The COVID-19 pandemic has created an unprecedented crisis for the world's airlines. The grounding of a significant proportion of commercial passenger airliners has been closely watched by analysts, investors and the media.
The impact of the pandemic on the industry and the consequent reduction in future cash flows from aircraft assets may be an indicator of impairment. This could require impairment tests to be carried out every time you report.
The COVID-19 crisis is having an unprecedented impact on the global air transport industry. Passenger aversion to flying and government-imposed restrictions on travel to and from quarantine zones are creating huge challenges.
Aircraft owners will have to consider the potential impairment of their aircraft assets. IAS 36: Impairment of Assets and FRS 102 require airline assets to be tested for impairment at each reporting date whenever there is an indicator those assets might be impaired.
The following impairment indicators might be relevant for aircraft owners in the current economic climate:
This list is not comprehensive and other indicators might present themselves.
A non-financial asset is considered impaired if it's carrying amount exceeds its recoverable amount. Recoverable amount is the higher of value in use (VIU) and fair value less costs of disposal (FVLCOD).
Aircraft lessors using VIU approaches may find that cash-flow forecasts and discount rates have moved a lot in a short time. While there is no single approach on how to incorporate these changes, the valuation process needs to be iterative and to make use of current information (to the extent that it is available).
To deal with uncertainty, companies are increasingly using several cash-flow scenarios to develop expected values for value in use—starting with a robust base case—and are adapting for more adverse potential outcomes. This approach facilitates detailed analysis, clear communication and improved risk management.
Aircraft lessors using the FVLCOD approach historically derive the value by way of engaging an external valuer. In the context of COVID-19, valuation reports received from external valuers may contain an uncertainty or qualifying clauses in relation to certain aspects of the valuation. For example, the uncertainty may relate to the lack of empirical data or reliable market transactions. As such, the ability to take the valuation without applying a significant level of judgement will be challenging. Equally, it will be critical to understand the limitations of any valuation and whether the valuation assumptions (e.g. half life vs full life, base value vs market value) remain appropriate in the current climate. Assumptions should be adjusted if reasonably available information indicates that other market participants would use different data by using, for example, recent transactions to assess current market sentiment.
Finally, an additional consideration are the requirements of IAS 10 and FRS 102 Section 32 (post balance-sheet events) and in particular the judgements that will be required as to whether any developments and new information provide more information about the circumstances that existed at the reporting date and, should therefore be adjusted in the financial statements. There is a consensus that the outbreak of COVID-19 in 2020 is a non-adjusting post balance-sheet event for periods ended by 31 December 2019. However, companies will need to judge how much of the impact of COVID-19 should be considered to impact balance-sheet dates from 31 March 2020 onwards.
While we expect most aircraft owners to have an indicator of impairment for reporting periods after 31 December 2019, the exact specifics may differ from entity to entity. Early discussion and agreement on these indicators with stakeholders is important, especially as this will drive subsequent decisions and workflow.
When defining the indicators, it is important to include all balance-sheet items impacted, including lease incentives and maintenance rights intangible assets.
In the new reality, historical expectations around lease duration, re-lease rates, downtime between leases and transition costs will need to be re-evaluated and kept under regular review.
Given the heightened uncertainty about the future direction of air travel, probability-weighted cash flows (for a base, mildly adverse and severe adverse case) are a valuable addition to the discounted cash flow analysis.
If using a single set of cash flows adjust for the risk from COVID-19 in the discount rate. Consider involving a valuation expert on a likely range of acceptable discount rates.
Valuation reports may contain uncertainty or other qualifying clauses in relation to certain aspects of the valuation. Discussions should also be had to better understand valuation methodologies (base value vs market value) and specific technical terms within a lease that could impact residual values and assumptions. Of particular importance will be any assumptions around redelivery conditions and maintenance conditions (especially where the utilisation of the aircraft is presently abnormally low).
In the current environment, we might expect a more detailed disclosure of the judgements made in determining whether an impairment indicator exists and the consequent impairment charge (if any). In some cases, enhancement of the prior year accounting policies would be beneficial to help users understand the process employed.
The challenges of the current impairment indicators, unfortunately, do not lead to a clear, decisive path forward. The aircraft market today combined with the independent methodologies used by appraisers will undoubtedly challenge asset values and will require further scrutiny on supporting assumptions for impairments tests. Answers to tough questions will require industry proficiency and hands-on experience, along with substantive knowledge of valuations and the asset class.
We are in the unique position of having an in-house aviation team that has real-world transactional experience, valuation expertise and the technical knowledge to support complex conversations needed during these challenging times. We can provide you with an approach rooted in industry accepted practices, proactive engagement and a solid reputation for solving complex problems as you navigate these uncertain times. Contact us today.
Aviation Finance Advisory Services Senior Advisor, PwC Ireland (Republic of)
Tel: +353 1 792 6232
Director, PwC Ireland (Republic of)
Tel: +353 1 792 6882