Discuss about the Financial Reporting for Australian Accounting Standards.
This particular report attempts to evaluate and comment on the information regarding leases provided in the Freedom Foods Group Limited (FNP) annual reports. Freedom Foods Group Limited is considered to be a differentiated food corporation operational in the Wellness and Health sector in a variety of brands encompasses freedom foodstuffs based in Australia (Ji, and Deegan, 2011). The business was formed in 1991 to offer diverse products to its customers. The new IFRS 16 brings most leases on statement of financial position for lessees in a single standard, abolishing the difference between finance and operating leases.
Under AABS 16 – Leases, the lessee will be obliged to recognize liabilities and assets for contracts with conditions of more than twelve months and also requires that both forms of a lease be realized on the balance sheet (Annan, 2014). Generally, the new IFRS 16 requirements abolish almost all off-balance sheet lessees accounting and re-define many frequently used financial metrics like EBITDA and leverage ratio. This aspect will basically rise comparability but may also impact agreements, cost of borrowing, credit rating and the company shareholders perceptions (Annual Report note 16, AASB 101.26).
AASB 16 basically presents a single lessee model of accounting and obliges a lessee to realize liabilities and properties for all leases with a period of more than twelve months except the fundamental property is of low cost. It sets out the principals for the measurements, presentation, recognition, and exposure of leases (Deegan, 2012). According to this particular standard, a lessee is needed to realize a right of usage of assets that represents its right to utilize the fundamental leased property and a leased liability that represents its liability to make payments on lease. According to AASB, the leaser will be required to state a capital lease as a liability and as an asset at the sum that is equivalent to the present cost at the start of the lease period (Wong, and Joshi, 2015).
In this case, Freedom Foods Group Limited will be required to recognize any lease agreement such as capital lease as a liability and as an asset at the cost that is considered to be equivalent to the present cost at the start of the lease moment in the lease period agreement (ElGazzar, Lilien, & Pastena, 2008). Under AASB 110 Presentation of Financial Statements and AASB Conceptual Framework, the accounting standard for lessees will basically require lessees to realize all leases on the balance sheet except for the short term leases and leases of low cost properties (Annual Report note 31, AASB 98.90).
Difference between finance lease and operating lease
A finance lease is considered to be an agreement where the rewards and risks are shifted to the leaseholder with the transfer of the property. It is also a lease agreement in which a leasing firm purchases the property for the consumer and then leases it to them for a particular contracted time. In this case, a lessor basically charges a rent as their payment for contracting the property to the lessee and the lessor preserves possession of the property but the lessee acquires unlimited use of the property provided it notes the conditions of the lease (Biondi, Bloomfield, Jamal, Ohlson, & Wilks, 2011). Consequently, an operating lease is considered to be the rewards and risks that are related to ownership of the leased asset and are transferred to the lessee. It will ordinarily run for not more than the entire profitable life of the property, and the lessor will presume the property to have a re-sale cost at the conclusion of the lease period. Operating lease is also a commercial covenant where the lessor allows the lessee to use the property for a period lessor that the property economic life against the rental payments.
According to the Freedom Foods Group Limited annual reports, the company leased plant and equipment and motor vehicles as a finance lease so as to utilize the property in its day to day company operations (Buchman, Harris, & Liu, 2016). In this case, the company will record the assets as a liability in its balance sheet while the lessor will record the same property as an asset on its balance sheet. Freedom Foods Group Limited also lease loan payables and bank bill facilities under an operating lease (Ji, and Deegan, 2011). This aspect is vital because it enhances the company to carry out its diverse operations at ease without any financial difficulty (Annual Report note 08, AASB 101.26). In this case, the company will record bank facilities and loans as liabilities in its statement of financial position and the bank will basically record these transactions as assets (Freedom Foods Group Limited financial reports, 2016).
For the perspective of the lessees, the potential implication of the adoption of new AASB 16 leases on assets is that the lessee company will be required to record the leased property as an asset in its balance sheet. Under AASB 110 Presentation of Financial Statements, the right to utilize the property will be measured by the lessee at the amount of the lease obligation plus any fundamental direct costs of the tenant. For example, leasing a motor vehicle will increase the company assets (Grenier, Pomeroy, & Stern, 2015). This will be able to increase the assets for the company because it will be treated as an asset and not as a liability.
Another implication on liabilities and debts is that the lessee company will increase its liabilities in its balance sheet because the leased asset will be treated as a liability and not as an asset (Annual Report note 27, AASB 101.26). Under AASB Conceptual Framework, the lease indebtedness will be measured through the present cost of the lease amounts discounting by the rate of interest implicit in the lease. For example, using finance loans for the company operations will reduce the company profits because of the interest on a loan that is being paid when due (Riccardi, 2016). From the perspective of lessees, leverage ratio will be greatly affected as it will increase since it is usually measured as net debt/company value. A higher leverage with unchanged observed levered Beta will result in a lower WACC and a higher company value. For example, use of lease plant and equipment and motor vehicles will affect the value of the company and thus leverage ratio. Accounting based on debt agreement will be greatly affected by the adoption of the new AASB 16 because an increase in the accounting-based debt covenants will basically increase the company value (Annual Report note 11, AASB 101.26).
As said, AASB 16 will increase the company value as at net debt will also increase while the equity value must remain the same. For the perspective of the lessees, the potential implication of the adoption of new AASB 16 leases on expense and profit is that the company will basically increase its liabilities because of the amount paid as interest on the loans utilized in its operations (Wong, and Joshi, 2015). Therefore, the profit for the company will decrease because most of the funds will be used to repay the borrowed loans in order to facilitate its long and short-term goals. For example, lease finances will reduce the company profits. In this case, increase in liabilities basically reduces the profit because most of the available revenues will be utilized to repay for the borrowed payments.
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Freedom Foods Group Limited financial reports. 2016. Retrieved from https://www.asx.com.au/asxpdf/20160831/pdf/439tq97gm9ybc4.pdf
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Wong, K. and Joshi, M., 2015. The impact of lease capitalisation on financial statements and key ratios: Evidence from Australia. Australasian Accounting Business & Finance Journal, 9(3), p.27.