Impact of IFRS 16 on Lease Accounting

This assignment examines the significant changes brought about by International Financial Reporting Standard (IFRS) 16 on lease accounting. It delves into the standard's core principles, highlighting its shift towards recognizing most leases on a company's balance sheet. The analysis explores the potential impact of IFRS 16 on financial reporting, assessing how it affects companies' debt ratios, asset values, and profitability. Furthermore, the assignment discusses the implications of IFRS 16 for businesses seeking growth through leasing arrangements.

Accounting Theory

Solution 1
The present section aims to provide an analysis of a current accounting article related to a
topic of accounting regulation. The article selected for the purpose is ‘Global accounting
standards to test tenants’ published in August, 2017, in The Sydney Morning Herald. The article
relates to the current changes proposed in the IASB/AASB standards regarding the recognition
and measurement of corporate leases (Cummins, 2017). The article analysis will aim to provide a
theoretical understanding of the various concepts and issues demonstrated in the article.
Article Analysis:
As per the article, the IASB (International Accounting Standards Board) have proposed
accounting changes in relation to the measurement of leases. The changes will have a significant
impact on the accounting standards adopted by AAASB (Australian Accounting Standards
Board) as AASB is converging with IASB standards with the objective of achieving
harmonization of accounting standards. The new rules are likely to have a profound effect on the
financial statements by transferring significant amount of debt liabilities in the balance sheet
(Chalmers et al., 2012). The AASB has adopted compliance with the proposed IASB changes
under its AASB 16 that will applicable to all the leases not just only real estate leases. The article
has discussed the challenges that will be faced by the Australian corporate sector for adopting
with the new global accounting standard developed in relation with the corporate leasing
(Cummins, 2017). The new changes will have a major influence on the corporate accounting
system and processes and will tend to increase the liabilities of a corporation (Carmona and
Trombetta, 2010).
The AASB has introduced changes in its current accounting standard of leasing as per
which any indirect lease costs such as lease fees, deign fees, surveys and all other related
obligations should be recognized as indirect lease costs. Thus, there will be a large impact on the
leases structure adopted by business companies in Australia as the proposed changes will
significantly influence the accounting of leases in the financial statements (Gaffikin, 2005). The
new standard requires the business companies to report all their operating leases on the balance
sheet and thus present a major financial reporting challenge before the business entities in
Australia. The AASB is incorporating the changes in its lease standards in order to improve the

quality of financial reporting as per the IAS reporting rules. This is done in accordance with the
normative theory of accounting which states that the main objective of financial reporting is
protect the interests of end-users (Cummins, 2017).
The normative theory of accounting helps in providing guidance to the accounting
professionals in developing the new accounting standards that improves the qualitative
characteristics of financial information. The theory has helped in developing the conceptual
accounting framework as per which the development of a high-quality financial statements
depends on the relevancy, reliability, comparability and understandability of the information
provided during these statements (Cummins, 2017). Thus, the proposed standard will improve
the reliability, relevancy and understandability of the financial information for the end-users by
disclosing all the information relating to the operating leases not only just reporting the
information of real estate leases. As such, the proposed changes in the AASB standard regarding
the measurement of operating leases can be stated in accordance with the normative accounting
theory. The theory seeks to define the objective of general purpose financial reporting to provide
financial information that is helpful in decision-making of the end-users such a s investors and
creditors (Vorster, 2010).
The article in this context has also stated that there will be large impact on the interest
coverage and return on capital of the company that will gradually decline since the adoption of
new standards. The article has stated that the business companies operating in Australia have to
encounter many new operational challenges besides financial reporting challenges in order to
comply with the new accounting rules of corporate leasing. This is because the identification and
recognition of operating leases will bring large-scale changes in the operational procedures of a
business entity. The business companies shave to modify its present operational processes in
relation to impairment testing, credit ratings and tax accounting for identification and recognition
of its operating leases. This will require significant investment on the part of the company
besides requiring large amount of time and efforts for implementing the changes in its business
operations as per the new AASB 16 standards (Gaffikin, 2007). The companies have to report
amortization and interest expenses in its profit and loss statement of the increasing debt liabilities
as per the new standards. The disappearance of the rental expenses will significantly increase the
EBITDA of the company but will be offset by the increasing debt liabilities of the company. The

major impact of the new accounting standard will be on business companies that have large and
complex lease portfolios as they will need to implement large changes in its data collection
procedures and accounting systems (Cummins, 2017).
However, besides the above discussed challenges introduced for the business
corporations to implement the new accounting standard for reporting of leases, there are also
some benefits associated with it for the businesses. The major benefit is that companies need not
to report the short-term leases during financial reporting. The removal of the concept of
operating and finance leases that exist in the reporting of leases under the previous AASB 17
standard would help the business organizations to incorporate the use of a single accounting
model for recognition of leases under the new AASB 16 standard (Cummins, 2017). Also, the
adoption of the new accounting rules would help in improving the transparency and
comparability of leasing activities of companies as per the normative theory of accounting. This
will help in achieving the trust and confidence of stakeholders and thereby increasing their
investment in the capital structure of the companies (AASB 16: A Critical Change to Financing
Growth, 2016).
Thus, the article has only emphasized on the challenges that will be faced by business
entities operating in Australia by the adoption of AASB 16. The article ahs not illustrated the
several benefits that business companies will realties with the new accounting rules and
standards for recognition and measurement of corporate leasing. There is need for undertaking
more researches in this area by the accounting researchers for providing an understanding to the
business companies regarding the usefulness of the new standard. There is potential lack of
accounting researches undertaken in relation to the benefits gained by the business companies
with the adoption of new reporting rules of IASB (Pierre and Guillaume, 2017). The accounting
articles published in Australia are only demonstrated the significant issues with the AASB 16
standards that can create a negative perception in the mind of business companies regarding its
long-term use (Harvey, 2016).
As such, the business companies will tend to restrict them from the implementation of the
new standard as suggested by positive theory of accounting. The positive theory of accounting
argues that accounting managers tend to implement the accounting methods that results in
maximizing the value of their business entity. Therefore, it can be said that it is highly essential

for providing knowledge to the business corporations reading the long-tern benefits that they can
be realized from the introducing of such accounting standards. The knowledge will help the
business entities around the world to realize that the current challenges faced for complying with
the new accounting standards will help them to promote their sustainable growth and
development. This is essential for universally accepting the new accountings standards proposed
by the IAASB relating to leases, valuation of fixed assets or any other in good faith by the
business entities around the world (Ghanbari et al., 2016).
Solution 2:
In this section of the assignment a current exposure draft submitted by the IASB on their
website has been taken and further it was analyzed in detail. Comments letters in relation to the
exposure draft will also be taken into consideration. Exposure draft contains the changes to the
IAS 16: Property, plant and equipments. Some of the major consideration of this exposure draft
is given below.
Issues and changes covered in the exposure draft
The exposure draft selected was submitted by the IASB and it is relation to the required
changes in IAS 16: Property, Plant and Equipment. The purpose of this exposure draft is to invite
people from all over the world can give their expert comments and provide any changes that are
required to be considered before making the exposure applicable in the current accounting
standard. As the exposure draft is in relation to the measuring the value of property, plant and
equipment than it is important for business organizations, individuals and other accounting
bodies that incorporates any relation for accounting of property, plant and equipment in the
books of accounts (IFRS® Standards Exposure Draft, 2017). IAS 16 applies to all the business
entities and it provides the provisions for how the property, plant and equipments are measured
at different times when making entry of such items in balance sheet. One of section under IAS 16
requires the companies to add the cost of testing equipments and other goods that are produced
before putting the property, plant and equipment to use, to the cost of property, plant and
equipment before bringing the assets to the actual location of its use. The Para 17(e) of the IAS
16 requires adding cost that is directly attributable to the value of property, plant and equipment
such as cost of testing of whether the assets will function properly after deducting the value of

net proceeds from the selling of any items that are generated while taking the assets to the actual
location and in condition that it can be use (Mande, 2014). Now it has been amended by
removing the clause under Para 17(e) that requires deduction of net proceeds from the selling of
any items produced in the course of testing the assets.
Now the new Para 20 A has been inserted that requires entity to recognize the sale of any
items produced during the course of testing and any cost of producing it in the profit and loss
account and not giving any effect to the value of the cost of property, plant and equipment. In
relation to this amendment, a transitional provision 80D has also been inserted in the IAS 16 that
requires entity to make the amendments retrospectively to those property, plant and equipment
that are brought to the actual location and condition of being it can be used as the manner
intended by the management on or after the most earliest period that the asset is presented in the
balance sheet. The cumulative impact can be provided under the under the retained earnings after
considering all the impacts of the amendments (Herrmann et al., 2011).
Evaluating the behavior of the regulator for introducing the exposure draft that it is in
accordance with the public interest theory or not
Public interest means that provisions must be such that it benefits the public at large not
the small section of the society. For example, presentation of the financial statements described
under the conceptual framework is designed in such a way that it fulfills the requirement of all
sections of people using it to present the financial position of their entity. So it can be said that if
any accounting standard that does not favor all section of society for drafted to provide benefits
to very one or two industries will not regarded as the accounting standard in public interest.
The public interest theory is defined as the practices that favor the economic theory that
fulfills the requirement of the public at large. As per the economic theory regulatory bodies such
as IAS must introduce such practices that satisfy the needs of the general public and also corrects
the malfunction market practices (Gaffikin, 2007).
The exposure draft as described above was made after considering the requirement of
only few class of industries such as extractive or petrochemical industries. The players in these
industries have to carry out intensive testing of plant and equipment before the assets actual put
to use. Basically the changes made in the exposure draft favor very small section of people not

all so it is necessary to check the impact of amendments to other class of people that have benefit
of introducing such amendments. As the amendments allows to make recognize the cost of
testing and goods produced during the testing in the profit and loss account will decrease the
amount of profits reported in the income statements as testing under above mentioned industries
are sometimes more than the cost of actual assets. So such companies will escape from paying
the actual income tax or can take various advantages of these amendments. So it can be said that
the proposed amendment is for benefiting the particular class of people not all sections of society
(IFRS® Standards Exposure Draft, 2017).
Outline of the comments provided by the different respondent on the proposed changes in
the IAS 16
IASB invites people to comment on the exposure draft so that any important rectification
can be made after considering such comments. So in this part of the assignment four comments
letter have been selected that are provided by the different section of the societies. The comment
letters provide the answers of the question that are asked in the exposure draft through a public
forum.
 Comment letter 1: It is submitted by the Brazilian Accounting Pronouncements
Committee and as per the reviews presented by the committee it can be said that they
agree with the proposed changes in the IAS 16 as they that believe that any incidental
changes to the value will be reported together cost incurred for that change and it must be
recognised under profit and loss account.
 Comment letter 2: It is submitted by the Association of Accounting Technicians, AAT
and according to their views they agree with the proposed changes. The reason for such
change that any assets that are not the integral part of the actual assets that are put to use
must not be added to the cost of such assets and also any goods produced during such
testing phase will not the regular process carries out by the entity.
 Comment letter 3: It is given by the accounting body DRSC in Berlin and they are not in
favor of the proposed change in IAS 16 because there is no proper definition of testing,
no clarification regarding which items are valid fro deduction purpose and which are not
and there is lack robust principle that allows the deduction of testing expenses from the
profit and loss account.

 Comment Letter 4: Individual Rhafael in Philippines has expressed his views that
proposed changes in the IAS 16 are valid as it simplifies the accounting work (IFRS®
Standards Exposure Draft, 2017).
Interpretation of comments letters as being 'for' or 'against' the regulation
After analyzing the comment letters it can be said that all four comments letters favor the
regulation except the comment letter 3 which requires some changes before it is made applicable
in the accounting standard.
Application of theories in each of comment letter
Theory of private interest applies to comment letters 1, 2 and 4 as they expressed their
views through looking at the problems faced by only few industries. Only the comment letter 3
has expressed his opinion in public interest because he provided detail explanation after looking
the public that are impacted by this proposed amendments (IFRS® Standards Exposure Draft,
2017).

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