IFRS 16 leases and its effects on management compensation systems in the Norwegian retail industry

Abstract

The background for this master thesis is the upcoming leasing standard issued by International Accounting Standards Board, IFRS 16 Leases. The standard will require lessees to recognize substantially all lease arrangements on the balance sheet. The current standard has been criticized for its binary classification, allowing lessees to keep certain leased assets off-balance sheet. IFRS 16 will have an effective date of 1 January 2019, and is deemed to have great impact on leasing-intensive industries. We examine how IFRS 16 will impact key ratios for companies applying IFRS, and consequently whether this will have any possible effects on bonus compensation contracts for Norwegian retail companies. After we present the relevant literature regarding lease accounting and management incentives and bonus contracts, we conduct a case study to analyze IFRS 16’s impact on the financial statements of two of the largest retail companies in Norway. The results are used to analyze the effect on identified elements in bonus contracts obtained from literature and sit-downs with executives of the case companies. This analysis includes a historical and a forward-looking approach. Succeeding interviews with auditors enlighten the topics from a professional perspective. When capitalizing operating leases, we find evidence suggesting a significant rise in operational measures included in bonus contracts (EBITDA, EBIT, NOPAT), while included financial measures (ROIC, ROCE, EVA) are likely to decline notably. However, IFRS 16 appears to have a diminishing effect on growth in ROIC/EVA when comparing different growth scenarios in a forward-looking approach. Interviewed experts claim that making bonus contracts more robust can lead to circumvention of any possible impact from future changes in accounting policies. To ease the transition, the experts state that acquisition of new ITsystems and possession of sufficient technical knowledge will be critical for estimating an accurate present value of all future lease payments.