Impact of AASB 16 on Lease Companies

This study explores the importance and impacts of AASB 16 on lease companies, comparing it to AASB 117. It discusses the changes in accounting for leases, the impact on profitability, and the implementation challenges. The study focuses on the technology, media, and telecommunication industries.

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Accounting theory and current issues
by Student Name
Class & Course
Professor
University
The City & State
Date

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Abstract
The new AASB 16 accounting for leases comes fully effective by January 1, 2020. The new
standard incorporated several changes to address the drawbacks that were experienced
under the AASB 117. This study sought to enlighten different users of financial statements
about the importance and impacts of AASB 16 on business operations. In tackling the topic,
the study focussed more on comparing AASB 16 and AASB 117. The findings show that
AASB 16 would not only improve the accuracy accounting information for lease companies
but also improve comparability to the information across different companies. Under the new
accounting for lease standards, both the finance and operating leases will be disclosed in the
balance sheet as either assets or liabilities. Such an action would lead to the reduction of
profitability level of lease companies. As a result, companies will choose to buy more assets
and lease a few after the standard becomes effective.
Table of Contents

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Abstract......................................................................................................................................2
1.0. Introduction.....................................................................................................................4
2.0. Comparative analysis of AASB 16 and AASB 117......................................................4
2.1. Evaluating the drawbacks of AASB 117: Accounting standard for lease......................4
2.2. The reason for changing the standard..........................................................................5
2.4. The impact of AASB 16 on companies that have significant levels of lease financing.7
a) The impact on shareholders..........................................................................................7
b) Book keeping complications..........................................................................................8
c) Timing............................................................................................................................8
2.5. Classifying most lease contracts as operating lease using the positive accounting
theory.......................................................................................................................................9
2.6. Implementation of AASB16 and comparability between lease asset companies.......10
2.7. The implementation of AASB 16 and its effect on the leasing market........................11
Summary/Conclusion.............................................................................................................11
List of references....................................................................................................................13

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1.0. Introduction
The new AASB 16 Accounting for Leases has introduced several changes. The purpose of
AASB 16 is to address the drawbacks that have been experienced under the AASB 117
Accounting for leases. The new accounting standards will impact the operations of entirely all
business entities. Lessees of assets are the most affected because they will be required to
comply with the new standards.
On the other hand, lessors are the least affected. Generally, AASB seeks to improve
transparency in the manner in which leasing companies operate. AASB came effective on
January 1, 2019, for companies that prepare their annual reports by December 31 annually.
Companies whose financial year-end by June 30 will start applying the standards from July 1,
2019. This paper enlightens different users of AASB principles about the importance and
impacts of AASB 16. The analysis focuses on comparing AASB 117 and AASB 16 to
understand the latter clearly.
2.0. Comparative analysis of AASB 16 and AASB 117
2.1. Evaluating the drawbacks of AASB 117: Accounting standard for lease
A significant disadvantage of AASB 117 is found under the classification of finance and
operating leases. While finance leases are represented as either asset or liability, operating
leases and off balance. The only disclosure of operating lease is made as lease payments
(expenses) in the profit and loss statement. However, some operating leases could not be
cancelled and required to be represented as either assert or liability. Preparers of books of
accounts took advantage of the accounting loophole to hide such liabilities from users of the
reports (Financial Accounting Standards Board, 2016, p. 79). Sometimes the information

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about liabilities associated with operating leases would be disclosed in the notes sections.
Most users lack the accounting expertise to interpret accounting notes, which made it easier
to conceal such information.
Failure of disclosure such liabilities in the financial statements the objectivity of financial
reporting. According to the objectives of financial reporting, financial statements are required
to provide a faithful representation (Deegan, 2012, p. 57). Therefore AASB 117 was used by
preparers of financial reports to manipulate the statements to serve the interest of the
company. Standards setters decided that it was time to eliminate AASB 117 because it failed
to provide a faithful representation of leasing contracts and transactions. A single accounting
model was introduced to record leases with a term of at least one year (Deegan, 2013, p. 78).
In conclusion, the AASB was abused by a financial report prepared by failing to disclose the
faithful representation of a company's lease transaction
2.2. The reason for changing the standard
The changes were necessary to eliminate the off-balance treatment of operating leases.
Standards setters show it wise to remove the previous distinction between finance and
operating leases. Lessees will be required to disclose, lease transactions on the balance
sheet. AASB 117 failed to capture the transactions of operating lease in the balance sheet.
Considering that companies had made financial commitments in such transaction, the
previous standards did not allow the faithful representation of entities. Stakeholders believed
that AASB could not give an accurate presentation of an entity's financial position (Deloitte,
2019, p. 9).

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Therefore, besides eliminating the distinction between finance and operating leases, the
changes allowed accurate representation of companies' financial position. The financial
information will be more useful to stakeholders by including lease liabilities in the balance
sheets.
2.3. The changes incorporated in the new accounting standard for lease AASB 16
AASB 16 was developed to address the drawbacks under the AASB117. The new accounting
standard for lease introduces several changes in the treatment of lease transactions. First,
the new standards will ensure that lease liability usage of assets is included in the balance
sheet. That is, companies will be required to include the benefits and costs associated with
leased assets in the balance sheet. Reflection of lease liabilities and benefits offers more
information in the balance sheet, which gives a more accurate representation (Ohm, 2019).
The changes come with complexities as well. The hidden and complexity issues under AASB
16 will increase the financial and commercial risks associated with financial reporting. The
treatment of expenses will also change under the new AASB 16 standard. The previous
standard treated leasing expenses as a straight line rental expenditure. The expense would
be more during the early years of a lease and less at the end of the lease under the new
standard (Mongoato, 2016).
The new standard has a significant impact on the balance sheet. It would be necessary to
explain such changes to the stakeholders and investors. First, the amount of assets and
liabilities would increase while equity would decrease. Second, an increase in the financial
costs and EBITDA would cause a decrease in the profit before tax and lease expenses. Third,
operating cash flow would increase, leading to a reduction in funding cash flow
(Vengadasalam, 2018).

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2.4. The impact of AASB 16 on companies that have significant levels of lease
financing
Although the changes incorporated in the AASB 16 will have a far-reaching effect on all
industries, technological, engineering and construction industries will be significantly
impacted. Companies operating in the three sectors engage in lease contracting more often.
This section examines the impact of the new accounting for rent on the technology, media
and telecommunication (TMT) companies (Deloitte, 2019, p. 14). Several concerns arise
when accounting for the leased assets by a TMT company. First, a company should consider
the services received or offered. Second, the existence of the assets used in creating
advertising content should be identified. Third, ascertain the economic benefits a company
would gain from using a leased asset. And fourth, determine whether a company has control
over the asset (s) (The Treasurer, 2017).
The impact of AASB 16 on TMT companies revolves around three areas: Impact on
stakeholders, impact of book keeping and timing.
a) The impact on shareholders
AASB 16 is data intensive and is bound to bring technical challenges to companies. TMT
companies while having to either outsource some services or increase their workforces to
handle new responsibilities effectively. The interaction of interaction across departments that
handle lease activities will also increase. Handling lease transactions will no longer be a
spreadsheet exercise. Employees and stakeholders in TMT companies will have to
understand the impact of the new standards on their daily operations. Employees will be
playing the role of detectives by uncovering, classifying and understanding the consequences
of leases (PWC, 2016).

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Moreover, companies will seek more collaboration and interaction between stakeholders to
establish and manage lease related activities. For example, the accounting and procurement/
leasing departments will work more closely once the rule becomes fully effective. Therefore,
employees will have to be trained on their new responsibilities under the new standards.
Training will help stakeholders to understand the new rule and its impact of applying other
accounting standards and principles (Leo & Knapp, 2014, p. 543).
b) Book keeping complications
Although the new rule seems to be straightforward, it brings about the difficulty in
bookkeeping. For example, assessing the lease transactions will raise debates on the
allocation and application of accounting rules. For instance, the difference between Generally
Accepted Accounting Principles (GAAP) and the International Reporting Standards (IFRS) will
complicate the harmonization of the accounting for lease standards. The inclusion of lease
transactions as liabilities and expenses would reduce the profitability level of entities
compared to the AASB 117 (AASB, 2019).
c) Timing
Timing of the new rule is also important to business entities. AASB 16 became effective on
January 1, 2019. The companies who had not met the essential requirements were given until
January 1, 2020, to comply. Companies require between 12 and 18 months to plan and
execute a transition into the new rules. A company that has not to start the process already is
bound to be constrained by time (Cutri, 2018).
Moreover, companies should test their new lease procedures to ascertain that they don't
conflict with other business systems and processes. Companies that have underestimated the

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time required to transit into the new standard will fight it rough. Therefore, companies should
prepare earlier for the impact of AASB 16 (Henderson & Peirson, 2015, p. 312).
In conclusion, the transition into the new accounting for lease standards is not a one-time
task. Henceforth, companies should clearly understand which items should be contracted as
leases and which ones should not. Full compliance with AASB 16 would require companies to
separate leases services from other existing contracts effectively. Moreover, companies are
required to develop procedures and processes that would ensure a continuous compliance
with the new standards. Therefore, the impact of the new rules does beyond the accounting of
the balance sheet as well as debt arrangements. AASB 16 also will affect how TMT
companies acquire assets and other companies (Dagwell, et al., 2015, p. 43).
2.5. Classifying most lease contracts as operating lease using the positive
accounting theory
Positive Accounting Theory (PAT) relies upon real events which are then used to translate
accounting standards. PAT mostly focus on two issues: One, the reason why companies
choose to apply specific accounting policies over others. And two, the manner at which firms
react to new accounting standards. PAT states that companies choose accounting policies
which are likely to maximize their profitability or the chance of survival (Gaffikin, 2008, p. 39).
The management is possible to manipulate financial information to achieve their self-interests.
The theory, however, states that choosing favourable accounting policies have economic
consequences. Based on PAT, companies strive to become as efficient as possible. Entities
accept accounting policies that minimalize their contract associated costs to achieve the
efficiency goal. Managers seek to eliminate or reduce the impact of contract negotiation and
renegotiation costs as well as monitoring the expenses (Gaffikin, et al., 2003, p. 90).

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Operating leases were not disclosed as assets or liabilities under the AASB 117. Moreover,
the costs associated with the leasing contracts and transactions were not the income
statement. Preparers of books of accounts took advantage of the accounting loophole to hide
such liabilities and expenses from users of the reports as such companies would report high
net incomes which would prompt payments of higher bonuses to the managers (Wolk, 2008,
p. 71). As stated under PAT, managers chose to classify contracts as operating leases and
not financial leases because the former would help them to minimize the contract costs and
maximize profitability. The action of the managers can be described as "opportunistic
behaviour"; the management chooses the operating lease option because it would serve their
personal interest best.
2.6. Implementation of AASB16 and comparability between lease asset companies
AASB 16 will have implications in the balance sheets, income statements and cash flow
statements. The new standard will expand the items that are presented in the balance sheet.
The present amount of lease payments will be recognized as lease assets, while future lease
values will be displayed as lease liabilities. The previous lease for lease kept operating leases
off the balance sheet. Operating lease expenses will not be recognized as depreciation under
leased assets and interest expenses under leased liabilities. Lastly, the cash flow statements
will remain unchanged. The changes are meant to improve the comparability of financial
information across companies. The International Accounting Standards Board (IASB)
introduced the AASB 16 to harmonize the application lease accounting policies (Eley, 2018).
The key benefit of the new standard of the lease will enhance faithful representations of
financial statements. Hans Hoogervorst, the chairman of IASB, stated that AASB 16 would
eliminate the guesswork that was previously used to calculated lease obligations by

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companies. The new standard will also improve the presentation of a company as health. The
move will ensure improved transparency between lessees and lessors. Companies operating
in the airlines, retailer, travelling and leisure industries have profoundly affected the drawback
of AASB 117. The introduction of AASB 16 will bring about fair financial based competition in
the sectors mentioned above. Improved comparability across leasing companies will assist
users of the financial statement to make the right decisions. Investors will rely on reliable and
accurate information to make investment decisions. The government will depend on faithful
representations of the companies when taxing them. Evaluators will also use specific details
to compare the performance of companies in the industry (Mills, 2017).
2.7. The implementation of AASB 16 and its effect on the leasing market
As stated earlier, the introduction of the AASB will lead to the growth of the balance sheet and
an increase in the gearing ratio. Therefore, companies will improve their liquidity ratio, which
means increased ability to finance their short term financial obligations. Likewise, the higher
the gearing ratio, the higher the ability of a company to use owners' equity to finance
investments (Martin, 2017). On the other hand, the new standard will lead to the reduction of
return on capital employed by a company. In short, the income realized from leased assets
would reduce. This argument forms the basis of companies choosing to buy more assets and
lease a few. The decision would be based on comparative benefit analysis. The profit
associated with acquiring and putting the asset into use will be higher compared to the gain
realized from leasing holdings to other companies (Biebuyck, 2017).
Summary/Conclusion
AASB 117 allowed leasing companies to keep information about operating leases off the
balance sheet. In the introduction of AASB16 will bring several implications of the recognition

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and treatment of lease contracts. The new accounting standard for lease will enhance the
accuracy and comparability of the accounting/ financial information. The AASB 117 has been
associated with several drawbacks.
The main shortcomings are that AASB 117 failed to recognize operating leases in the balance
sheet. Management of businesses entities used the weaknesses of the previous standards to
advance their self-interest. Preparers of books of accounts took advantage of the accounting
loophole to hide such liabilities and expenses from users of the reports as such companies
would report high net incomes which would prompt payments of more top bonuses to the
managers by minimizing the contract costs and maximizing the profitability. The action of the
managers can be described as "opportunistic behaviour". The management chooses the
operating lease option because it would serve their personal interest best.
AASB 16 impacts the operations of businesses entities in general but has significant
implications for lease asset companies. The study has established that lease companies
operating in the construction, engineering and TMT industries will be most affected. With the
remaining one year period before the standard becomes fully effective, companies are on the
rush to comply with its requirements. AASB 16 will have implications in the balance sheets,
income statements and cash flow statements. The new standard will expand the items that
are presented in the balance sheet. Most importantly, AASB 16 will eliminate the guesswork
that was previously used to calculated lease obligations by companies.

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List of references
AASB, 2019. AASB 16 Leases - Assess The Financial Impact Now. [Online]
Available at: https://www.pkf.com.au/blog/2018/aasb-16-leases-assess-the-financial-impact-
now/
[Accessed 18 May 2019].
Biebuyck, C., 2017. Why IFRS 16 will radically change the retail sector. [Online]
Available at: https://economia.icaew.com/features/july-2017/why-ifrs-16-will-radically-impact-
the-retail-sector
[Accessed 18 May 2019].
Cutri, M., 2018. Article: AASB 16 Leases: Minimising the impact on profit and loss. [Online]
Available at: https://www.bdo.com.au/en-au/insights/education/articles/aasb-16-leases-
minimising-the-impact-on-profit-and-loss
[Accessed 18 May 2019].
Dagwell, R., Wines, G. & Lambert, C., 2015. Corporate Accounting in Australia. Sydney:
Pearson Higher Education AU.
Deegan, C., 2012. Australian Financial Accounting. Sydney: McGraw-Hill Education Australia.
Deegan, C., 2013. Financial accounting theory. 4th Edition ed. North Ryde, N.S.W: McGraw-
Hill Education.
Deloitte, 2019. Changes to lease accounting standards: Exploring the impact beyond the
balance sheet, New York: Deloitte.

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Eley, J., 2018. New rules force retailers to rethink lease accounting. [Online]
Available at: https://www.ft.com/content/9657cd82-c891-11e8-ba8f-ee390057b8c9
[Accessed 18 May 2019].
Financial Accounting Standards Board, 2016. Preparing For the Upcoming Leasing Standard:
hat a Lessee Needs to Know, New York: FASB.
Gaffikin, M., 2008. Accounting Theory. Frenchs Forest: Pearson Edmundson.
Gaffikin, M., Dagwell, R. & Wines, G., 2003. Corporate Accounting in Australia. 1 ed. New
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Henderson, S. & Peirson, G., 2015. Issues in Financial Accounting. Sydney: Pearson Higher
Education AU.
Leo, K. & Knapp, J., 2014. Company Accounting. New York: John Wiley and Sons Australia.
Martin, R., 2017. The effects of the new leasing standard are wider than you might think.
[Online]
Available at: https://www.rsm.global/australia/insights/ifrs-news/effects-new-leasing-standard-
are-wider-you-might-think
[Accessed 8 May 2019].
Metz, R. D., 1985. Off Balance Sheet Finance. Sydney: Graham & Trotman.
Mills, J., 2017. Thoughts on the impact of changes to AASB 16. [Online]
Available at: https://www.intelligentinvestor.com.au/thoughts-on-the-impact-of-changes-to-
aasb-16-1878181
[Accessed 18 May 2019].

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Mongoato, R., 2016. Pros and cons of the new IFRS lease accounting standard. [Online]
Available at: https://www.financialinstitutionslegalsnapshot.com/2016/04/pros-and-cons-of-
the-new-ifrs-lease-accounting-standard/
[Accessed 18 May 2019].
Ohm, M., 2019. New Leasing Standard (AASB 16) Brings Significant Impacts. [Online]
Available at: https://www.hlb.com.au/new-leasing-standard-aasb-16-brings-significant-
impacts/
[Accessed 18 May 2019].
PWC, 2016. In depth: A look at current financial reporting issues, Nettherlands: Price Water
Coopers.
The Treasurer, 2017. Leasing. [Online]
Available at: https://www.treasurers.org/node/336407
[Accessed 18 May 2019].
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Available at: https://www.accru.com/2018/10/aasb-16-new-lease-standard/
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Wolk, H. I., 2008. Accounting Theory: Conceptual Issues in a Political and Economic
Environment, Volume 2. London, UK: SAGE.