AASB 16: Accounting Standard for Lease

This report explores the accounting standard for lease, AASB 16, and its impact on the lease market. It discusses the changes from the previous standard, the drawbacks of the old standard, and the reasons behind classifying lease contracts as operating lease. The report also examines the relation between positive accounting and manager behavior, and how IFRS 16 improves comparability between leasing and borrowing. Finally, it explores the potential effects of AASB 16 on the leasing market.

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AASB 16
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Abstract
The purpose of this report is to understand the accounting standard for lease by critically
examining the new accounting standards for lease AASB 16 and comparing it with the old
accounting standards.
The study enable one to find out the changes the new accounting standards has brought about,
impacts of the changes to the lease market. It also gives reason as to why managers use the
different kind of accounting method, it also gives an insight about the positive accounting theory
and how it relates to the mangers decisions on use of particular accounting method.

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Table of Contents
Abstract......................................................................................................................................................2
Introduction...............................................................................................................................................4
Critical evaluation of AASB 117...............................................................................................................5
Drawbacks.................................................................................................................................................5
Why the changes were necessary.............................................................................................................6
New changes incorporated in the new leasing standard AASB 16.........................................................6
Reasons why companies have a tendency of classifying most of lease contract as operating lease......8
Relation between positive accounting and behavior of managers........................................................10
How enactment of IFRS 16 will advance comparability between firms that lease assets and those
that borrow to buy...................................................................................................................................11
Effects of AASB 16 on the leasing market incase companies decide to buy more and lease less.......11
Annual Reports of Abacus Property group...........................................................................................11
The principle of the earned.....................................................................................................................13
How is the monthly determination of first category income................................................................14
Conclusion................................................................................................................................................15
References................................................................................................................................................17

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Introduction
Accounting methods are them rules a company follows in reporting revenues and expenses.
Throughout the years, the methods of accounting have improved and have gone through
significant changes to cater for the changing and developing world.
The AASB 117 is a standard in accounting which was issued and made applicable in Australia.
This standard was formulated to outline the accounting procedures that would be adhered by the
lessor and lessee when they enter into a contract of lease.
In recent years, this accounting principle AASB 117 for lease accounting has been retracted and
improved to a newer version known as AASB 16 introduced because the former had several
limitations.

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Critical evaluation of AASB 117
The AASB 117 is a standard in accounting which was issued and made applicable in Australia.
This standard was formulated to outline the accounting procedures that would be adhered by the
lessor and lessee when they enter into a contract of lease.
In recent years, this accounting principle AASB 117 for lease accounting has been retracted and
a new improved version known as AASB 16 introduced because the former has major draw
backs.
Drawbacks.
The rules of accounting provided under AASB117 did not disclose the different types of leases
that were newly developed on the balance sheet.
The model of accounting that was followed under AASB117 did not show the accounting
information that was needed to cater for stakeholders’ needs and also other financial statements
users.
This accounting standard made it hard and complex to disclose requirements that were related to
the transactions in the lease and also the amounts made it hard for any organization to follow
these rules.

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Why the changes were necessary
Unlike rules provided by AASB 17, the rules provided by AASB 16 are simple, this standard of
accounting uses layman’s language which is easy to understand and implement as compared to
the provisions of AASB 117 which are not easy to implement.
The amount reported in the financial statement in regard to assets and debt would be increased
which would lead to an increase in the leverage amount that is reported. The accounting based
covenant of debt will have consequences because of the increased amount leveraged for the
organization.
Lease expenses in AASB 16 are reported in a way that they tend to be front loaded. That is most
of the expenses will be put in the first few years of the lease matching with the depreciation
expense charged on accelerated basis. Hoyle,, Schaefer and Doupnik,(2015) This will have an
influence with the profits reported in the financial statements for each year.
New changes incorporated in the new leasing standard AASB 16
The new IASB lease regulation requires firms to include the greater part of leases in the balance
sheet, so they will identify the new assets and liabilities. Leases offer an important and flexible
source of financing for many companies.
However, the current accounting standard makes it difficult for investors and other third parties
to obtain an accurate picture of a firm’s leasing assets and liabilities, especially for industries
such as the airline industry, retail trade. and transportation. There was a concern about absence of

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clear information broken down by the tenant companies in relation to their obligations for lease
contracts and the fact that there were high off-balance payment commitments.
This new scenario is the one that will produce a "significant" change in the balance sheet of
companies, fundamentally among those specialized in renting commercial premises, renting
hotels, renting airplanes or renting land for wind farms, which could go from having a very low
level of leverage at a very high level, therefore you will see an increase in your leverage.
As it currently stands, all the companies under that have a substantial level of leasing will be
affected these changes, it is estimated that they have an estimated 3.3 trillion USD value of
leased assets from which about 85% of these assets are not included on their balance sheet, due
to this investors have been forced to often overestimate their liabilities due to the unreliable
calculations.The new accounting standards will end the assumptions involved when coming up
Joubert, Garvie and Parle (2017) with the company’s lease requirements , it will provide the
desirable transparency on the firm’s assets and liabilities and also enable organisations that
borrow to buy and leasing companies to compare amongst themselves.
The leasing will possibly have substantial impact on the entities which may not be immediate but
will be obvious. These changes give a more precise representation of the financial situation of
the business, reflects on its liabilities and come up with important financial information for the
sake of investors and shareholders.

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The standard will modify the ramework of the expenses. Instead of it being a rental expense
there will be more at the beginning years and less the advancing in years hence having an
influence on earning profile.
Due to the probable financial reporting faults, the proper use of an asset will be non-current
while the lease liability will be differentiated between current and non-current.
Another impact will be that there will be more companies that will now qualify as a large
proprietary company in addition to the right of use assets on their balance sheet increasing total
asset and possibly the need for auditing the financial statements to be lodged.
Considerable influences with bank covenants which can cause possible gaps if companies are not
hands on about approaching their financiers.
Reasons why companies have a tendency of classifying most of lease contract as operating
lease
The categorization of lease, implemented in AASB 117 standard was founded due to the
intensity to which threats and returns related to rights of the asset being leased lies with the
lessor or the lessee. De Simone (2016) Such risks include obsolescence, diffrences caused by
changing commercial enviroment and loss. The returns included appreciations and profits over
the assets economic life.
A lease is classified as finance when:
If the lease handsover the possession of the asset to the renter at the end of the agreement

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If the renter of the asset has an option to buy the asset at a lower fee as compared to the fee
indicated on the date the choice can be excersiced and at the start of the agreement, it is
reasonably definite that the option will be implemented. The ease agreement is for major part of
the economic life of the asset even if Wong, and Joshi,( 2015) the title is not transferred.
An operating lease is a contract that allows for the use of the asset but does not transfer the
ownership rights of the asset. the operating lease are accounted as off balance sheet financing
because the leased assets and the possible associated liabilities of future rent payment are not
included on the company’s balance sheet.
Operating lease is more popular as most companies have a tendency of classifying their lease
contracts as operating lease for a number of reasons
The company does not bear the risk of obsolescence as there is no transfer of ownership.
In case the equipment is technological, it is likely to be outdated quickly. Incase this happens the
company does not bear such risks.
The lease payments are tax deductible. A lease allows the company to deduct the payments as
operating expenses during the period in which it is paid, interests and costs of depreciations can
be deducted when the item is purchase therefore firms in a lower tax bracket are more likely to
classify a lease as an operating lease.
Operating leases provide greater flexibility to companies as they can replace and update their
equipments more often, hence the company can generate cash flow with the continuous update of
equipments.

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Relation between positive accounting and behavior of managers
Positive accounting theories is concerned with forecasting actions such as choices of accounting
policies by companies and companies response to these proposed accounting standards. The
accounting treatment for leases can be easily be influenced by self-interested managers, hence
the need for the positive accounting theories that predicts such actions. Öztürk and Serçemeli
(2016) Positive accounting is crucial when dealing with lease accounting since how a lease is
recorded on a company financial statement brings about the difference of whether an employee
will achieve their set goals or not.
The positive accounting theory looks into the efficiency of the company by looking at ways
through which managers show the real presentation of the firm’s performance especially the
self-interest managers who only adapt accounting standards that only for their individual benefit
in the sense that the firm also benefits. Kusano, Sakuma and Tsunogaya( 2016) It looks at the
different theories that explain what intentions make the managers choose a specific accounting
methods over another. These theories are:
Administrative compensation hypothesis, this states that administators who have tied up
inducements to the firm mostly manipulate the figures to try and show a better performance
than it really is.
Debt equity hypothesis states that mangers show enhanced profits with the intention of showing
improved performance and readiness to pay the debts it may have gathered in the business , the
more the debt, the likelihood of the managers to use accounting methods to show accounting
profits.

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Political hypothesis assumes that the firm show the firm’s profit much less by using different
accounting approaches so that the firm does not entice political attention from politicians who
often have interest on high profit industries.
How enactment of IFRS 16 will advance comparability between firms that lease assets and
those that borrow to buy
According to IASB the implementation of IFRS 16 is expected to drastically improve the
comparability of organisations that lease assets and those that borrow assets to buy, the IASB is
aware that the comparison is crucial to the stakeholders and analysts Xu, Davidson and Cheong
(2017).The absence of information from the balance sheet about the leases mean that stakeholders
and analysts cannot compare companies without making adjustments hence airline 1 has more
influence and a better asset base compared to the second airline when actually the reverse is true.
Effects of AASB 16 on the leasing market incase companies decide to buy more and lease
less.
Adoption of IFRS 16 has potential to give rise to behavioral changes that will upset the leasing
market. Xu, Davidson, and Cheong (2017) For instance, the fact that the lessee accounting
requirement in IFRS 16 provides a greater comparability between the lessees and the leasers ,
companies may decide to buy assets rather than leasing them.
For instance the companies decide to buy assets rather than lease them, there will be a significant
change in the economy since buying of assets uses a large amount of money. Buying assets such
as airpcraft requires a large amount of money to be drawn out of the company finances as
compared to leasing of the same asset.

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With the new accounting standards there will be an increase of assets in the balance sheet and a
decrease of financial liabilities on the same. Assets will increase since they are not being leased
and the small growing companies cannot afford to buy the same assets hence an increase in
assets in the balance sheets. Such cases will cause affect the leasing markets.
Annual Reports of Abacus Property group
This section covers annual reports of Abacus property group which is a company listed in the
ASX and deals with property. Lin, and Graham, (2018) The company has leased some of its
properties for commercial use. The biggest change in the area concerns the unification of lease
types. The current rule says that there are two types: financial and operational leasing. The first
recognizes the contract in the balance sheet of the lessee; already the second, recognizes the
value of leasing as a rent.
Accounting standards understands that all leases are recognized within the Company's Balance
Sheet. The new standard also offers exemption from leases of up to one year or whose values are
very low.
The new tax obligations are part of significant changes for the accounting industry. De Simone
(2016) Therefore, you need to prepare and adapt your company within the established deadlines.
At first it may sound cumbersome, but its management will flow much better after the

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adaptations. Gong, (2018) Leases as rent of first category and its relation to deductable expenses
of business income: leases, subleases or assignment of real or personal property
Next, the assumptions that the income tax legislation determines as transactions considered as
first category and therefore taxed with the mentioned tax will be analyzed.
what types of leasing goods generate the first category income
When making a revision of the text of article 23 of the Income Tax Law, we observe that they
are included as first category income:
(i) Those produced by the lease and sublease of properties1.
(ii) The improvements introduced in the leased or subleased goods that are not reimbursable by
the lessee.
(iii) The unlawful rent of properties and other assets.
In the case of lease or sublease, the product will be considered as gross income in cash or in kind
from the lease (the lease is understood), including its accessories, amount of taxes assumed by
the lessee and corresponding to the lessor and payments for the services. which supplies the
latter.

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Not only the leases qualify as first category income, because other income that has the same
treatment as the consideration received from third parties for real rights such as , use and
habitation, , etc., can be assimilated.
The principle of the earned
In accordance with the provisions of subparagraph b) of article 57 of the Income Tax Law, the
first category income is allocated to the taxable year in which they accrue. In the same sense,
they are considered accrued month by month, regardless of whether the owner of the properties
is satisfied with paying the conductive mercy.
You can even present the case in which a natural person who is generating the first category
income does not receive from the tenant the amount of the lease, either due to an oversight, a
delay in payment or various reasons.
How is the monthly determination of first category income
Its determination is made by applying a single deduction of 20% of the gross income to the
income received on a monthly basis and to the remainder that is the net income an 6.25% rate is
applied. 5% on gross income without deduction. (Camfferman and Zeff,., 2015 ) This amount will
be paid as a down payment using the lease receipt approved by board for payment purposes.
The minimum allowed income

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In the case of minimum presumed income, this is conceptualized as a limit, for tax purposes, of
contractual freedom between the parties and exists in two cases, in the case of the lease of
furniture furnished or not, for tax purposes, it is presumed that the monthly rent can not be less
than 6% of the value of the property and in the case of the transfer of property, furniture or real
estate other than property (machinery or ships, for example) made free of charge, at a price not
determined or at a price Less than the market value of taxpayers who carry out business, they
generate an annual gross income of not less than 8% of the acquisition, production, construction
or income value of the leased assets.
The fictitious income constitutes a presumption inaccounting, established in clause d) of art. 23rd
of the Income Tax Law, which indicates that when the owners of the properties have ceded their
occupation for free or not determined the fictitious rent will be 6% of the value of the property
declared in the self-assessment corresponding to the Property Tax Camfferman and Zeff (2015).
As we can see, the first category income assumptions are based on the passive exploitation of
real estate through assignment for third-party use; they are produced by the simple affectation of
the capital different from the active rents based on the activity of the company
Conclusion
Accounting for lease agreements is related to the International Accounting Standard (AASB 17
and also AASB 16. Unlike the previous rules that become effective in 2018, this rule will be

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mandatory only on January 1, 2019. The application of these rules will be vital in the lease
contracts in the future. The key change will be the increase in transparency and comparability.
In January 2016, the IASB published IFRS 16 Leases to materialize its desired goal for lessees to
include leases in the balance sheet. All companies that rent significant assets to use in their
business will have to recognize more assets and liabilities. This will have an affect on a variety
of sectors, from airlines that rent planes to the retail sector that rents premises as points of sale.
The tenants will now recognize most of the leases in the balance sheet. Sacarin (2017) This could
require a significant effort to recognize all leases and remove all the data from the leases needed
in order to apply the standard. The broader the rental portfolio, the greater the impact.
IFRS 16 deals therefore with the identification of lease agreements as their accounting handling
in the financial reports of lessees and lessors.
The most significant changes will correspond to the tenant's accounting.
Elimination of the dual accounting model for tenants. Disappearance of the differentiation
between financial leasing that is recorded in the balance sheet and in the operating lease for
which the recognition of future lease payments is not required.
A single model in which all the rents on the balance sheet are recognized, considering them as if
they were financed purchases, will be recognized both in the asset for the proper use and in the
liabilities for the lease, with exceptions for short-term leases, that is to say , when the lease

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period, according to the new standard, is equal to or less than 12 months and the leases of low
value assets, that is, assets with a maximum value of USD 5,000 when they are new, even if they
are material in aggregate form.
Apart from the accounting effects, the new requirements modify in a significant way the usual
indicators used by entities, investors and analysts such as EBITDA, EBIT and the rotation of
assets, convenants, among others. Porter (2016). The extra assets and liabilities identified and the
change in the demonstration will therefore affect key performance ratios, for example,the assets
and the debt ratios and, therefore, may prevent compliance with debt clauses that do not apply on
frozen or previous accounting principles, a circumstance that must be explained and that will
affect the historical information available in companies and in the market.
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