G2. Leases

AP Accounting principles

When an agreement is entered into, the company must first consider whether the contract is or contains a lease. A contract is or contains a lease if:

• it contains an identified asset
• the lessee is entitled to essentially all economic benefits arising from the use of the identified asset
• the lessee is entitled to control the use of the asset

If any of the above conditions are not met, the contract is not regarded as a lease or containing a lease and is therefore classified as a service contract.

On the commencement date of the lease, meaning when the asset becomes available for use by Essity, a right-of-use asset and a financial liability are recognized in the balance sheet.

The right-of-use asset is measured at cost and includes the following:

• the value of the amount of the lease liability
• lease payments made on or before the commencement date, after deductions for any benefits received in conjunction with signing the lease.
• initial direct fees
• an estimate of expenses expected to be paid to restore the asset to the condition as stipulated in the terms of the lease

The right-of-use asset is recognized in the balance sheet under the heading Property, plant and equipment within the category non-current assets and is depreciated on a straight-line basis over the shorter period of the asset’s anticipated useful life and the lease term. The useful life is assessed on the basis of the length of the underlying contract taking into consideration the cancellation and renewal options.

The lease liability is measured at the present value of the following lease payments:

• fixed fees, less any incentive receivables
• variable lease payments due to an index or rate
• amounts expected to be paid in accordance with residual value guarantees
• the exercise price for a purchase option, if the lessee is reasonably certain of exercising the option
• financial penalties to be paid on termination of the lease, if the lease term reflects that the lessee will utilize this option.

Lease payments are normally discounted using Essity’s incremental borrowing rate as the implicit rate of the lease cannot be readily determined in most cases. The incremental borrowing rate used is determined on the basis of the contract currency of the agreement and the length of the lease.

The lease liability is recognized in the balance sheet under the heading Non-current financial liabilities as well as Current financial liabilities. Lease liabilities are measured at amortized cost according to the effective interest method. The liability is remeasured when future payments are amended by index or by other means, such as a new assessment of future residual value commitments, or the exercise of purchase, renewal or cancellation options. When the lease liability is remeasured as described above, a corresponding adjustment of the value of the right-of-use asset is made. When making lease payments, the contribution is allocated between interest expense and amortization of the lease liability outstanding. In the consolidated cash flow statement, payments pertaining to the amortization of lease liability are recognized in financing activities and payments pertaining to interest expenses are recognized as interest paid. In profit or loss, depreciation of the right-of-use asset is recognized in operating profit while interest expense is recognized in financial expenses.

Essity has decided to apply the exemption rules for short-term leases and leases where the underlying asset has a low value. These leases are not included in the right-of-use asset or the liability. Lease payments for these contracts are expensed on a straight-line basis over the useful life. For 2018 and 2017, IAS 17 Leases was applied as operating lease payments were expensed.

KAA Key assessments and assumptions

Assessments and assumptions must be used when reporting leases in accordance with IFRS 16 Leases. The two most significant are assessments concerning the length of the lease and the discount rate to be used. The implicit rate of the leases cannot be readily determined and lease payments are therefore discounted over the expected lease term using Essity’s incremental borrowing rate. The incremental borrowing rate corresponds to what Essity would need to pay to use a loan to finance the purchase of an equivalent asset for a similar duration in the contract currency of the lease. The length of the lease is determined as the non-cancellable lease term together with terms that may be covered by an option to extend a lease if it is reasonably certain that the contract will be renewed and periods covered by an option to terminate the lease if it is reasonably certain that a possibility to cancel the lease will not be utilized. When assessing if it is reasonably certain that a renewal option or cancellation option will be used, all relevant facts and circumstances that create economic incentives or deterrents are taken into account. The assessment of the lease term is reviewed in cases where facts and circumstances have significantly changed.

Essity enters into leases on a continuous basis for office buildings, distribution centers and vehicles, such as trucks, forklifts and passenger cars.

Lease terms for properties are generally between 3 and 15 years, while lease terms for vehicles are generally between 3 and 5 years. Essity also has leases with a shorter lease term than 12 months and leases pertaining to assets of low value, such as office equipment. For these, Essity has chosen to apply the exemption rules in IFRS 16 Leases, meaning the value of these contracts is not part of the right-of-use asset or lease liability. There are no significant extension periods not taken into account in the lease liability.

In addition to the expenses in the table above, Essity recognized SEK 255m relating to costs for short-term leases, leases of low-value assets and variable lease payments. The total earnings impact of leases, including depreciation and interest expenses, was SEK 1,249m in 2019. Lease payments totaled SEK 1,203m.

The maturity structure concerning undiscounted future lease payments during future lease terms is presented in Note E5 Liquidity risk.

Essity has entered into binding leases regarding office properties where the lease term has yet to begin, future lease payments for these contracts are SEK 174m distributed over 10 years.