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IFRS 16 valuation impact

What you need to know now

For companies reporting under IFRS (International Financial Reporting Standard), it is important to note that the guidelines on accounting for leases has changed, effective for financial periods beginning on or after 1 January 2019. The previous standard, IAS 17, has been replaced by IFRS 16 and companies need to be aware of how the new standard impacts key valuations metrics, especially when considering M&A transactions.

Under the old standard, leases could be recorded as either finance or operating leases. Under IFRS 16, all leases are now treated as finance leases. And, while this change shouldn’t affect the fundamental and economic valuation of a company, it will lead to an increase in leased assets and financial liabilities on the balance sheet of the lessee, while Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) of the lessee increases as well.

To better understand how IFRS 16 will affect the valuations of South African companies, Deloitte applied the new standard to a sample of 75 JSE listed companies across a range of sectors to illustrate the impact it will have on implied multiples and leverage ratios. Based on this research, it is advised that companies pay special attention to the following key points in performing valuations:

  • The lease obligations and average remaining lease term of the target should be analysed;
  • In Discounted Cash Flow valuations, leases expenses should be treated as an operating cash outflow or adequately reflected in net debt;
  • The terminal value should appropriately consider the required continuation of leases after the expiry of current agreements;
  • In market approach valuations, the comparability of target and peers should consider whether assets are owned or leased; and
  • When using EV/EBITDA multiples, net debt should appropriately be adjusted or an EV/EBITA multiple should be considered.

As with any new standard, IFRS 16 may require a period of adjustment. Deloitte is committed to ensuring the transition is as seamless as possible for its clients involved in M&A transactions and valuations of businesses. For more information on how IFRS 16 might affect your business, transaction or valuation, talk to Deloitte today.

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