DOCUMENT 2

ACCOUNTING TRIGGER

PRE-RELEASE TRIGGER:

Page 10 - I have attached a summary of the salient terms and conditions of the proposed wet leasing agreement. Please give
this some thought – the board requested that I investigate the financial reporting implications of the proposed agreement and I
would like to get your input.

STEP 1 – KNOWLEDGE/RESEARCH
(Theory/Research gathered – General Principles of the standards/Purpose of the standard)

What is the purpose of “wet leasing”?

A wet lease is typically utilized during peak traffic seasons or annual heavy maintenance checks, or to initiate new routes.
On-Time wants to introduce a new route (GEORGE / OR TAMBO), therefore the fifth aircraft might be useful in support of our
expansion strategy (Distance between OR Tambo to George is 1hour50minutes).

The purpose of a wet lease is typically driven by specific operational or business needs.
1. Capacity Expansion:
 Wet leasing allows airlines to quickly expand their operational capacity without the need to purchase additional
aircraft or hire and train additional crew members. This is particularly beneficial during peak travel seasons or
when there is a sudden increase in demand.
2. Operational Flexibility:
 Airlines may enter into wet lease agreements to gain flexibility in adjusting their fleet size based on varying
demand or seasonal fluctuations. It provides a more agile response to changing market conditions without
committing to long-term aircraft ownership.
3. Crew and Maintenance Inclusion:
 In a wet lease, the lessor not only provides the aircraft but also supplies the crew, maintenance services, and
insurance. This can be advantageous for the lessee as it reduces the burden of managing and training
additional staff.
4. Route Expansion or Testing:
 Airlines may use wet leases to test the viability of new routes or explore expansion into new markets without
making a long-term commitment. It allows them to assess demand before making significant investments.
5. Covering Aircraft Downtime:
 Airlines may opt for wet leases to cover periods when their own aircraft are undergoing maintenance, repairs,
or upgrades. This ensures continuity of service without disruptions.
6. Temporary Capacity Needs:
 Wet leases are often used for temporary or short-term capacity needs. Instead of investing in new aircraft for a
brief period, airlines can lease aircraft and crews for the specific duration required.
7. Operational Expertise:
 The lessor, being the provider of both aircraft and crew, brings its operational expertise to the lessee. This can
be beneficial for the lessee, especially if the lessor has experience in specific types of operations or in certain
regions.
IFRS 16 is triggered 

Identifying a lease:
Par 9 - At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. A contract is, or contains, a
lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

Identified Asset - An asset is typically identified by being explicitly specified in a contract. However, an asset can also be identified
by being implicitly specified at the time that the asset is made available for use by the customer.
Operating Lease - A lease that does not transfer substantially all the risks and rewards incidental to ownership of an
underlying asset.

Finance Lease - A lease that transfers substantially all the risks and rewards incidental to ownership of an
underlying asset.
STEP 2 – UNDERSTANDING THE ISSUE
(Context – Industry – How is the standard being applied)
(Context – Case Study – How we should be applying the standard)
What problem is the standard solving? /Why is the item accounted for under the standard?
Does it make sense to apply the cost model the entity is applying? Consider your industry research - any micro or macro issues
affecting entity for the applying the standard.
Based on IFRS 16 assessment, “wet leasing” meets the definition of a lease. However, it is important that we determine whether
the wet leasing is a finance lease or operating lease.

ASSESSMENT:

Classification – Operating Lease or Finance Lease

The lease contains the use of one Airbus 320 aircraft, as well as related goods and services to operate the envisaged flight route,
including: Pilots, Cabin Crew, Supporting equipment, Meals, Maintenance of aircraft in accordance with industry and legal
standards.

The lessee only provides fuel and covers airport fees (landing and parking fees, etc.). The aircraft is on the lessor’s
operators’ certificate and the lessor registers the aircraft with the South African Civil Aviation Authority.

B53 – The classification of leases for lessors in this Standard is based on the extent to which the lease transfers the
risks and rewards incidental to ownership of an underlying asset.
Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return
because of changing economic conditions. Rewards may be represented by the expectation of profitable operation
over the underlying asset’s economic life and of gain from appreciation in value or realisation of a residual value.

The lessor will be responsible for maintaining the asset and making sure that it is insured should there be anything technically
wrong with the aircraft. Also, the asset is registered with SACAA and is on the lessor’s operating certificate. = Risks lies with the
Lessor

The lessor will be entitled to monthly payments in arrears from leasing the asset to On-Time. = Rewards are transferred to the
Lessor

NB – Lease period is 18 months (this period does not give rise to a short-term lease = What Is a Short-Term Lease? A lease
agreement is typically considered short term if it is signed for a duration of six months or less.)

Seems like all risks and rewards are not transferred to the lessee but the lessor making this arrangement an OPERATING
LEASE.

STEP 3 APPLY
Do a practical example – get your hands dirty.
Look at the integrated report – How the competitor is applying the standard.
Overview – What is happening in South Africa (Refer to your industry research)?
Avoid being general, always answer the WHY?
Discuss why certain disclosures or measurements will not be applicable to the entity, is it because of its nature or size? (e.g.
discontinued operation disclosure – looks at the size of the entity)
OPERATNG LEASE

In the context of the case study

If the lease period was less than 12 months.

1. Operating Lease Accounting:

 Treat the wet lease as an operating lease. Operating leases are expensed over the lease term rather than
being capitalized on the balance sheet.
2. Lease Payments:
 Classify the lease payments as operating expenses on the income statement. These payments may include
fixed fees, variable fees based on usage, and any other relevant costs.

3. Financial Statement Presentation:

 Reflect the wet lease expenses on the income statement under appropriate expense categories, such as
"Aircraft Lease Expense" or similar. Provide a clear breakdown of fixed and variable costs if applicable.
4. Disclosure:
 Include relevant disclosures in the financial statements, such as details about the terms of the wet lease, the
nature of expenses incurred, and any significant obligations or commitments related to the lease.

If the lease period is greater than 12 months. (ON-TIME – lease agreement is 18 months)

For operating leases with a term greater than 12 months, lessees must show a right-of-use asset and a lease liability on their
balance sheets, initially recorded at the present value of the lease payments calculated the same way as required for finance
leases. On its income statement, the lessee does not record interest expense and amortization expense for the right-of-use asset
separately. Rather, the lessee must recognize a single lease expense (which includes both interest and amortization) allocated
over the lease term on a straight-line basis (or other rational and systematic basis if more representative of benefits received
from the leased asset). All cash payments must appear in the operations section of the lessee’s statement of cash flows.

The interest rate implicit in the lease is the rate of interest that causes the present value of the:
ƒ lease payments; and
ƒ the unguaranteed residual value (in respect of the lessor) to equal the sum of:
ƒ the fair value of the underlying asset; and
ƒ any initial direct costs of the lessor, for example legal costs and commissions in negotiating and arranging a lease.
Consequently, the interest rate implicit in the lease represents the required rate of return that the lessor excepts from the lease
contract. Both the guaranteed residual value (included per the definition of lease payments) and the unguaranteed residual
value are taken into account when calculating the interest rate implicit in the lease.

PRACTICAL EXAMPLE

N=3 PMT = R10 000 FV= R0 r=5% Compute PV = R27 233

 BALANCE SHEET

INCOME STATEMENT
In the context of the industry (Comair)

STEP 4 APPLY AND EVALUATE

What other standards does this standard trigger (Oher implications – e.g., tax)

LESSOR’S PERSPECTIVE – OPERATING LEASES

 CALCULATING THE INTEREST IMPLICIT RATE (LESSOR’S PERSPECTIVE)

FV = Unguaranteed Value + Guaranteed Value > - R 55 000

PMT = Annual payment > - R75 760
N=5
PV (Fair Value) = R280 000 + Initial direct cost incurred by the lessor
Compute r = 15,182% (this will be used to determine the operating lease – right of use assets)

TAX IMPLICATIONS – OPERATING LEASES

REFER TO DOCUMENT 6 => OPERATING LEASES INCOME TAX IMPLICATIONS

STEP 5: WHAT IF?

Do I have enough information to cover all audiences – auditors, board of directors, audit committee and CEO/CFO?

FINANCIAL MANAGEMENT (STRATEGY)

Qualitative and Quantitative Factors to consider when acquiring the additional aircraft

When an airline considers acquiring an additional aircraft, various qualitative factors come into play to assess the impact on its
operations, financial health, and strategic position. Here are some key qualitative factors the airline industry needs to consider:
1. Market Demand and Growth:
  Evaluate current and projected market demand for air travel. Consider factors such as economic conditions,
population growth, and trends in passenger preferences. An additional aircraft should align with the anticipated
growth in the industry. (GEORGE/OR TAMBO NEW ROUTE = 85% DEMAND)
2. Route Network and Expansion Strategy:
 Assess how the new aircraft fits into the airline's route network and expansion strategy. Consider if it allows the
airline to enter new markets, improve existing routes, or enhance overall connectivity.
3. Operational Efficiency:
 Evaluate the aircraft's fuel efficiency, maintenance requirements, and overall operational performance.
Newer, more fuel-efficient aircraft may contribute to cost savings and environmental sustainability (Climate change).
4. Competitive Landscape:
 Analyze the competitive landscape to understand how the additional aircraft enhances the airline's
competitiveness. Consider the types of aircraft used by competitors, their service offerings, and any potential
competitive advantages gained.
5. Fleet Compatibility:
 Consider how the new aircraft integrates with the existing fleet. Commonality in fleet types can lead to
operational efficiencies in terms of maintenance, crew training, and spare parts management.
6. Customer Experience and Brand Image:
 Evaluate how the additional aircraft contributes to the overall customer experience. Modern and comfortable
aircraft can enhance the airline's brand image and customer satisfaction.
7. Regulatory Compliance:
 Ensure that the new aircraft complies with regulatory requirements and standards. Consider any certifications
needed for specific routes or international operations.
8. Financial Viability:
 Assess the financial viability of acquiring and operating the additional aircraft. Consider the initial acquisition
cost, financing options, and the long-term impact on the airline's financial performance.
9. Leasing vs. Purchasing:
 Evaluate whether to lease or purchase the aircraft. Consider the financial implications, flexibility, and risk
associated with each option.
10. Environmental and Sustainability Considerations:
 Consider the environmental impact of the new aircraft. Evaluate fuel efficiency, emissions, and the airline's
commitment to sustainability, which can be important for both regulatory compliance and public perception.
11. Supply Chain and Manufacturer Relationships:
 Assess the relationship with aircraft manufacturers and the availability of spare parts. A good relationship with
the manufacturer can contribute to timely maintenance and support.
12. Political and Geopolitical Factors:
 Consider any political or geopolitical factors that may impact the airline industry, such as trade agreements,
regulatory changes, or international relations affecting air travel.

WET LEASING vs DRY LEASING

The choice between wet leasing and dry leasing depends on the specific needs, operational preferences, and strategic objectives
of the airline. Both arrangements offer distinct advantages and considerations, and the decision often involves a trade-off between
control and operational simplicity.

1. Definition:
 Wet Lease:
 In a wet lease, the lessor provides the aircraft along with the necessary crew, maintenance, and insurance. The
lessee essentially rents both the aircraft and the operational services.
  Dry Lease:
 In a dry lease, the lessor provides only the aircraft without crew, maintenance, or insurance. The lessee is
responsible for operating and maintaining the aircraft.
2. Crew and Maintenance:
 Wet Lease:
 The lessor provides a complete package, including a qualified crew, maintenance services, and insurance. The
lessee has fewer operational responsibilities.
 Dry Lease:
 The lessee is responsible for providing and managing the crew, arranging for maintenance, and securing
insurance. This gives the lessee more control over operations.
3. Operational Control:
 Wet Lease:
 The lessor retains significant operational control as it provides both the aircraft and the operational services. The
lessee has limited control over crew and maintenance decisions.
 Dry Lease:
 The lessee has greater operational control, making decisions about crew selection, maintenance schedules, and
operational procedures.
4. Flexibility:
 Wet Lease:
 Provides flexibility for the lessee in terms of quickly adding capacity without the need for hiring additional staff or
managing maintenance. Well-suited for short-term or seasonal needs.
 Dry Lease:
 Offers flexibility for the lessee to tailor crew selection, maintenance practices, and operational procedures
according to its specific requirements. Typically involves a longer-term commitment.
5. Cost Structure:
 Wet Lease:
 Generally, the cost structure is more straightforward as it includes a bundled fee covering the aircraft, crew,
maintenance, and insurance.
 Dry Lease:
 The lessee incurs separate costs for crew, maintenance, and insurance, allowing for more transparency in cost
breakdown.
6. Risk and Responsibility:
 Wet Lease:
 The lessor bears the responsibility for crew training, maintenance, and insurance, transferring operational risk to
the lessor.
 Dry Lease:
 The lessee assumes more operational risk and responsibility, including crew training, maintenance planning,
and insurance coverage.
7. Duration:
 Wet Lease:
 Often used for short-term or temporary capacity needs, and agreements can be more easily terminated or
renewed.
 Dry Lease:
 Typically involves longer-term commitments and is more suitable for lessees with stable and consistent
operational needs.

WET LEASING vs TAKING UP A LOAN TO ACQUIRE THE AIRCRAFT

Wet Leasing:
1. Operational Flexibility:
  Wet leasing provides immediate access to additional aircraft and operational services without the need for a
significant upfront investment. This flexibility is beneficial for short-term or seasonal capacity needs.
2. Reduced Operational Responsibility:
 The lessor in a wet lease arrangement is responsible for providing the aircraft, crew, maintenance, and
insurance. This reduces the lessee's operational responsibilities and allows them to focus on other aspects of
their business.
3. Cost Structure and Transparency:
 Wet leasing often involves a bundled fee that covers the aircraft, crew, maintenance, and insurance. This can
provide a clear and predictable cost structure, simplifying budgeting and financial planning.
4. Testing New Markets:
 Airlines can use wet leasing to test the viability of new routes or markets without making a long-term
commitment. It allows for exploration without the financial risk associated with aircraft ownership.
Considerations:
 Wet leasing may be more cost-effective for short-term needs, but the long-term costs can accumulate.
 The lessee has less control over crew selection, maintenance schedules, and other operational aspects.

Taking a Loan:
1. Ownership and Asset Appreciation:
 Taking a loan allows the airline to own the aircraft, and the asset may appreciate over time. This can contribute
to the airline's balance sheet and long-term financial stability.
2. Operational Control:
 Aircraft ownership provides the airline with full operational control, allowing for flexibility in crew selection,
maintenance practices, and operational procedures.
3. Long-Term Cost Efficiency:
 While the upfront costs may be higher, owning an aircraft can be more cost-effective in the long run. The airline
avoids continuous lease payments and may benefit from lower operating costs over time.
4. Tailored Fleet:
 Aircraft ownership enables the airline to tailor its fleet to specific operational requirements, leading to potential
efficiencies and competitive advantages.
Considerations:
 Aircraft ownership involves significant upfront costs, including the purchase price, maintenance reserves, and insurance.
 The airline bears the responsibility for crew training, maintenance, and other operational aspects.
Choosing Between the Options:
 Consider the duration of the aircraft need. If it's short-term, wet leasing may be more suitable. For long-term needs and
strategic goals, ownership through a loan may be preferable.
 Evaluate the financial health of the airline and its ability to secure financing for ownership.
 Assess the impact on the airline's balance sheet and financial leverage.
BRIEF OVERVIEW
NET PRESENT VALUE
(DECIDE WHETHER TO ACQUIRE THE AIRCRAFT FIRST BEFORE YOU DECIDE ON FINANCING OPTIONS)

1. ACQUIRING THE AIRCRAFT (NPV) – ACQUISITION COST R10 000 000

2. FINANCE OPTIONS (NPV)

PURCHASING AN AIRCRAFT (VIA A LOAN) – MIGHT HAVE TO INCLUDE ADDITIONAL OPERATING COSTS

Tax deductible on the interest paid => not the capital portion of R4 163.49
LEASING THE AIRCRAFT