant to the IASB and other standard setters as it gives insight in

how investment professionals deal with off-balance sheet items (operating leases). The significant

valuation difference between the two categories, based on respectively IAS 17 and IFRS 16, provides

empirical evidence that the concerns and the intervention of the IASB are merited even though it is not

always perceived as such by the investment professionals themselves.

9. Limitations

The results of this dissertation are naturally limited by data deficiencies and various assumptions. Even

though I allowed for varying sample sizes in the different tests, in order to deal with these issues, the

amount of respondents remains often limited. The additional test analysing whether the early respondents

are significantly different from the late respondent is based on a reduced sample due to the unknown date

of reception from the various associations. Therefore, the sample consisted solely of questionnaires sent

17 Based on the sample used in the Likert score analysis. 18 Based on the sample used in the ‘Opinion on IFRS 16’ analysis

37

and received by myself. Tests such as for example the Factorial ANOVA who provide statistically

significant results are not necessarily significant from an economic point of view. Conclusions drawn

from tests based on limited samples should be analysed carefully before generalizing it to the overall

population.

As the Likert item was initially not incorporated in the questionnaire sent to the investment professionals,

only the respondents who could be identified afterwards were contacted to quantify their opinion on IFRS

16 with a 5-point Likert item. The open question gauging the opinion on IFRS 16 itself was interpreted by

myself and is therefore subject to personal interpretation. Future research could use the top five rationales

both pro and contra IFRS 16 mentioned by the respondents in this dissertation and convert them into

multiple-choice questions. This way, a larger sample could be addressed, which could test the validity of

my results. This dissertation focussed at Belgian and Luxembourgish investors and analysts. The topic

IFRS 16 can and should however be explored from different points of view. A similar research could be

conducted to test whether creditors interpret the Financial Statements differently or if IFRS 16 will

impact the credit analysis as significantly as it influences company valuation.

To my knowledge, there has not been a research yet that investigated the impact for the leasing

companies. IFRS 16 will most likely cause a shockwave through the leasing industry. Analysing and

anticipating how the lessors will deal with the new standard or how the lease market will evolve should

be researched as leasing remains a popular way of financing in Europe. (Leaseurope – European Leasing,

2015)

VIII

10. References

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Statement Recognition vs. Disclosure: Evidence from SFAS No. 106. Accounting Review, (74), p. 403–

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Deloitte (2016). Leases: A guide to IFRS 16. Retrieved from

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Perspectives, 7(3), p. 227-256.

IX

Dyckman, T. (1964). On the Investment Decision. The Accounting Review, 39(2), p. 285-295. Retrieved

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138-147.

XII

11. Appendix

Annex 1

Annex 1: Flowchart – IFRS 16

Source: IFRS 16 In depth, PWC

XIII

Annex 2

Annex 2: Questionnaire Category 1 (IAS 17)

Section 1: Personal background I would like to ask you some questions about your demographics and professional occupation. For the next questions, please highlight your answer or elaborate if necessary. The entire survey should not take longer than 15 minutes.

• Are you a professional investor as an occupation?

• Characterize your occupation briefly please (e.g. Private Equity, Venture Capital, Bank,…)

• Number of years of experience in current occupation: 0-10 11-20 21-30 Over 30

• Age: 20-30 31-40 41-50 Over 51

• Sex:

• Level of accounting knowledge IFRS: None Limited Average Advanced

Yes No

M F

XIV

Section 2: Valuation In the second section, I will ask you to do a valuation of the company, based on the Financial Statements I provided below. 1) Using the EV/EBITDA multiple of 4 and the information provided in the document, what is the

calculated equity value of the firm? 2) Did you make any adjustments to EBITDA?

a. If yes, which one?

b. If no, why not?

3) Did you take into account operating leases?

c. If yes, how?

d. If no, why?

4) Please give your opinion on the elimination of the difference between operating and finance leases. Do you think it improved the quality and transparency of the Financial Statements?

e. If yes, why?

f. If no, why?

5) How would you normally calculate a quick estimate of the (equity) value of the company? (pick only one)

a. DCF method b. Multiple (e.g. EV/EBITDA, P/E) c. Adjusted book value d. Dividend Discount model e. Other

6) If you have any questions or remarks, please write them below.

XV

7) Post-questionnaire addendum: In addition to your answer provided in question 4, how would you assess the statement: “eliminating the difference between operating and finance leases will improve the quality and transparency of the Financial Statements”, on a 5-point Likert scale ranging from 1= strongly disagree, to 5= strongly agree?

1 2 3 4 5 Section 3: Financial Statements Introduction: Company X is a manufacturer of car parts. It was founded 20 years ago and is considered to be a solid company. The Balance Sheet and Income Statement have been stable over the last couple of years. SummaryBalanceSheet(€thousand)

PPE 600 Equity 686Developmentcosts 41 Long-termdebt 210

Goodwill 44 Provisions 43Otherintangibleassets 15 Deferredtaxliabilities 13

Shareholdings 25 TOTALnon-currentliabilities 264Otherfinancialassets 12 Short-termdebt 147

Deferredtaxassets 56 Tradepayables 350

TOTALnon-currentassets 793 Othercurrentpayables 107Inventory 250 TOTALcurrentliabilities 604

Tradereceivables 311 Cash 202 TOTALcurrentassets 763

TOTALASSETS 1.556 TOTALEQUITYANDLIABILITIES 1.556 StatementofIncome(€thousand)

Revenue 2.073Costofsales (1.410)Otherexpenses (338)Investmentincome 9EBITDA 334Depreciation&amortization (109)EBIT 225Netinterestcost (8)Taxes (58)NetIncome 159

XVI

Accounting Policy: The consolidated Financial Statements are prepared in compliance with IFRS. The firm uses a historical cost basis unless stated otherwise below. Crucial accounting policies:

• PPE are carried at cost, net of accumulated depreciation and any impairment in value. • Assets held under finance lease are recognised and recorded at inception under PPE. Leases

where the lessor retains substantially all the risks and rewards incident to ownership are classified as operating leases and are therefore not recognised on the balance sheet. Lease payments are recognised in the statement of income under other expenses.

• Goodwill is measured at cost and annually tested for impairment. • Development costs and other intangible assets are measured at cost less

amortization if the necessary criteria are met. • Inventories are stated at the lower of cost or market value. • Shareholdings are valued using the equity method. • Other financial assets are measured at amortised cost, using the effective interest rate method,

less impairment cost. • Provisions for employee benefits are the net of the present value of the obligations to the defined

benefit plan and external plan assets. Discretionary valuations and significant accounting estimates:

• Recognition, measurement and impairment of intangible assets required management judgement. • The present value of the defined benefit obligation is determined according to annual actuarial

assessment. • The company holds a limited number of minority investments in unlisted firms. Managerial

estimates were used to determine the Fair Value of these investments.. • Deferred tax assets are recognised for all unused tax losses. The company’s management had to

estimate the amount of deferred tax assets that could be recognised based on the amount of future taxable profit.

• Impairment of assets is based on the assumptions used to calculate the recoverable amount. Notes and additional information:

• The tax percentage is 25%.

• A leading audit firm has audited the company. The corporate governance is therefore of high standard.

XVII

• Inventories In € ‘000 31.12.15 31.12.14 raw materials 102 96 work in progress 48 44 finished products 82 77 goods in transit 18 14 TOTAL 250 231 In € ‘000 31.12.14 Provis-

ions Use/release Exchange

rate fluctuation

change in consolidation area

31.12.15

write down provision 33 13 -9 0,6 -1,6 36

• Trade receivables

Expired receivables mainly refer to leading car manufacturers.

• Financial Debt & Derivatives

Summary € ‘000 Liquidity 202 Current financial debt 147 Net current financial debt -55 Non-current financial debt 210 Net financial debt 155

• Leases The company has outstanding lease agreements for several production facilities and headquarters. The company concluded that not all significant risks and rewards were transferred to the company. Therefore these contracts are considered to be operating leases. Theeffective annual interest rate for the finance lease obligations is 6%

MinimumFuturerentalpayments:€‘000 31/12/15 31/12/14<1year 22 191-2years 19 152-3years 19 153-4years 19 154-5years 19 15>5years 108 96Total 206 175

XVIII

• Provision for Employee Benefits

In € ‘000 31.12.14 Provisions Use/release Interest expense

Exchange rate fluctuations

change in consolidation area

actuarial gain/loss

31.12.15

employees' leaving entitlement

23 0 -1 0,4 0 -0,2 -1,2 21

defined benefit plans

9 0,3 -0,7 0,4 0,5 0 -0,5 9

defined contribution plans

1 0,6 -0,6 0 0 0 0 1

total 33 0,9 -2,3 0,8 0,5 -0,2 -1,7 31

• Valuation

A company with similar characteristics (growth potential, seize, industry,…) was recently valued 4 times its EBITDA.

XIX

Annex: 3 Annex 3: Questionnaire Category 2 (IFRS 16)

Section 1: Personal background

I would like to ask you some questions about your demographics and professional occupation. For the next questions, please highlight your answer or elaborate if necessary. The entire survey should not take longer than 15 minutes.

• Are you a professional investor as an occupation?

• Characterize your occupation briefly please (e.g. Private Equity, Venture Capital, Bank,…)

• Number of years of experience in current occupation: 0-10 11-20 21-30 Over 30

• Age: 20-30 31-40 41-50 Over 51

• Sex:

• Level of accounting knowledge IFRS: None Limited Average Advanced

Yes No

M F

XX

Section 2: Valuation In the second section, I will ask you to do a valuation of the company, based on the Financial Statements I provided below. 1) Using the EV/EBITDA multiple of 4 and the information provided in the document, what is the

calculated equity value of the firm? 2) Did you make any adjustments to EBITDA?

g. If yes, which one?

h. If no, why not?

3) Please give your opinion on the elimination of the difference between operating and finance leases.

Do you think it improved the quality and transparency of the Financial Statements?

i. If yes, why?

j. If no, why?

4) How would you normally calculate a quick estimate of the (equity) value of the company?

(Pick only one)

f. DCF method g. Multiple (e.g. EV/EBITDA, P/E) h. Adjusted book value i. Dividend Discount model j. Other

5) If you have any questions or remarks, please write them below. 6) Post-questionnaire addendum: In addition to your answer provided in question 3, how would you assess the statement: “eliminating the difference between operating and finance leases will improve the quality and transparency of the Financial Statements”, on a 5-point Likert scale ranging from 1= strongly disagree, to 5= strongly agree? 1 2 3 4 5

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Section 3: Financial Statements Introduction: Company X is a manufacturer of car parts. It was founded 20 years ago and is considered to be a solid company. The Balance Sheet and Income Statement have been stable over the last couple of years. SummaryBalanceSheet(€thousand) PPE 751 Equity 686Developmentcosts 41 Long-termdebt 322Goodwill 44 Provisions 43Otherintangibleassets 15 Deferredtaxliabilities 13Shareholdings 25 TOTALnon-currentliabilities 378Otherfinancialassets 12 Short-termdebt 186Deferredtaxassets 56 Tradepayables 350TOTALnon-currentassets 944 Othercurrentpayables 107Inventory 250 TOTALcurrentliabilities 643Tradereceivables 311

Cash 202 TOTALcurrentassets 763

TOTALASSETS 1.707 TOTALEQUITYANDLIABILITIES 1.707 StatementofIncome(€thousand)

Revenue 2.073Costofsales (1.410)Otherexpenses (316)Investmentincome 9EBITDA 356Depreciation&amortization (122)EBIT 234Netinterestcost (17)Taxes (58)NetIncome 159

Accounting Policy: The consolidated Financial Statements are prepared in compliance with IFRS. The firm uses a historical cost basis unless stated otherwise below. Crucial accounting policies:

• PPE are carried at cost, net of accumulated depreciation and any impairment in value.

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The firm chose to adopt the new lease standard IFRS 16 early, which erases the distinction between operating and finance leases. All lease obligations are therefore recognised on the balance sheet and no longer incorporated in the income statement.

• Goodwill is measured at cost and annually tested for impairment. • Development costs and other intangible assets are measured at cost less

amortization if the necessary criteria are met. • Inventories are stated at the lower of cost or market value. • Shareholdings are valued using the equity method. • Other financial assets are measured at amortised cost, using the effective interest rate method,

less impairment cost. • Provisions for employee benefits are the net of the present value of the obligations to the defined

benefit plan and external plan assets. Discretionary valuations and significant accounting estimates:

• Recognition, measurement and impairment of intangible assets required management judgement. • The present value of the defined benefit obligation is determined according to annual actuarial

assessment. • The company holds a limited number of minority investments in unlisted firms. Managerial

estimates were used to determine the Fair Value of these investments. • Deferred tax assets are recognised for all unused tax losses. The company’s management had to

estimate the amount of deferred tax assets that could be recognised based on the amount of future taxable profit.

• Impairment of assets is based on the assumptions used to calculate the recoverable amount. Notes and additional information:

• The company has been audited by a leading audit firm. The corporate governance is therefore of high standard.

• The tax percentage is 25% and the interest percentage 6%.

• Inventories In € ‘000 31.12.15 31.12.14 raw materials 102 96 work in progress 48 44 finished products 82 77 goods in transit 18 14 TOTAL 250 231 In € ‘000 31.12.14 Provis-

ions Use/release Exchange

rate fluctuation

change in consolidation area

31.12.15

write down provision 33 13 -9 0,6 -1,6 36

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• Trade receivables

Expired receivables mainly refer to leading car manufacturers.

• Financial Debt & Derivatives

Summary € ‘000 Liquidity 202 Current financial debt 186 Net current financial debt -16 Non-current financial debt 322 Net financial debt 306

• Leases The company chose to apply IFRS 16 early. The new standard eliminates the difference between operating and finance leases. All lease contracts are therefore recognized as a financial debt on the balance sheet. As a consequence, operating lease payments have been eliminated from the income statement.

• Provision for Employee Benefits

In € ‘000 31.12.14 Provisions Use/release Interest expense

Exchange rate fluctuations

change in consolidation area

actuarial gain/loss

31.12.15

employees' leaving entitlement

23 0 -1 0,4 0 -0,2 -1,2 21

defined benefit plans

9 0,3 -0,7 0,4 0,5 0 -0,5 9

defined contribution plans

1 0,6 -0,6 0 0 0 0 1

total 33 0,9 -2,3 0,8 0,5 -0,2 -1,7 31

• Valuation A company with similar characteristics (growth potential, seize, industry,…) was recently valued 4 times its EBITDA.

XXIV

Annex 4

Annex 4: Sample Selection and Composition

Sample Description Obs.

1) Full Sample 58

This sample is based on all the questionnaires and excludes:

-4 questionnaires from the test phase

This sample consists of:

-Respondents Category 1 31

-Respondents Category 2 27

2) Sample used in Equity Value analysis 56

Sub-sample of the Full Sample excluding:

- 2 questionnaires with failed manipulation checks

3) Sample used in descriptive Lease Treatment 29

Sub-sample of the Full Sample excluding:

- 27 questionnaires from the 2nd category

- 2 missing answers from category 1

4) Sample used in Likert score analysis 13

Sub-sample of the Full Sample excluding:

- 45 questionnaires with no Likert scores.

5) Sample used in ‘opinion IFRS 16’ analysis 51

Sub-sample of the Full Sample excluding:

- 7 questionnaires with incomplete or unclear answers