Critical Discussion Of Practical Implications

Introduction

The IASB (International Accounting Standards Board) hold the responsibility of developing accounting standards and conventions that business entities need to follow for developing financial reports. The IASB has developed a new accounting standard of IFRS 16 for ‘leases’ that business entities around the world need to follow for reporting their operating and finance leases on the balance sheet. The IASB has also directed AASB (Australian Accounting Standards Board) to adopt the use of new accounting standards for leases by developing AASB 16 that will replace previous AASB 117 standards for leases from the year 2019. There has been development of exposure drafts by the FASB (Financial Accounting Standards Board) and IASB for gaining feedback from the stakeholders regarding the proposed new accounting standard. In this context, the present essay critically discusses the practical implications of new accounting standards has considered the fundamental characteristics of the financial information stated in the AASB framework. This has been done through analyzing the discussion presented in the article developed by Churynk, Reinstein and Lander (Churyk, Reinstein and Lander, 2015).

Critical Discussion of Practical Implications of New Leases Standards as per Fundamental Characteristics of AASB Framework

Two fundamental characteristics of financial information stated in the AASB’s Framework for Preparation and Presentation of Financial Statements

The AASB framework for the preparation and presentation of financial statements has presented the conceptual framework of financial reporting used by business entities in Australia for developing financial reports. The qualitative characteristics of useful financial information as stated in the AASB framework are relevance and faithful presentation. The financial information is said to be relevant if it can make a difference in the decision-making of the users such as investors and creditor. The financial information in order to be relevant should have a predictive and confirmatory value. The predictive value of a financial information means that it should be able to predict the future financial growth of an entity (Freeman and Freeman, 2015). On the other hand, confirmatory value of the financial information should be able to provide feedback about an entity past and present financial results. The faithful representation of the financial information should be able to represent the economic phenomena through providing complete, neutral and error-free information. The financial information should be able to provide complete knowledge regarding the financial phenomena through providing all the necessary descriptions and explanations (Framework for the Preparation and Presentation of Financial Statements, 2016).

Impact of Compliance with the new standard for leases, i.e. AASB 16 Leases on lease accounting and reporting and business metrics by the lessee and lessor as discussed in Churyk, Reinstein and Lander (2015), i.e. practical implications

The main objective of the IASB behind the development of new standards for leases is to eliminate the differences that exist between operating and finance leases and to report them on the financial statements through the use of similar accounting conventions. The new standards for leases have eliminated the difference between the operating and finance leases and have directed the business entities to use only a single lessee accounting model for recognition of leases. This applies to all leases having time-period of more than 12 months (IASB issues new leasing standard, 2016). The article ‘Leasing: reducing the game of hiding risk’ presented by Churyk, Reinstein and Lander has discussed the implications of the FASB and IASB on leases standards. The article has presented the concerns regarding the new leases standards that can result in increasing the complexity of recording leasing transactions in the balance sheet. As per the article, the FASB and IASB have proposed to introduce new lease standards for overcoming the problem of not recording many lease obligations on the balance sheet. As such, the use of the new proposed standards can result in complete disclosure of the economics of the lease transactions as per the qualitative characteristic of faithful presentation of financial information. The article has also presented the discussion regarding the use of similar accounting methods for recording lease transactions as proposed in 2010 exposure draft in the year 2012. The IASB have directed the business entities to report some lease obligations through the use of straight-line basis method while others through the use of amortization basis. As such, the recognition of leases by business corporations would require the use of separate accounting conventions after they have been initially recorded through the use of same accounting methods. The subsequent measurement often develops differences that would require adjustment in the financial statements afterwards. The standard would require significant quantitative and qualitative disclosures about the lessees and lessors in the financial statements. As such, it can be said that new leases standards often increases the complexity of recording lease transactions for business entities (Churyk, Reinstein and Lander, 2015).

Explanation of affect of Compliance with AASB 16 requirements identified in Part (2) on the reporting of lease information that satisfies two fundamental characteristics specified in the Framework

As per the qualitative characteristics of relevancy and faithful representation, the new leases standard has increased the disclosure requirement of leases in the financial statements. The business entities are also required to report the operating leases in the balance sheet under the new accounting standard of AASB 16. Thus, the business entities are required to adopt proper classification criteria for determining the type of leases and therefore causing major changes in the financial reporting structure of business entities. The recognition of a particular contract under a lease or a service is very critical as it determines the identification of the related assets and liabilities (Albert, 2016). Thus, it can be said that business entities need to implement major changes in their financial reporting system for complying with the new accounting standards for leases. The increased disclosure requirement would help in providing relevant and complete information about the leases to the end-users of a business entity (Dagwell, Wines and Lambert, 2015).

The article has also stated that many financial users, developers and auditors are in support of retaining the present leasing standard. This is because the new leases standard would increases the asset and liabilities of a business entity resulting in causing changes in their financial ratios (Singer, 2017).  As such, the article has emphasized that whether there is need for adopting new standards or only there is a need for proper implementation of the existing standards. The article has presented that there will be improvement in the gross margin, cash flow and EBIT of business entities with the adoption of new standards but interest coverage and return on assets will be lower. The business entities that incorporate the use of operating leases to a large extent such as banking, telecommunication and retail will be largely impacted by the new accounting standards (Churyk, Reinstein and Lander, 2015).

The practical implications of the new accounting standards discussed in the article have also considered the qualitative characteristics of the financial information. As per the article, the new standards will help in meeting the relevance characteristics of the financial information by only provide relevant information relating to leases and excluding other such information such as variable lease payments from measurement of leased assets and liabilities. Also, the financial information would be faithfully presented through the use of new accounting standards for leases. This will be because the new rules will increase the presentation of key financial metrics of a business entity that are used to present its financial valuation to the end-users. The inclusion of operating leases also on the balance sheet would help in providing the end-users complete financial information about the operating leases that is not required to be reported under the existing leases accounting standards. The lease transactions would be represented completely without any hiding of materialistic facts about leases under the proposed accounting standards (Churyk, Reinstein and Lander, 2015).

The practical implications discussed in the article have only considered the qualitative characteristics of financial information presented in the AASB framework to only a little extent. The practical implications mainly relate to the impact of new standard on the credit worthiness of business entities. The implications have discussed the improvement in some of the financial metrics while the lower returns provided by some of the financial measures under the new standards (Australian Accounting Standards Board, 2017). The practical change in the financial reporting system of some of the industries that mainly uses operating leases is also discussed in the practical implications section of the article. Thus, the discussion held in the article mainly relates to highlighting the problems in the adoption of the new accounting standards for leases by business entities. The author in the article have mainly emphasized on the increasing complexities that will result from the implementation of the new standard for business entities. It has not adequately considered whether the new leases standards are in accordance with the qualitative characteristics of the financial information. The article recommends upgrading the existing accounting standard for leases rather than implementing the new standards for leases. It has not placed any importance on whether the new accounting standards are in accordance of the qualitative characteristics of the financial information (Churyk, Reinstein and Lander, 2015).

Conclusion

Thus, the new accounting standard for leases of AASB 16 as discussed in the article would increase the financial disclosure requirement for leases in the financial reports of business entities. Thus, the article has proposed that old standard should be modified rather then adoption of new accounting standards for leases. The practical implications mentioned in the article on the proposed standards for leases have not adequately considered the fundamental characteristics of financial information.

References

Albert, A. 2016. Top 5 biggest changes with the new lease accounting standard (asc 842). [Online]. Available at: https://www.gaapdynamics.com/insights/blog/2016/08/16/top-5-biggest-changes-with-the-new-lease-accounting-standard-(asc-842)/ [Accessed on: 27 October 2017].

Australian Accounting Standards Board. 2017. [Online]. Available at: https://www.aasb.gov.au/Pronouncements/Current-standards.aspx  [Accessed on: 27 October 2017].

Churyk N. T., Reinstein A. and Lander G. H.  2015. Leasing: reducing the game of hiding risk. Journal of Accounting and Organizational Change 11(2), pp.162-174.

Framework for the Preparation and Presentation of Financial Statements. 2016. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/Framework_07-04_COMPjun14_07-14.pdf [Accessed on: 27 October 2017].

IASB issues new leasing standard. 2016. [Online]. Available at: https://www.iasplus.com/en/news/2016/01/ifrs-16 [Accessed on: 27 October 2017].

Singer, R. 2017. Accounting for Leases Under the New Standard, Part 1. [Online]. Available at: https://www.cpajournal.com/2017/08/23/accounting-leases-new-standard-part-1/ [Accessed on: 27 October 2017].

Dagwell, R., Wines, G. and Lambert, C. 2015. Corporate Accounting in Australia. Pearson Higher Education AU.

Freeman, S. and Freeman, J. 2015. Financial Accounting: A Practical Approach. Pearson Higher Education AU.