Implications of IFRS 16 adoption Evidence from Swedish publicly listed firms Master’s Thesis 15 credits Department of Business Studies Uppsala University Spring Semester of 2020 Date of Submission: 2020-06-27 Jonathan Spånberger Momtahina Rista Supervisor: Derya Vural-Meijer Abstract In this study, we investigate how the implementation of IFRS 16 is affecting the financial statements of Swedish publicly listed firms, and what implications there are for financial statement users. These effects are analyzed by looking at transitional effects on total assets, total liabilities and EBITDA and by comparing different sectors, following estimations of sectoral differences in prior studies (e.g. Fülbier et al., 2008; Morales-Díaz & Zamora-Ramírez, 2018a). As a way of approximating the practical implications of IFRS 16, this study is analyzing changes in the key financial ratios: D/E and EV/EBITDA. We find significant median increases in total assets, total liabilities and EBITDA in the full sample, as well as within each sector group. Further, we confirm the existence of sectoral differences, finding the largest median increases in the Consumer Services sector and the smallest in the Financials sector. We also confirm that IFRS 16 bring new implications for financial statement users, since important and commonly used financial ratios are significantly changed: we observe a significant median increase in the D/E ratio and a significant median decrease in the EV/EBITDA multiple. Keywords: IFRS 16, lease accounting, off-balance sheet financing, impact assessment, transitional effects Table of Contents 1. Introduction .......................................................................................................................... 1 2. About IFRS 16 ...................................................................................................................... 4 3. Theory and literature review .............................................................................................. 6 3.1 Asymmetric information and IFRS .............................................................................. 6 3.2 Asymmetric information and lease accounting ............................................................ 7 3.3 Effects of capitalizing operating leases ......................................................................... 9 3.3.1 Balance sheet effects .................................................................................................. 9 3.3.2 Profit and loss statement effects .............................................................................. 11 3.4 Hypotheses development .............................................................................................. 12 4. Methodology ....................................................................................................................... 14 4.1 Research design ............................................................................................................. 14 4.2 Data and sample ............................................................................................................ 15 4.3 Statistical methods of hypothesis testing .................................................................... 16 4.4 Methodological considerations .................................................................................... 21 5. Results ................................................................................................................................. 23 5.1 Results from the full sample ........................................................................................ 23 5.1.1 Effects on financial statements ................................................................................. 23 5.1.2 Effects on key financial ratios .................................................................................. 24 5.2 Results by sector ........................................................................................................... 25 5.2.1 Effects on financial statements ................................................................................. 27 5.2.2 Effects on key financial ratios .................................................................................. 29 6. Discussion ............................................................................................................................ 31 6.1 Effects on financial statements .................................................................................... 31 6.1.1 Results from the full sample ..................................................................................... 31 6.1.2 Results by sector ...................................................................................................... 32 6.2 Implications for financial statement users ................................................................. 34 6.2.1 Effects on key financial ratios .................................................................................. 34 6.2.2 Impact on information asymmetries ......................................................................... 36 6.2.3 The implementation process .................................................................................... 37 7. Conclusions ......................................................................................................................... 39 References ............................................................................................................................... 41 Appendix A – Examples of differences in reporting of transitional effects ...................... 45 1. Introduction The aim of this study is to investigate how the implementation of IFRS 16 – the new accounting standard on leasing – is affecting the financial statements of Swedish publicly listed firms, and what implications there are for financial statement users. IFRS 16 is the most recently implemented standard within the International Financial Reporting Standards (IFRS): a series of global, principle-based, accounting standards aimed at facilitating cross-border capital movement by eliminating national differences in accounting regulations (IFRS Foundation, 2019a). The standards are used widely all over the world, including Sweden where IFRS has been mandatory for publicly listed firms since 2005 (European Commission, 2019). IFRS 16 was implemented in fiscal years started January 1st, 2019 or later. The main impact is that future payments of operating leases need to be capitalized. IFRS 16 replaced IAS 17, under which finance leases were capitalized but fees from operating leases were reported as operating expenses, complemented with information disclosed in notes. According to the IFRS Foundation, the aim of IFRS 16 is to “faithfully represent lease transactions” and to “provide a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases” (IFRS Foundation, 2019b). Hence, an implicit aim is to decrease the information asymmetry between the firms and their stakeholders (Hoogervorst, 2016). During the last decades, there seems to have been an increase in the usage of operating leases, creating a suspicion of companies deliberately using operating leases as a way of keeping assets and liabilities out of the financial statements, so called “off-balance sheet financing” (Abdel-Khalik, 1981; Imhoff & Thomas, 1988; Imhoff et al., 1991; Reason, 2005; Duke et al., 2009). Previous studies such as Imhoff et al. (1993) are pointing out how disclosed, but not recognized, information about operating leases in the annual reports (as was the case under IAS 17) seem to not be utilized to the same extent by all stakeholders. Hence, the results point to a need of including such information in the financial statements, i.e. capitalizing the operating lease expenses. In similar studies, although not explicitly about leasing, Ahmed et al. (2006) and Davis-Friday et al. (1999) also provide evidence of differences in utilization of the information in recognized and disclosed amounts. There has, however, been a lot of criticism of the IFRS 16 and its counterparty within US GAAP: FASB ASC 842 (Accounting Today, 2013; Tysiac, 2013; Bratten et al., 2013; Altamuro et al., 2014). The criticism is not mainly regarding whether or not more information is needed, but rather regarding the complexity of the suggested model of using capitalization and the 1 proportion between benefits and negative economic consequences that could be caused by the new standard (Accounting Today, 2013; Tysiac, 2013; Kabureck, 2015). Some business representatives claim that capitalizing operating leases is a complex and time-demanding activity, which does not have proportionate benefits for stakeholders (Accounting Today, 2013). Further, Bratten et al. (2013), Altamuro et al. (2014) and Giner & Pardo (2018) point to evidence indicating that a lot of stakeholders are in fact utilizing disclosed and recognized information about operating leases in a similar way. Hence, a possibility of achieving similar results with a less complex accounting standard than IFRS 16 is indicated. Concluding the debate on lease capitalization, there exist evidence pointing in different directions regarding the most appropriate way to decrease the information asymmetries that seem to exist under IAS 17 and US GAAP (e.g. Imhoff et al., 1993; Bratten et al., 2013; Altamuro et al., 2014). However, rather than the studies showing explicitly contradicting evidence, the opposite