Changes in the Leasing Standard
Discuss About The Disclosure Economic Of Benefits Operating?
The accounting function has the key role in the effective operation of the company. The accounting is done by following the accounting standard of the company. These accounting standards are prepared and developed by the standard setting bodies. There are two major bodies which prepared the same – IASB and FASB. The report has been started with the introduction to the changes in the accounting standard relating to leases. For the purpose of the report the company – Health Scope Limited has been selected and the audited financial statement along with the company’s statutory reports for the financial year ending 30th of June 2017 has been considered. The reference has been made to the position and the performance of the company in financial terms in connection with the changes in the accounting standard leases. At first the benefit or the losses that the company will have from the changes has been discussed and thereafter the effects in the financial statements have been detailed. In third section it has been discussed whether the new reporting practices will be considered as more useful for the users of the financial statements of the company. Before concluding the report, the understanding has been made to the chief executive officer of the company.;
The new leasing standard will be effective from the first of January of two thousand and nineteen. As every company operating in different industries will be using the plant and machinery or the buildings on the leases and hence will be affected by the changes in the accounting standard on leases.
The earlier accounting standard on leases has become irrelevant for the users of the financial statements to take the decision. It is because the accounting treatment made by the companies in the financial statements of the lessor and the lessee does not facilitate the true and fair presentation of the financial position and performance of the company. It has been mentioned in the journals of the big auditing and accounting firms that the old standard has become vague as the accounting treatment is done in confusion and does not facilitate the comparison of the position and performance of the company with the different companies in the same industry or across the globe. Thus, in order to facilitate the comparison and understandability changes have been made in accounting standards (FASB, 2016).
Why Leasing Standard Has Been Changed
The accounting treatment and the presentation in the financial statements have been changed. The accounting treatment on the part of the lessor will remain unchanged; the major effect will be on the lessee only. The lessor will now also be required to differentiate the leases into operating and financial lease and the lessee is now not required to make the necessary bifurcation of the leases (Day and Stuart,2013).
The stakeholder that is chosen for the purpose of the study is the Health Scope Limited and it operates under the GICS - industry sector Health care. It means a lot for the chosen company as the company is the lessee in all the cases and is listed company and will have to record the effect of the changes made in the accounting standard. The company has made the note in the financial statements regarding the applicability of the relevant accounting standard (Singer, 2013).
The company has the benefit in the sense that the company’s financial statements will present more in a defined manner and in a faithful manner. Another advantage is that the company is not required to differentiate the leases into operating and financial lease rather they are required to record the leases as the actual assets and claim the depreciation accordingly as in case of the intangible assets. Secondly the company has the advantage of treating the lease payments as the liability and setting off the principal portion from the loan and charging the balance excess payment to the profit and loss account as the interest on lease (Lim, Mann and Mihov,2014).
The main disadvantage that the company will have the increased compliance with the provisions of the accounting standard as the lease asset and liability both are required to be created. Second disadvantage is the increase in the cost of compliance with the relevant procedure and provisions (Gross and Huston, 2014).
The changes in the accounting standard of the leases will have the material impact on the financial position and the financial performance of the company. The company has in the Note number 2 of the annual report have mentioned that company is unable to identify the exact effect of the changes in the current year financial statements and hence the effect has not been disclosed and has not been taken into the consideration (Ely, 2015).
The changes in the accounting standard will not only affect the financial position and financial performance of the company but also the cash flow statement of the company. Following will be the effect with the changes in the accounting standard:
What Will Change
Income Statement – In the earlier standard, only the lease rentals are required to be disclosed in the statement of profit and loss account as operating Expense. But as per the changes made in the new accounting standard, three heads of expenditure will be there (Arrozio, 2016). First is the operating expense which includes the service fee, second will be the expenditure of depreciation on the leased assets and third will be interest on the lease rentals that will be disclosed in the statement of the profit and loss. The expenditure will be high as per the new accounting standard and hence the profit will be low in the new accounting standard and will be high in the old accounting standard (Ma, 2010).
- In the earlier no assets or liabilities are recognized but as per the new changes these are required to be recognized.
- The changes have focused on the model based on the right of use rather than the model on the basis of the risk and rewards which is specified in earlier standard. The company will be required to record the asset and record the liability at the date when the lease is started (Moore and Nagy, 2013).
- The liabilities which are related to the leases will be measured on the basis of the lease term. It includes the lease which is optional in which the lease term may be extended and which cannot be terminated.
- The lease rental if any occurs because of some contingency or some significant event or due to the difference between the index rate then the same shall be added in the value of the assets and liabilities (Knubley, 2010).
- Cash Flow from operating activities has been decreased.
The detail of the ratios has been given in the Appendix 2 and the relevant section of the leases in the financial statement of the company has been mentioned in Appendix 1. The ratios that might be affected is the capital gearing ratios, current ratio, EBIT, Net Income and Earnings per share. The effect will be like capital gearing ratio will increase (Company Official Website, 2017).
The overall evaluation of the accounting standard number 16 is that the users of the financial statements will have the more detailed and exhaustive information about the working of the company. The users can have the comparison at uniform level and will be able to take the informed decision (Singh, 2011).
The new accounting standard will provide the more detailed information about how much is the leased assets and how much is the related liabilities. The financial statements will provide the true and fair view with faithful representation as the company will now charge the depreciation on the leased assets for the loss of wear and use.
In order to conclude the study, the new accounting standard will facilitate the accountability, comparability and the better analysis of the financial position and the financial performance of the company. The company – Health Scope Limited will have the positive impacts of the changes in the accounting standard.
Arrozio, M.M, (2016). “Changes in the financial ratios of the wholesale and retail sector companies arising from the new accounting of the operating lease”. Revista Eniac Pesquisa, 5(2), pp.139-159.
Company Official Website, (2017), “Annual Report 2017” available at www.healthscope.com.au/ accessed on21/09/2017.
Day, R. and Stuart, R., (2013), “New lease accounting proposal: what it means and what companies can do to prepare.” Financial Executive, 29(6), pp.11-13.
FASB, (2016), “New Guidance on Lease Accounting” available at https://www.fasb.org/jsp/FASB/FASBContent_C/NewsPage&cid=1176167901466 accessed on 21/09/2017.
Ely, K.M., (2015), “Operating lease accounting and the market's assessment of equity risk”. Journal of Accounting Research, pp.397-415
Gross, A.D., Huston, G.R. and Huston, J.M., (2014). “The path of lease resistance: How changes to lease accounting treatment may impact your business”. Business Horizons, 57(6), pp.759-765.
Knubley, R., (2010). Proposed changes to lease accounting. Journal of Property Investment & Finance, 28(5), pp.322-327
Lim, S.C., Mann, S.C. and Mihov, V.T., (2014),
“Market Recognition of the Accounting Disclosure and Economic Benefits of Operating Leases: Evidence from Borrowing Costs and Credit Ratings”.
Ma W, (2011), “Impact on Financial Statements of New Accounting model for leases” available at https://digitalcommons.uconn.edu/cgi/viewcontent.cgi?article=1194&context=srhonors_theses accessed on 21/09/2017
Moore, S. and Nagy, A., (2013), “CONTRACT STRUCTURING UNDER THE NEW LEASE ACCOUNTING RULES: THE CASE OF CUSTOM DESIGN RETAIL, INC.” Global Perspectives on Accounting Education, 10, p.81
Singer, R, ( 2017), “Accountinq for Leases Under the New Standard, Part 1: Definition and Classification of Leases and Lessee Accounting”. CPA Journal, 87(8).
Singh, A.,( 2011). A restaurant case study of lease accounting impacts of proposed changes in lease accounting rules. International Journal of Contemporary Hospitality Management, 23(6), pp.820-839.
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