Impact of IFRS 16 on Financial Reporting

This assignment delves into the significant implications of the International Financial Reporting Standard 16 (IFRS 16) on financial reporting practices. It examines how the new standard, which mandates the capitalization of operating leases, affects the presentation of balance sheets and key financial ratios. The analysis incorporates case studies, research findings, and expert opinions to provide a comprehensive understanding of IFRS 16's impact on companies and stakeholders.

Running head: ADVANCED FINANCIAL ACCOUNTING
Advanced financial accounting
Name of the university
Name of the student
Authors note

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Table of Contents
Assessment Task Part A:.................................................................................................................2
Requirement i).................................................................................................................................2
Requirement ii)................................................................................................................................2
Requirement iii)...............................................................................................................................2
Requirement iv)...............................................................................................................................3
Requirement v)................................................................................................................................3
Requirement vi)...............................................................................................................................4
Requirement vii)..............................................................................................................................4
Requirement viii).............................................................................................................................5
Assessment Task Part B:.................................................................................................................5
Requirement i).................................................................................................................................5
Requirement ii)................................................................................................................................6
Requirement iii)...............................................................................................................................7
Requirement iv)...............................................................................................................................7
Requirement v)................................................................................................................................8
References list:...............................................................................................................................10

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Assessment Task Part A:
Requirement i)
Sims metal management limited conducts an impairment testing annually for goodwill
and other intangible assets. Testing of impairment is conducted when there is objective evidence
given by circumstance or happening of any events. Whenever there exists indication that it will
be difficult to recover the carrying amount of other definite lives intangible assets as indicated by
occurrence of some events and prevailing circumstances. Allocation of goodwill has been done
for impairment testing. The impairment testing for the cash-generating unit depicts excess
headroom of A$ 104.1 million for the year ending 30th June, 2016 (Simsmm.com 2018).
Requirement ii)
Sims metal management conducts the impairment testing of assets by reviewing the
amount of their carrying value and when there exists and indication that assts require
impairment. There is recognition of impairment loss when the estimated recoverable amount is
lower than the carrying amount of such assets. Recognition of trade and receivables is done at
fair value and measuring it subsequently at amortized cost by deducting any provision of
impairment. Trade receivables is written off against impairment account when it is identified by
organization such receivables become uncollectible. For impairment purpose, the carrying
amount of property, equipment and plant are reviewed and as indicated by existence of any

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objective evidence and thereafter there is recognition of impairment loss. Intangible assets and
goodwill are tested annually for impairment as indicated by circumstances and occurrence of
events. Assessment of impairment of assets are done by grouping them at the lowest levels where
the cash flows have been separately identified and they are not dependant of cash flows
generating from other group of assets. Organization conducts annual testing of investment that is
made in joint ventures as indicated by the fact that their carrying value amount cannot be
recovered and there are any circumstances and events (Simsmm.com 2018).
Requirement iii)
Impairment charge attributable to intangible assets and other goodwill for financial year
2016 stood at A $ 53 million. After the analysis of annual report of Sims metal management
limited, it has been ascertained that there has not been any impairment charge for the financial
year 2015 and 2017 in relation to assets and other goodwill (Simsmm.com 2018).

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Requirement iv)
Sims metal management limited makes use of assumptions for conducting impairment
testing of goodwill and other intangible assets. Projection of five-year cash flow is done by
organization for computing the value in use and this is based on the budget after board approval
for the year 2017 and 2018 respectively. Historical average forms the basis of making four year
forecast and takes into account historical value for four years. Projections of five years
incorporates margin and price of commodity that are drawn from past experiences, estimates of
management relating to inherent impact on volume of future volatility and other factors relating
to current and expected future economic conditions. Organization also makes the application of
Gordon growth model for the determination of terminal value from the cash flow of final year.
Management makes best estimates in projecting the cash flow by referring to results that are
historical for determination of expense, income, cash flows for each cash generating unit and
capital expenditures (Simsmm.com 2018). Value in use of goodwill is determined by using
expected future cash flows. An estimation of CGU’s to intangible assets and goodwill
recoverable amount is required to be made for determining potential impairment relating to it.
Higher of any value in use and fair value less cost to sell helps in determining CGU recoverable
amount. Assumptions concerning growth rates and discount rates are to be made for the
calculations related to impairment testing.

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Requirement v)
The existence of subjectivity in estimating and making judgment by management has the
possibility of considerably affecting the impairment testing of organization. Moreover, it would
also have difficulties in gaining accurate inputs required for the impairment testing. Amount that
is to be recovered becomes highly sensitive when there is involvement of high degree of
subjectivity and assumptions cannot be made about terminal growth rate verification. There is
gaming in impairment testing methodology due to manipulation of recoverable amount, as the
management will be acting opportunistically. Presence of high degree of subjectivity has the
likelihood of impairment testing outcome. It is ascertained after the evaluation of annual report
of Sims metal management limited that there is low prevalence of subjectivity in testing of
impairment of assets. Nevertheless, assumptions and estimates concerning computation of value
in use, discount rate and determination of cash flow requires judgment of management and there
is possibility that value generated using such assumptions will fluctuate on substantial basis.
Moreover, impairment requirement is determined by impairment status based on economic
events and conditions and specific circumstances (Arrozio et al. 2016). It is certainly possible
that assumptions made by Sims metal management limited about forward-looking statements
will not be appropriate owing to involvement of subjectivity.

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Requirement vi)
Evaluation of annual report of Sims metal management limited indicates that impairment
testing methodology of is interesting. The impairment charge of cash generating unit was
impacted by margin pressure that arises from volatility in the prices of commodities and
landscape of competitive market. There were reassessment of US recycling solutions relating to
cash flows and this has indicated the fact that there is no recoverability of carrying amount of
goodwill. There would be fluctuation in the value of impairment charge recorded if the
assumptions about discount rate keep on changing. Calculations of value in use forms the basis
of estimating recoverable amount and it is performed independently by firm valuating the assets.
Impairment on investment is recognized by organization by assessing recoverable amount of
investments that are made in SA recycling (Simsmm.com 2018).
Requirement vii)
Analysis of annual report of Sims metal management limited concerning impairment
testing depicts that impairment that is recorded in the financial year 2016 involves impairment
that are recognized are offset closely by reversing the impairments that are recorded in the
previous year (Simsmm.com 2018). It has been ascertained from the annual report that there has
been impairment reversal in relation to property, plant and equipment. An insight that is gained
regarding impairment is that value of impairment charge fluctuates if there is any modification in
discount rate while all other assumptions remaining same.

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Requirement viii)
Some of the financial liabilities and assets that are involves in the preparation of general
purpose financial report is based on fair value. Net loss generated by financial assets revaluation
is measured at fair value. Designations of investments in marketable securities are done as
financial assets that are at fair value. Last quoted price forms the basis of measurement of assets
fair value. Recognition of any alterations in fair value is accumulated in separate resources as
equity and done in the comprehensive income statement (Pavić et al. 2017). The estimated and
carrying amount of fair value of financial liabilities and assets of group is materially same.
Determination of financial instruments fair value that is not traded in active market is done using
broker quotes that are available readily. Organization makes use of valuation methodology for
classifying financial instruments that are measured at fair value by using hierarchy
(Simsmm.com 2018).

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Assessment Task Part B:
Requirement i)
The existing lease standard that is IAS 17 is associated with several criticisms that make
investors difficulties in having a true and fair view of financial position of reporting entities. For
the classification of lease as operating or finance, the standard allows lesser and lessees to
evaluate the transactions. One of the major flaws that are associated with the existing standard is
that organizations have incentives to make the classification of lease as operating lease. This has
the major consequence of key financial ratios of companies and classifying lease contracts as
operating lease finance is more favorable for companies. Financial ratios such as return on assets
and debt to equity ratios will get worsen if the lease contract is classified, as finance lease as
against operating lease and this does not affect the two ratios (Czajor and Michalak 2017). If the
positive income is generated by operating lease might improve the return on assets. It is
noteworthy to take into account that costs and benefits of both the lease whether financial and
operating leases are equal. However, the benefits provided by operating lease in terms of
financial ratios are purely an accounting illusion that is created in the investor’s eyes. IASB has
made the estimation that 85% of total amount of lease commitments out of US $ 3.3 million does
not appear on balance sheets (Brouwer et al. 2015). Therefore, actual liabilities of organization
might be less than what is presented on balance sheet and this is the reason why the existing
standard did not reflect true economic reality.
Requirement ii)
Providing user with information about entities that helps them in making economic
decisions is the objective of financial report that is prepared under the current lease standard.
Leasing transactions are likely to be classified unfaithfully under the existing standard. The rue

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debt structure of companies is not provided on the balance sheets because of absence of value of
operating leases. Information that is presented in the balance sheets concerning leased assets and
liabilities is not sufficient and making accurate calculations for bringing some of lease
commitments back to balance sheet is difficult. Absence of operating lease on balance sheets for
impoverishing comparability between companies requires users to make the adjustments in the
balance sheets for operating leases (Nobes 2015). For ascertaining true debt structure,
discounted amount concerning leases is added back to balance sheet, which is not appropriate.
This explains why the off balance sheet liabilities were up to 66 times more than debt that is
reported on balance sheets.
Requirement iii)
The balance sheet of airline companies is formed under different accounting model and
there do not exist difference between operating lease and financing lease. Complications in
creating difference between financing and operating leases are one of the controversies that are
associated with affecting financial position of airline companies. It is so because either airline
companies buy aircraft fleets or they lease the fleets. This difference in lease accounting
illustrates financial position of such companies would be different. However, in reality, there
exists possibility that financial position of some airline companies is similar and identical.
Leasing structures and particular method of financing will affect the individual airline companies
(Karwowski 2016). Therefore, it can be said that there were no level playing field between some
airline companies.
Requirement iv)
The reason why the new lease standard will be unpopular is attributable to several
criticism associated with it. Debt structure and balance sheets of companies would increase due

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to focus on operating lease capitalization. There is a possibility of violating existing debt
covenants of business due to 100% increase in balance sheets. It is indicative of the fact that
companies will be required to make renegotiation of debt covenants and this excludes
agreements concerning leases (Joubert et al. 2017). Furthermore, companies in receiving credits
have raised concerns. The impact of short-term leases would have absurd consequences on their
financial statements due to the implementation of the standard. Criticism of lease burden is also
because of considerable increase in administrative burden and some of the common examples in
relation to this are new IT systems, educational efforts, and increased expenditures in the
consultation fees and changes in process and control systems. Complications and increased cost
of reporting is another criticism of new lease standard because organizations having lot of lease
agreement will need to invest time in management information and investment in large amount
of new IT systems (Osei 2017). It is so because, there will be need of making estimations in
detail relating to right to use assets and lease liability.
Requirement v)
The implementation of new lease standard will make financial reports of organizations
useful to investors and financial analysts and will facilitate enhancement of comparison between
them. However, benefit of enhanced comparability will be achieved at the expense of
organizations recognizing all lease agreements on their balance sheets. Lease accountings that
are classified unfaithfully will be addressed under this standard. Implementation of the standard
will no longer require investors to make rough estimations and rough calculations for bringing
back lease commitments on balance sheets by computing substantial lease obligations.
Facilitation of transparency regarding the lease obligations will lead to better-informed decisions
among investors (Edeigba and Amenkhienan 2017). There will be more balanced lease versus

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buy decisions as adoption of standard will lead to efficient allocation of capital and better
decisions on part of management.
References list:

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Arrozio, M.M., Gonzales, A. and da Silva, F.L., 2016. Changes in the financial ratios of the
wholesale and retail sector companies arising from the new accounting of the operating
lease. Revista Eniac Pesquisa, 5(2), pp.139-159.
Brouwer, A., Hoogendoorn, M. and Naarding, E., 2015. Will the changes proposed to the
conceptual framework's definitions and recognition criteria provide a better basis for IASB
standard setting?. Accounting and Business Research, 45(5), pp.547-571.
Czajor, P. and Michalak, M., 2017. Operating Lease Capitalization-Reasons and its Impact on
Financial Ratios of WIG30 and sWIG80 Companies. Przedsiębiorczość i Zarządzanie, 18(1, cz.
1 Practical and Theoretical Issues in Contemporary Financial Management), pp.23-36.
Demir, Z. and Bas, E., 2017. THE EFFECT OF TAS 17 “LEASING” STANDARD AND
IMPLEMENTATION OF THE NEW IFRS 16 “LEASES” STANDARD ON THE AIRLINE
COMPANIES. PressAcademia Procedia, 3(1), pp.153-173.
Edeigba, J. and Amenkhienan, F., 2017. The Influence of IFRS Adoption on Corporate
Transparency and Accountability: Evidence from New Zealand. Australasian Accounting,
Business and Finance Journal, 11(3), pp.3-19.
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. Journal
of New Business Ideas and Trends, 15(2), pp.1-11.
Karwowski, M., 2016. The risk in using financial reports in the study of airline business
models. Journal of Air Transport Management, 55, pp.185-192.

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Nobes, C., 2015. IFRS Ten Years on: Has the IASB Imposed Extensive Use of Fair Value? Has
the EU Learnt to Love IFRS? And Does the Use of Fair Value make IFRS Illegal in the
EU?. Accounting in Europe, 12(2), pp.153-170.
Osei, E., 2017. THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB), AND THE
INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB) SINGS SIMILAR TUNE:
COMPARING THE ACCOUNTING TREATMENT OF NEW IFRS 16 WITH THE IAS 17,
AND THE NEW FASB MODEL ON LEASES. Journal of Theoretical Accounting
Research, 13(1).
Pavić, I., Dečman, N. and Sačer, I.M., 2017, January. The Influence of Changes in the Notes on
Evaluation of Indebtedness and Other Performance Measures–The Analysis of Lease Financing.
In Vision 2020: Sustainable Economic development, Innovation Management, and Global
Growth.
Pwc.com. (2018). [online] Available at:
https://www.pwc.com/gx/en/audit-services/publications/assets/a-study-on-the-impact-of-lease-
capitalisation.pdf [Accessed 21 Jan. 2018].
Sacarin, M., 2017. IFRS 16 “Leases”–consequences on the financial statements and financial
indicators. The Audit Financiar journal, 15(145), pp.114-114.
Sandblom, P. and Strandberg, A., 2015. The Value Relevance of the Proposed New Leasing
Standard. An event study of the European Stock Markets’ Reaction to the proposed replacement
of IAS17.

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https://simsmetalmanagementlimited.gcs-web.com/static-files/94983c52-add1-483f-a503-
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[Accessed 21 Jan. 2018].
Warren, C.M., 2016. The impact of International Accounting Standards Board
(IASB)/International Financial Reporting Standard 16 (IFRS 16). Property Management, 34(3).
Wong, K. and Joshi, M., 2015. The impact of lease capitalisation on financial statements and key
ratios: Evidence from Australia. Australasian Accounting Business & Finance Journal, 9(3),
p.27.