Accounting Theory and Current Issues: A Critical Evaluation of AASB 117 and its Replacement by AASB 16

This report evaluates the drawbacks of the existing lease standard AASB 117 and its replacement by AASB 16. It highlights the misrepresentation of financial statements by managers and the impact of the new standard on leasing market. The report also discusses the reasons why companies tend to segregate most of the lease as operating leases under AASB 117 and the impact of IFRS implementation on comparability among entities. Subject: Accounting, Course Code: 10

Running head: ACCOUNTING THEORY AND CURRENT ISSUES
Accounting theory and current issues
Name of the student
Name of the university
Student ID
Author note

1ACCOUNTING THEORY AND CURRENT ISSUES Reference
Abstract
The purpose of the study is to focus on the existing lease standards AASB 117 and its
replacement by AASB 16. The report will highlight the drawbacks associated with the existing
standard and the usage of the same by the managers for misrepresenting the financial
statement that will misguide the users of financial statement who take crucial decisions based
on these information. The existing standard does not involve the concept of the lease liability
and the right of use asset on the balance sheet of the company. Thus, the financial statement
does not show actual financial representation of the company. Hence, to modify this treatment
new AASB 16 has been introduced that is applicable from 1st January 2019.

2ACCOUNTING THEORY AND CURRENT ISSUES Reference
Table of Contents
Introduction.................................................................................................................................4
Critical evaluation of old lease accounting standards (AASB 117) and drawbacks...................4
Necessary for Change................................................................................................................4
Incorporation of change in new lease accounting standard AASB 16.......................................5
Impact of the entities those have considerable level of the lease financing...............................5
Reason why the companies have tendency to segregate most of the lease as operating
leases under AASB 117..............................................................................................................6
As per IASB, implementation of IFRS is expected to improve the comparability among the
entities.........................................................................................................................................7
Impact of AASB 16 implementation on leasing market..............................................................8
Key disclosures by BHP Billiton regarding transition from AASB 117 to AASB 16....................8
Conclusion..................................................................................................................................9
Reference..................................................................................................................................10

3ACCOUNTING THEORY AND CURRENT ISSUES Reference
Introduction
AASB 16 supersedes AASB 117 and is effective from 1st January 2019. As per the
existing lease standard while any lease is determined to be similar in economic terms with
purchase the lease is recognized as finance lease and reported in the balance sheet of the
company. Rest all the leases were used to be classified as operating lease and were not
recognized under the balance sheet of the company. The off balance sheet leases were used
to be accounted as same as the service contracts with reporting the rental expenses under
the income statement (Aasb.gov.au 2019)
Critical evaluation of old lease accounting standards (AASB 117) and drawbacks
The AASB 117 standards were incorporated which help to ease the work of accountant
by providing a set of rules and regulation in accordance with the lease for accounting. AASB
117 provides the purview on every art of the lease except use minerals, oil, natural gas and
all the non-regenerative resources. AASB 117 does not deal with the lease of agreement for
motion pictures, videos, patents and copyrights. The standard has some serious drawbacks
regarding the scope of the standard. There are many exemption associated with it. While
using the AASB 117 standard there was no difference between the operational lease and
financial lease for lessees. Due to this there are many leases which are omitted from the
balance sheet or it does not come under the balance sheet of the company ( Bond, Govendir
and Wells 2016) During the future payments under the operating lease arrangement is not
included under the balance sheet of the company in spite of the company is committed to the
future expenditures. This create a huge havoc in the stakeholders as the company is not
presenting the financial statement which provide actual reflection of the company’s current
financial position and hence the company unable to satisfy the stakeholders which may result
some serious change in the market and the price of the shares of the company. The standard
does not involve the concept of the lease liability and the right of use asset on the balance
sheet of the company (AASB 2015). Thus, the financial statement does not show actual
financial representation of the company. Due to the absence of the liability from the balance
sheet because of the standard does not help in the case of operating lease as the leases was
non-cancellable for the leases it affects the stakeholders of the company because there was
no representation of the liability in the balance sheet of the company. Thus, to remove such
problem from the financial accounting system the Australian Accounting Standard Board need
to remove this standard so that the stakeholders does leave in the dilemma after looking the
financial statement of the company (Aasb.gov.au 2019)
Necessary for Change
AASB 117 is the standard which used to deal with the lease of the company. As per
mentioned in the above part AASB 117 though explains the lease system by differentiating
the lease into operating lease and financial lease. While providing the operational lease in the
financial statement of the company there remains an obligation in accordance with the future
payments which falls under the future lease arrangements which is not present in the balance
sheet of the company in spite of being the company has future expenditures associated with
it. Due to the above reason the financial statement of the company remains in the darkness in
the case in case of the liability of the company. By utilizing this standard the financial
statement of the company will not include the liability in the balance sheet of the company

4ACCOUNTING THEORY AND CURRENT ISSUES Reference
(Aasb.gov.au 2019). According to this standard the company need to mention the liability
associated with the lease of the operating part of the company and hence the balance sheet
will not show the real liability. This will represent a fake view about the financial health of the
company and hence the stakeholders of the company will be in dilemma about the financial
health by seeing and analyzing the false report of the company. This gives impression of the
company in the market which may result in the decline of the share price of the company in
the market (Laing and Perrin 2014). The company also loses trust of the shareholders as the
company will show less liability in respect of the actual (Hu, Percy and Yao 2015). To remove
such problem the Australian Accounting Standard Board has replaced the current standard of
lease with the new standard where such problems are being revised so that the company
should not go from such problem and also it is revised to safeguard the interest of the
shareholders of the company (Ahmed and Alam 2014). The new standard will help the
company to formulate a correct financial statement so that the company’s stakeholders can
actually analyze the present financial sate of the company.
Incorporation of change in new lease accounting standard AASB 16
AASB 16 has brought a new definition of lease which is little bit similar as its previous
lease standard that is AASB 117. The main difference which prevails between the two
standards is the methodology of the measurement of the lease for the company. In this
standard lease is segregated in the two parts include they are lease contract and the service
contract. In this standard there is a facility of providing the lease in the balance sheet even in
the case of the asset where the company realizes the lease of certain part of the lease. The
new standard helps to split the rental or lease payment into two halves they are lease element
non-lease element. Accounting lease element will be calculated when the element meets the
criteria of the AASB 16 ((Aasb.gov.au 2019). Accounting for the service element lease will be
treated as same as its predecessor where it is seen that the expenses is made in profit and
loss. The biggest change in the two standard is that during inception of the calculation of
lease there is no requirement in differentiating the financial and operating lease. AASB 16
provides the single model of accounting for every lease for the leases. In this case the lease
needs to recognize a right of use asset and also the liability associated with it in the financial
statement of the company. This helps to identify the financial position of the company. As per
this standard the asset shall be depreciated and a liability amortized over the lease term. As
per the exception of this standard states this standard exempts from this rule are as follows
1. Lease of short-term assets
2. Lease of the low value of the company (Aasb.gov.au 2019)
The only problem lies with the companies who are following the operating lease as there
are important standard. By adopting the new standard the financial condition of the
company will change and hence the balance sheet of the company.
Impact of the entities those have considerable level of the lease financing
As per the existing rules if the lease does not qualify for as the capital asset, they are
regarded as the operating lease and monthly payments are recognized as the rent expenses.
However, as per the new accounting standards for lease accounting treatment of operating
will change significantly. For the lessees, the leases which are for more than 12 months will

5ACCOUNTING THEORY AND CURRENT ISSUES Reference
require to be reported under the balance sheet of the entity as the right-to-use assets and the
corresponding liability shall be created for paying the rent. The liability as well as assets shall
be measured at present value of lease payments initially. It includes the payment that is
required to be paid in the optional renewal periods if lease is reasonably certain for exercising
the option for extending the lease (Xu, Davidson and Cheong 2017). PV shall be computed
through using discount rate that is implicit in lease or the incremental borrowing rate of the
lessee. Assets will be depreciated and liability will be reduced by the amount of lease
payments. However, for the lease with the term of less than 12 months the lessee is allowed
to make the election of accounting policy for not recognizing the assets and liabilities.
However, for the leases, the associated parties and month to month lease, it is crucial to
determine if arrangement is actually made in month to month basis (Aasb.gov.au 2019).
Indications for long term lease are –
 Leases made considerable improvement to property and the improvements are
depreciated over the period of more than 1 year.
 Lessee is providing guarantee for the debt of the lessor
 Lessee is the only user of right-to-use asset and delivers required cash flow for lessor
to provide service for debt
 It will be disruptive economically for lessee for relocating to the new facility (Morris
2017)
If the above mentioned criteria are not met, the month-to-month leases shall be
reported under new guidance for right-to –use assets and shall record the associated liability.
New lease standards will further change the certainty in which lease costs are recorded. For
instance, the executor costs like insurances or property taxes will be included in lease
payments that are used for computing lease liability and the right-to-use assets. New
accounting standards for lease will also require additional disclosures both in terms of
qualitative as well as quantitative aspects which in turn will have impact on the ratios that
lenders as well as other financial statements users use for evaluating the financial position as
well as performance (Bozzolan, Laghi and Mattei 2016)
Reason why the companies have tendency to segregate most of the lease as operating
leases under AASB 117
Generally, the lessee prefers to treat the lease as the operating lease instead of
finance lease. If the lease is considered as the finance lease both lease liability as well as
leased assets shall appear in the financial statement at the fair value of the leased asset
reduced or if the amount is lower, at the amount of PV of minimum lease payments. It will
have an adverse impact on the gearing ratio of the company like debt to asset ratio. If the
lease is subject to the debt contract that had debt to assert constraints and the constraints
become binding, the lessees may particularly be opposed to treat the lease as the finance
lease. Apart from that another point is there that in early years of the lease, the recognised
expenses are comparatively high. Interest expense that is based on opening liability is higher
in the early years as the amount of liability is higher. Further this amount along with the
depreciation charges related to lease asset may result into higher amount of total expenses in
case the same is treated as operating lease. It is of specific concern for the entities for
different reasons and they may seek in reporting higher profits in the earlier years
(Aasb.gov.au 2019).

6ACCOUNTING THEORY AND CURRENT ISSUES Reference
Proponents of the positive accounting theory attempt predicting the accounting
behaviour through observing what actually takes place and application the same to specific
situations. It is observed that capitalization of finance lease will have significant impact on the
recorded accounting numbers that will in turn affect the contract among the shareholders and
managers. It is hence expected that the rational managers select off-balance sheet
treatments for avoiding the negative economic impact. It has found that the managers arrange
the lease contracts with the lessors and thereby transfers the leases from finance lease to the
operating lease. However, this treatment of lease by the managers will misguide the users of
the financial statements those take decisions based on the financial statements and hence,
will violate the positive accounting theory (Sieverding 2018)
As per IASB, implementation of IFRS is expected to improve the comparability among
the entities
IASB expects that the IFRS 16 will significantly improve comparability of the financial
information. The reason behind this is –
 The entities will recognise the liabilities and assets for all the leases
 The companies will measure the rights those are only obtained and the liabilities those
are only incurred through the lease.
 The companies will measure all the lease liabilities and lease assets in same manner
(Dakis 2016)
Owing to these facts, the financial statement will replicate differing operating decisions
that are made by different entities. While the lease is similar in economic terms in context of
borrowing for buying an asset like lease for new aircraft for more than 20 years, the amount
reported in compliance with IFRS 16 will be same with the amount that would have been
reported if the entity were borrowing the amount for buying the aircraft (Aasb.gov.au 2019).
However, in case the lease is different in economic terms from the borrowing for buying the
asset for instance lease of new aircraft for 6 years, the amount recognizes in compliance with
IFRS 16 will reflect different economic decisions. The liabilities and assets will be reported at
fewer amounts as compared to which would have been reported if the entity required to
borrow for buying the aircraft. Under this circumstance, right of the entity to use the aircraft for
6 years is significantly different as compared to the right that would have been obtained if the
company would have bought the aircraft. Accordingly, amounts recognised through
application of IFRS 16 are estimated to be significantly different as compared to borrow for
buying the asset (Brumm and Liu 2019)
Example – in the below presented table estimated impact of off balance sheet leases for 2
entities in airline industry that is industry that uses the plant, property and equipment
intensively are presented. Airline 2 leases 70% of the aircraft whereas airline 1 leases 10% of
aircraft. Crucial information used by the analysts and investors are total assets and the long
term liabilities. It can be affected significantly by off balance sheet treatments.
Airline 1 (leases <10% of
aircraft
Airline 2 (leases <10% of
aircraft
Reported in
balance sheet
(IAS 17)
All leases
reported in
balance
sheet (IFRS
16)
Reported
in balance
sheet (IAS
17)
All leases
reported in
balance sheet
(IFRS 16)

7ACCOUNTING THEORY AND CURRENT ISSUES Reference
Property, plant and equipment
16,9
08.00
19,92
6.00
15,74
8.00
24,0
20.00
Long term liabilities
13,2
32.00
16,56
7.00
9,61
5.00
18,3
20.00
Equity
6,7
19.00
6,40
2.00
5,60
4.00
5,1
71.00
Ratio of long term liabilities
to equity 2.0:1 2.6:1 1.7:1 3.5:1
As per the above shown table the figures are contrasted as reported by the entities in
context of the amounts reported as per IAS 17 and amounts reported as per IFRS 16.
Amounts that is reported through application of IAS 17 reveals that airline 1 has higher level
of financial leverage and higher level of asset base as compared to the airline 2. However, in
actual the opposite scenario will be true if the off balance sheet accounts are taken into
consideration. Application of IAS 17 in absence of information regarding leases will mean that
the analysts as well as the investors will not be able to compare the entities properly without
making the adjustments (Davern et al. 2019).
Impact of AASB 16 implementation on leasing market
IASB considered whether the IFRS 16 may increase the behavioural changes that will
have impact on the leasing market. For instance, as the requirements of lease accounting as
per IFRS 16 offers greater comparability among the entities who leases the assets and who
borrows for buying the assets, the entity may decide to buy the assets instead of leasing
them. IASB further considered whether the IFRS 16 may provide incentives to the structure of
transaction for achieving the desired accountings results. For instance, reducing length of the
lease term and making payment for lease variable, they will attempt to identify the smaller
lease liabilities. Consider the possible impacts, IASB observed that till the economy remains
same or there is not any significant change, entities will continue requiring assets for
generating revenue as well as operating their business (Hana and Patrik 2017)
As per the expectation of IASB the companies will decide for buying the assets instead
of leasing, specifically if the entities are willing to pay more amounts as the leases were not
recognised in the balance sheet. However, it is further mentioned by IASB that there are
numerous business reasons for which the companies will continue leasing. Particularly, it is
observed by IASB that lease provides finance where the traditional bank facilities are not
available. Further, even if some of the entities decide to buy the asset, the entities will still
require asset financing. Hence, it can be stated that significant changes will not be there even
after implementation of AASB 16 (Laing and Perrin 2014)
Key disclosures by BHP Billiton regarding transition from AASB 117 to AASB 16
The company has progressed the implementation project through focussing on the
review of contracts, aggregating the data supports for evaluating accounting impacts to apply
new standards and assessing need for the changes to the process and systems. While
evaluation of impact in context of adopting the standards it is expecting that the changes will
have material impact on the financial statement of the company. Information regarding
undiscounted amount of operating lease commitments of the company as per IAS 17 / AASB

8ACCOUNTING THEORY AND CURRENT ISSUES Reference
117 on leases that is the current lease standards is disclosed under note 31 – commitments
(BHP 2019)
Conclusion
From the above discussion it is concluded that the existing AASB 117 has some
serious drawbacks regarding the scope of the standard. There are many exemption
associated with it. While using the AASB 117 standard there was no difference between the
operational lease and financial lease for lessees. It has found that the managers arrange the
lease contracts with the lessors and thereby transfers the leases from finance lease to the
operating lease. Further, the existing standard allows the treatment of lease by the managers
will misguide the users of the financial statements those take decisions based on the financial
statements and hence, will violate the positive accounting theory. Hence, the change is
necessary as new lease standard AASB 16 will help the company to formulate a correct
financial statement so that the company’s stakeholders can actually analyze the present
financial sate of the company.

9ACCOUNTING THEORY AND CURRENT ISSUES Reference
Reference
AASB, C.A.S., 2015. Investment property.
Aasb.gov.au. 2019. [online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB16_02-16.pdf [Accessed 27 May
2019].
Aasb.gov.au. 2019. [online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB117_07-04_COMPapr07_07-07.pdf
[Accessed 27 May 2019].
Ahmed, K. and Alam, M., 2014. The effect of IFRS adoption on the financial reports of local
government entities. Australasian Accounting, Business and Finance Journal, 6(3), pp.109-
120. Cristea, V.G., 2017. Valuation For Biological Assets With Historical Cost Accounting Or
Fair Value Accounting?. Challenges of the Knowledge Society, pp.701-706.
Ball, F., Tyler, J. and Wells, P., 2015. Is audit quality impacted by auditor
relationships?. Journal of Contemporary Accounting & Economics, 11(2), pp.166-181.
BHP. 2019. BHP Annual Report 2018. [online] Available at: https://www.bhp.com/investor-
centre/annual-report-2018 [Accessed 27 May 2019].
Bond, D., Govendir, B. and Wells, P., 2016. An evaluation of asset impairments by Australian
firms and whether they were impacted by AASB 136. Accounting & Finance, 56(1), pp.259-
288.
Bozzolan, S., Laghi, E. and Mattei, M., 2016. Amendments to the IAS 41 and IAS 16-
implications for accounting of bearer plants. Agricultural Economics, 62(4), pp.160-166.
Brumm, L. and Liu, J., 2019. New leasing accounting standard. Taxation in Australia, 53(8),
p.449.
Dakis, G.S., 2016. Upcoming changes to contributions and leasing standards. Governance
Directions, 68(2), p.99.
Davern, M., Gyles, N., Potter, B. and Yang, V., 2019. Implementing AASB 15 Revenue from
Contracts with Customers: The preparer perspective. Accounting Research Journal, (just-
accepted), pp.00-00.
Hana, B. and Patrik, S., 2017. Will the amendments to the IAS 16 and IAS 41 influence the
value of biological assets?. Agricultural Economics, 63(2), pp.53-64.
Hu, F., Percy, M. and Yao, D., 2015. Asset revaluations and earnings management: Evidence
from Australian companies. Corporate Ownership and Control, 13(1), pp.930-939.
Joubert, M., Garvie, L. and 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), pp.1-11.

10ACCOUNTING THEORY AND CURRENT ISSUES Reference
Laing, G. and Perrin, R.W., 2014. Deconstructing an accounting paradigm shift: AASB 116
non-current asset measurement models. International Journal of Critical Accounting, 6(5/6),
pp.509-519.
Morris, R.D., 2017. Discussion of: The Phoenix Rises: The Australian Accounting Standards
Board and IFRS Adoption. Journal of International Accounting Research, 16(2), pp.155-157.
Sieverding, A., 2018. A critical analysis of the accounting for sale and lease back transactions
under the new IFRS 16(Doctoral dissertation).
Xu, W., Davidson, R.A. and Cheong, C.S., 2017. Converting financial statements: operating
to capitalised leases. Pacific accounting review, 29(1), pp.34-54.