42. Leases

The Group acts as a lessor in lease agreements relating to vehicles, buildings, including office space, and machinery and equipment. The Group conducts lease activities through the entities from the PKO Leasing SA Group and KREDOBANK SA.

The Group as a lessor classifies leases as operating or finance leases.

A lease agreement is classified as an operating lease if substantially all risks and benefits from owning the underlying assets are not transferred. In such an instance the Group records lease payments as income on a straight-line basis.

A lease agreement is classified as a finance lease if substantially all risks and benefits from owning the underlying assets are transferred. The Group classifies agreements as finance leases where at least one or all of the following conditions have been met:

• the lease transfers ownership of the underlying asset to the lessee by the end of the lease term;
• the lessee has the option to purchase the underlying asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception date, that the option will be exercised;
• the lease term is for the major part of the economic life of the underlying asset even if title is not transferred;
• at the inception date, the present value of the lease payments amounts to at least substantially all of the fair value of the underlying asset (in a sublease it is the value of the right-of-use asset arising from the master lease agreement); and
• the underlying asset is of such a specialized nature that only the lessee can use it without major modifications.

At the inception of a lease, the Group as a lessor in a finance lease presents receivables in an amount equal to the net investment in the lease, i.e. gross investment in the lease discounted with the interest rate implicit in the lease.

Gross investment in the lease is the sum of:

• lease payments receivable by a lessor under a finance lease; and  any unguaranteed residual value accruing to the lessor.

Interest rate implicit in the lease applied by the Group is the rate of interest that causes the present value of the lease payments and the unguaranteed residual value to equal the sum of the fair value of the underlying asset and any initial direct costs of the Group.

Lease agreements or agreements containing a lease according to the Group’s classification include agreements under which the Group:

• obtains the right of use of the identified asset and the supplier’s ability to substitute an alternative asset is not significant; and
• has the right to obtain substantially all economic benefits from the right of use over the period of use; and             has the right to direct the use of the identified asset over the period of use, when:
• the Group has the right to direct how and for what purpose the asset is used throughout the period of use; or  the relevant decisions about how and for what purpose the asset is used are predetermined.

The Group applies exceptions and does not recognize right-of-use assets and liabilities with respect to:

• short-term leases, which include agreements without an option to buy an asset, concluded for a period not exceeding 12 months from the inception date, in particular agreements concluded for an indefinite period with a short (up to 12 months) notice period, without significant penalties, which include in particular leasehold improvements incurred and relocation costs;
• low-value leases (an asset’s value is lower than PLN 20 000, determined based on the value of a new asset, regardless of the age of the leased asset), excluding agreements for rental of space.

The Group initially measures lease liabilities at the present value of the lease payments outstanding as at that date.

The amount of the lease liability is affected by:

• fixed payments less any lease incentives payable;
• variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date;
• any residual guarantees expected from the lessee;
• the exercise price of a purchase option if the probability that the lessee would exercise that option is higher than 50%;
• payments of penalties for terminating the lease, if the lease agreement contains an option for the Group to terminate the lease as a lessee.

The Group does not classify variable fees that depend on external factors as lease payments.

After initial recognition the Group’s lease liabilities are measured at amortized cost.

The Group records revaluation of lease liabilities as an adjustment to the right-of-use asset. If as a result of remeasurement the carrying amount of the right-of-use asset is reduced to zero and the lease liability is further reduced, the Group recognizes the remaining amount of the remeasurement as a profit or loss.

The Group initially measures the right-of-use assets at cost, which comprises:

• the amount of the initial measurement of the lease liability;
• any lease payments made at or before the commencement date, less any lease incentives received;  any initial direct costs incurred by the Group.

The Group subsequently measures the right-of-use asset at cost less accumulated depreciation (depreciation calculated under the straight-line method) and accumulated impairment losses, adjusted for any remeasurement of the lease liability.

To discount future lease payments, the Group applies discount rates that:

• have been calculated based on yield curves reflecting the cost of financing in a given currency;
• cover the tenor of the longest lease contract subject to measurement and reflecting – for a given currency – a fixed market interest rate and the Group’s cost of financing (the tenors of the lease agreements are within the range from 1 to 99 years);
• have been read from the curve for maturity corresponding to a half of the maturity of the lease agreement.

The Group performs quarterly updates of the incremental borrowing rate for lease agreements.

The Group applies the same discount rates for the portfolio of car leases and property leases, including rights to perpetual usufruct of land, taking into account the impact of the lease security on the discount rate applied.

The Group recognizes the lease payments relating to short-term or low-value leases as cost using the straight-line method, over the term of the lease. The differences between the amounts paid and those arising from the straight-line recognition of the costs are recorded as prepayments or accruals.

The implementation of the standard resulted in the Group recognizing lease liabilities presented in the Note “Other Liabilities” of PLN 956 million at the present value of future lease payments which are to be paid up to the start of the application of IFRS 16 and which consist of fixed and variable lease payments, depending on market indicators.

The amount of the liabilities were adjusted by costs paid in advance of PLN 4 million as at 1 January 2019 (disclosed in “Other assets”).

As at 1 January 2019 the Group recognized right-of-use assets of PLN 960 million, which include the amount of the initial valuation of the lease liability of PLN 956 million and lease payments of PLN 4 million paid in advance.

Furthermore, in connection with the implementation, the Group classified the right of perpetual usufruct of land as a lease contract. Consequently, the Group wrote down the right of perpetual usufruct of land disclosed in the accounting ledgers as at 31 December 2018, charging PLN 111 million to undistributed profit.

The implementation of IFRS 16 required the Group to adopt the following significant estimates affecting the measurement of lease liabilities and right-of-use assets:

Establishing the term of the lease for contracts concluded indefinitely

In the case of contracts concluded indefinitely regarding the Bank branches, the Group accepted a lease term which is consistent with the period of depreciation of non-depreciated investments made in these properties as at the date of transition and, in the absence of such investments, a 4-year term, taking into account any significant costs related to a change of location of the branches during their operation. The total impact of the extension of the term of the lease on the value of the liability in excess of the irrevocable term of the lease (contractual notice period) amounted to PLN 227 million.

Determining the interest rate used to discount future cash flows

The discount rates used by the Group to discount future lease payments (incremental borrowing rates) were within the range from 2.06% to 8.68% for PLN, from 0.6% to 4.0% for EUR, from 3.8% to 4.0% for USD and 18% for UAH, and were calculated on the basis of curves reflecting the cost of financing in the given currency, encompassing the tenor of the longest lease agreement which is to be measured. The tenors of lease contracts lie within a range of 1 to 99 years. The discount rates adopted for the purpose of the estimate were rates for maturity corresponding to one-half of the maturity of the lease agreement.

The total impact of the discount factor from the application of the above rates to the present value of lease liabilities was PLN 410 million.

The increase in assets arising from recognizing right-of-use assets under lease contracts resulted in an increase in capital requirements of PLN 78 million as at 1 January 2019. Furthermore, in view of the write-down of the right of perpetual usufruct of land of PLN 111 million, the Group’s own funds will decline by the same amount. This has contributed to a reduction in the Tier 1 capital ratio by approx. 14 bp and the total capital ratio by approx. 15 bp.

Reconciliation of the difference between the amounts of future lease charges from irrecoverable operating leases disclosed in accordance with IAS 17 as at 31 December 2018, and the lease liabilities recognized as at 1 January 2019 in accordance with IFRS 16 is shown in the table below:

The impact of the implementation of IFRS 16 on the recognition of additional financial liabilities and the corresponding right-of-use of assets is shown below:

As a result of implementing IFRS 16, in 2019, administrative expenses were not charged with net lease instalments of PLN 221 million. The costs of lease instalments in the amount of PLN 206 million were allocated to depreciation and PLN 26 million was allocated to interest expense.