Aircraft leases under IFRS 16

Does an aircraft agreement contain a lease?

A dry lease, of the aircraft alone, almost always does. The aircraft is an identified asset, specified by its manufacturer serial number, and the lessor's rights to substitute another aircraft are rarely substantive because swapping aircraft is costly and needs the airline's agreement. The airline decides how and for what purpose the aircraft is used, which routes it flies and when, so it controls the use of the aircraft. A wet lease, where the lessor also provides crew, maintenance and insurance, is less obvious. One of IFRS 16's own illustrative examples, an aircraft operated by the supplier's crew, concludes that the contract contains a lease because the customer decides where and when the aircraft flies, with the crew and other services as non-lease components. Many wet leases cover only a season, so the short-term lease exemption often applies. See identifying a lease.

Aircraft leases: a 12-year example

An airline leases a new narrowbody aircraft for 12 years at US$ 4.2 million a year, paid annually in arrears, with no extension options it is reasonably certain to use. Its incremental borrowing rate for a 12-year, dollar-denominated borrowing secured on the aircraft is 6%. The lease liability is the present value of the rentals, US$ 35.21 million, and the right-of-use asset is the same amount, depreciated straight-line over 12 years at 2.93 million a year.

Over the lease, the expense equals the rent paid, US$ 50.4 million, but it is front-loaded: 5.05 million in year 1 against 3.17 million in year 12, because interest falls as the liability is repaid. For an airline that renews its fleet steadily, the effect evens out across many leases; for one that is expanding, reported costs rise faster than cash rents. See IFRS 16 lessee accounting and the discount rate.

How do US dollar rentals affect an airline reporting in another currency?

Suppose the airline's functional currency is the euro, and the dollar strengthens during year 1 from US$ 1.10 to US$ 1.00 per euro. The lease liability is a monetary item, retranslated at the closing rate; the right-of-use asset is non-monetary and stays at the rate on the commencement date.

Although the airline has repaid part of the debt in dollars, the euro liability has risen, and roughly €3.0 million of the change is an exchange loss in profit or loss, with no matching gain on the asset. Airlines with large dollar lease books manage this by earning dollar revenue, hedging, or designating the dollar lease liabilities as hedging instruments in cash flow hedges of highly probable dollar revenue, which IFRS 9 allows for foreign currency risk. The effective part of the exchange difference then goes to equity until the hedged revenue is recognised. See IFRS 9 hedge accounting. Shipping companies largely avoid the problem because their functional currency is usually the dollar; see functional currency in shipping.

What is included in the lease term and payments?

The lease term is the non-cancellable period plus extension periods the airline is reasonably certain to use and periods after a termination option it is reasonably certain not to use. For aircraft, the fleet plan, the cost of returning the aircraft and the availability of replacements are key evidence. The liability includes fixed rentals, rentals that vary with an interest rate, such as rents reset to a floating dollar rate, measured at the current rate and remeasured when it changes, and purchase options the airline is reasonably certain to exercise. Lease incentives from the lessor, such as contributions to cabin work, reduce the right-of-use asset. See the lease term.

How are maintenance and other variable payments treated?

Payments that depend on use, such as maintenance reserves charged per flight hour or cycle, or rent that varies with utilisation, are variable lease payments outside the liability. Maintenance reserves need their own analysis because the lessor reimburses them when maintenance is done; see maintenance reserves and checks. Obligations to return the aircraft in a specified condition are covered in lease return conditions, and aircraft financed by selling them to a lessor on delivery in aircraft sale and leaseback.

How are aircraft leases presented?

Right-of-use aircraft are often shown with owned aircraft in the fleet, with a note splitting them, and lease liabilities within borrowings and net debt. Under IFRS 18, from 2027, depreciation is in the operating category and interest on lease liabilities in the financing category for most airlines; in the cash flow statement, repayments of the liability are financing cash flows. Airlines disclose the maturity of lease liabilities, expenses for short-term and variable leases, and the number of leased aircraft. See IFRS 16 disclosures.

How does US GAAP differ?

Under ASC 842, an airline also recognises a right-of-use asset and lease liability, but most aircraft leases are classified as operating leases, with a single straight-line lease cost of US$ 4.2 million a year in operating expenses, so there is no front-loading and no interest expense. Aircraft leases that transfer most of the asset's economic life or value are finance leases, accounted for much like IFRS 16. Lessors, under both frameworks, usually keep the aircraft on their balance sheets as operating leases. See IFRS 16 vs ASC 842 and airline accounting.

This guide is general information. It is not tax or legal advice for your situation.