Understanding AASB 16 Lease Essay And Its Financial Reporting Implications.

AASB 16 Lease - What is it About?

Discuss about the Measuring Country Differences In The Enforcement.

Accounting standards change to improve the current standards that are deemed ineffective for reporting financial information. Accounting standards refer to authoritative guidelines for financial reporting. Companies use accounting standards as guidelines to prepare their financial statements (Brown, Preiato, & Tarca, 2014). Accounting standards are developed from accounting principles, concepts and widely accepted accounting theories. Accounting standards in Australia are governed by Australian Accounting Standards Board (AASB). The AASB has mandate to develop, issue, and maintain accounting standards in Australia in accordance to Australian company law (Joubert, Garvie, & Parle, 2017). Development of accounting thought improves the existing accounting standards to enhance effectives of financial reporting. The following write-up analysis an accounting current article on a new development on lease accounting that will be implemented on 1^st January 2019 published on CPA Australia website titled “The bottom line on leasing under IFRS 16”. The new accounting standard is contained on the AASB 16 Lease in Australia and IFRS 16. The write up will involve discussing explaining the article, analyzing accounting concepts and outlining article’s implications.

The article is about the bottom line of the lease accounting standard that will be in operation starting January 1^st 2019. The Article is written by Rachael McKinney with Ram Subramanian and David Hardidge. The new accounting standard on lease is in accordance with the IFRS 16/AASB 16 Lease Australia. The article is motivated by the large amount of money (trillions) that the new accounting standard will bring to the balance sheets while it will pose challenges to it implementation (McKinney, Hardidge & Subramanian, 2018). According to the article, around US$2 trillions that are from lease assets are not recorded on the balance sheets by listed companies either applying IFRS or US GAAP accounting standards. This show that a lot of assets and liabilities of a company are not included in the balance sheet that can undermine businesses financial information transparency. The AASB 16 Leases accounting standards with eliminate the current accounting distinction that exist between operating and financial leases that will bring the off-balance sheet arrangements into the company’s balance sheet (McKinney, Hardidge & Subramanian, 2018). The operating lease will be recorded on the Company’s balance sheet as Right-Of-Use (ROU) asses and corresponding lease liability. The lease asset will be faced with depreciation while the interest of the lease assets will be recognized as lease liability. The authors foresee challenges of varying Consumer Price Index (CPI), peppercorn leases and novated lease contracts. The AASB 16 lease accounting standard will be exceptional to short-term lease, low-value lease, biological assets lease, licenses for intellectual property and intangible assets licenses leases. The AASB 16 lease will therefore lead to inclusion of lease assets in the balance sheets enhancing company’s financial information disclosure transparency (McKinney, Hardidge & Subramanian, 2018).

Underpinning Accounting Concepts

The AASB 16 Lease has several accounting concepts that have been used by the authors of the article to describe what the new accounting standard will change and challenges to be addresses. Lease refers to an arrangement between a lessor and a lessee to provide an asset when the lessee makes periodic payments as agreed with the lessor. A leased asset provides benefits to lessee and has for long time been either finance lease or operating lease (removed in the new accounting standards). These leases where accounted differently in the lessee financial statements. Financial lease was accounted fully while operating lease was not accounted. Financial lease transferred rewards and risks to lessee while operating lease did not transfer inherent rewards and risks to the lessee. This led to difference in accounting for a leased asset under the two difference agreement. The AASB 16 Lease removes the distinction between operating and finance lease when accounting for a leased asset (Joubert, Garvie, & Parle, 2017). This entails that all leased assets will be accounted the same as Right of Use asset (ROU). The concepts underpinning this new accounting standard are entry to books of accounts, depreciation, and recognition.

First, the leased asset requires recognitions in the financial statements. Recognition in accounting allows a component to be classified correctly in financial statements (Xu, Davidson, & Cheong, 2017). Lease will be classified as asset under property, plant, and equipment. This is because leased asset provides future economic benefits that a company controls and is as a result of transaction. Leased assets will be recorded as Right Of use assets under non-current assets of a company. Lease will also be recorded on balance sheet as lease liability under long term liabilities that the company will be owing to the lessor (Sunder, Sunder, & Zhang, 2018). Right of Use will be the amount that the lessee incurred to acquire the leased property. 

The AASB 16 Lease will require all listed companies to account for lease. Businesses will have to disclose lease in all it financial statements. In the balance sheet, the lease will be recorded as ROU as asset and lease liability on the companies liabilities. There should be double entry on every transaction or book entry. This concept of double entry will be met by increasing asset account by ROU and increasing liability account by lease liability (Maffei, 2016). The ROU will be the total cost of the asset leased as it provides benefits to the business while lease liability will be the total liability that the business owes to the leased asset owner. Accounting for operating lease will ensure no assets that provide benefits to a company are left out of the balance sheet.

Implications of AASB 16 Lease on Financial Reporting

Another accounting concept that is associated with the new AASB lease accounting standards is depreciation. Depreciation refers to tear and wear that occur to an asset reducing it value and efficiency in the production process (Warren, & Jones, 2018). Assets depreciate with time and use over their useful lives. Lease will be subject to depreciation. Companies will need to account for depreciation in order to report assets at fair value. Fair value of an asset is the amount that an asset can be sold at or exchanged to settle a liability in an orderly market (Tan?Kantor, Abbott, & Jubb, 2017). The asset fair value is therefore the amount after deducting depreciations. Depreciation is calculated either by a straight line method o declining balances method. Accumulated depreciation is then deducted from lease property in the balance sheet and accounted as an expense in the statement of profit and loss. Depreciation will be calculated based on the time period of the lease contract.

The new AASB 16 accounting standards will have several implications to financial reporting. It will affect disclosure and profits and losses recorded in the financial statements.

The first implication will be full disclosure of leased property on the company budgets. Leased assets will be disclosed as ROU that will show users of financial reports all assets that the company has and their ability to provide economic benefits in the future (McKinney, Hardidge & Subramanian, 2018). This will enhance transparency in financial reporting hence improving financial decision.

The second implication of AASB 16 Lease standards is that depreciation charge and interest expense will be higher at the start of lease term than the periodic lease rentals. This will be as a result of financing effect phenomenon (Joubert, Garvie, & Parle, 2017).

Another implication of the AASB 16 Lease is that it will affect profits and loss. There will be interest expenses and depreciation instead of lead payments. The net profits recorded will be lower at the beginning of the lease term and interest rates payable will be high. The change will also affect the company’s earnings before interest, tax, depreciation and amortization (EBITDA) and earning before interest and tax (EBIT) (Liapis, & Kantianis, 2015).

Lastly, the AASB 16 Lease will pose a challenge of determining interest or discount rate that will affect interest element of rental payment. This will lead to companies using incremen6tal borrowing rate to determine the interest rate for the standard to work and meet it objective of enhancing transparency in financial reporting.

Conclusion

Accounting standards offer guidelines for financial reporting. New accounting standards are developed to solve accounting problems and improve financial reporting. From the article, the AASB is implementing AASB 16 Lease accounting standards that will be effective starting 1^st January 2019. The new accounting standards on lease reporting aim to increase transparency in financial reporting by disclosing all leased assets. The AASB 16 Lease requires companies to account for leased assets whether they are under operation or finance lease terms. The underpinning accounting concepts in the article are component recognition, depreciation and entering/ accounting for ROU (leased asset). The article concluded that AASB 16 Lease will have several implications such as lowering net profits at the start of lease term, enhance disclosure on the balance sheet and pose a challenge of determining interest rate to used in accounting for leased assets in the company.

References

Brown, P., Preiato, J., & Tarca, A. (2014). Measuring country differences in enforcement of accounting standards: An audit and enforcement proxy. Journal of Business Finance & Accounting, 41(1-2), 1-52.

Joubert, M., Garvie, L., & Parle, G. (2017). Implications of the New Accounting Standard for Leases AASB 16 (IFRS 16) with the Inclusion of Operating Leases in the Balance Sheet. The Journal of New Business Ideas & Trends, 15(2), 1-11.

Liapis, K. J., & Kantianis, D. D. (2015). Depreciation methods and life-cycle costing (LCC) methodology. Procedia Economics and Finance, 19, 314-324.

Maffei, M. (2016). Amortization and Depreciation. Global Encyclopedia of Public Administration, Public Policy, and Governance, 1-7.

Rachael McKinney, R., Hardidge, D., & Subramanian, R. (2018). The bottom line on leasing under IFRS 16. Retrieved from https://www.intheblack.com/articles/2018/03/01/leasing-under-ifrs16

Sunder, J., Sunder, S. V., & Zhang, J. (2018). Balance sheet conservatism and debt contracting. Contemporary Accounting Research, 35(1), 494-524.

Tan?Kantor, A., Abbott, M., & Jubb, C. (2017). Accounting Choice and Theory in Crisis: The Case of the Victorian Desalination Plant. Australian Accounting Review, 27(3), 273-284.

Warren, C. S., & Jones, J. (2018). Corporate financial accounting. Cengage Learning.

Xu, W., Davidson, R. A., & Cheong, C. S. (2017). Converting financial statements: operating to capitalised leases. Pacific Accounting Review, 29(1), 34-54.