Current Issues in Financial Reporting

This article discusses the current issues in financial reporting, specifically focusing on the impact of IFRS 16 leases on businesses. It explains the changes in lease accounting, including the recognition of leases on the balance sheet and the elimination of operating leases. The article also explores the effects of the new lease requirements on financial statements and ratios, as well as the industries most affected by these changes.

Running head: CURRENT ISSUES IN FINANCIAL REPORTING
Current Issues in Financial Reporting
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1CURRENT ISSUES IN FINANCIAL REPORTING
Introduction:
The IASB has issued the IFRS 16 leases which will replace the present standard of
IAS 17 leases. IFRS 16 has eliminated the notion of operating lease for the lessees and
effectively considers all the leases as the financial leases. The outcome is that all the leases
would be identified as the liabilities in the balance sheet instead of committing the same in
the notes of the financial statements (Beuselinck et al. 2017). As per IFRS 16, a lease is only
existent provided the customer has the right of controlling the use of the recognized asset for
a time period and substantially obtain all the economic benefit from the use.
The requirements of new IFRS 16 states that all the companies should recognize
leases on the balance sheet by capitalising the leases based on the present value of payments
and representing the lease as the assets whereas the future lease payments would be identified
as the financial stability. The present will discuss the new model of lease and its impacts on
the business. The main changes and the one the present essay would examine is that the IFRS
16 will not anymore by any difference between operating and financial leases in the financial
reports of the leaseholders.
Discussion:
Presently, company’s accounts for the item of operating lease provided that majority
of the risks and rewards are not yet transferred to them. In such situation, they merely record
the rental expenditure based on straight line basis over the terms of lease and not recording
any long term assets or liabilities (Morales-Díaz and Zamora-Ramírez 2018). Such
accounting treatment would come to an end excluding the circumstances where the low value
items and short term lease falling under twelve months.
This implies that the companies would be required to include the right of use assets
and a corresponding liability based on the present value of lease payments. While for

2CURRENT ISSUES IN FINANCIAL REPORTING
majority of the companies, this implies that the significant sum of assets and liabilities which
was recorded earlier and only stated under the disclosure note of lease commitments would
presently be required to include in the financial position statements (Li, Sougiannis and Wang
2017). This would presently close the practice of substantial leased property assets being the
off-balance sheet items and now these items will be bought into the balance sheet.
The most likely results are that majority of the entities would now approach the real
estate transactions in the different manner. Earlier, it might have been reasonable to obtain
properties under the operating lease instead of taking external borrowings for financing the
assets to keeping the degree of borrowings low (Morris 2017). This would not be anymore
the case and procurement teams would most probably indulge in the prolonged discussion
regarding the leasing or purchase of new assets.
The off-balance sheet items means the assets and debts or financing activities that is
not on the balance sheet of the company. Companies use them as the picture of assets and
liabilities at any point of time (Temiz and Güleç 2017). Under the new requirements nearly
all the off-balance sheet items would abolished which increase comparability but may impact
credit ratings, borrowings costs and perception of stakeholders on the organization.
The introduction of new lease would lead to change in profit and loss statements.
Presently, all the all the rental operating leases are presented as operating expenditure based
on straight-line basis as a result the same sum is expensed every year. As per new IFRS 16,
there would be both a finance cost and depreciation (Christensen et al. 2015). Under the IAS
17, the entities were under obligation of separating the components of lease and components
of services. While the absence of diligence in carrying out this exercise might not present an
issue relating to operating lease under the IAS 17 since both the elements were considered in
the identical fashion from the perspective of accounting.

3CURRENT ISSUES IN FINANCIAL REPORTING
Under the IFRS 16, as the lease component is necessarily required to be documented
on the balance sheet, the accurateness of the separation and the distribution of payments
among the lease and service elements would turn out to be more important (Pownall and
Wieczynska 2018). For example, a lessee might take the decision of accounting for lease and
non-lease components altogether as the lease but the outcome of doing so is that the service
elements would be identified on balance sheet.
Under the IFRS, the lessees are required to reconsider the term of lease given that
something significant happens which is inside the control of Lessee’s and creates an impact
on the assessment of lessees as to whether it would use the option of extending the term of
lease, purchase the asset or it would terminate the lease.
According to André, Filip and Paugam (2015) the lease term would create an effect
on the total lease liability identified. Consequently, judgement would be required to recognize
all the necessary factors and conditions that might affect the term of lease. Under this
situation, companies should consider the economic factors that are relevant for assessment
namely, contractual based, asset based, market based and company based. The examples of
economic factors also includes the costs associated to the cessation of lease, presence of
important leasehold improvements, the significance of underlying assets to the operations of
lessee’s and the previous practice of lessee’s relating to the period over which it has been
typically used over the types of assets.
As stated by De George et al. (2016) the new lease model would create an impact on
the financial statements. Under the new lease the balance sheet of lessees is anticipated to
growth in the form of right of use assets and lease liabilities that is related with the previous
operating lease would be identified on the balance sheet. In addition to this, the straight line
expenditure which was earlier identified for operating lease would be replaced by the

4CURRENT ISSUES IN FINANCIAL REPORTING
depreciation charge and the interest expenditure. Such kind of changes would lead to a form
of declining total lease expenditure as and when the lease matures which is similar to the
present expense identification pattern for the finance leases.
The proposed lease would create a significant effect on the several key financial
statement ratios computation that is used for evaluating the performance or position of the
company. For example, under the new IFRS 16, gearing ratios would increase because there
will be added liabilities that would be bought into the debt element of computation. Beside
the deterioration of gearing computations the figures of EBITDA is probably going to
increase for those companies that would be applying the new mode of IFRS 16 (Giner and
Pardo 2018). The prime reason for this is that the operating lease rentals would not anymore
exist and would be replaced by the finance and depreciation costs as both are excluded from
the EBITDA. As evident, this would prohibit the comparability of the EBITDA among the
companies that are implementing IFRS 16 and some US firms that chooses to record the
items in the profit and loss statement as operating lease under ASC 842.
Another evidences that can be cited is the computations of return on capital employed.
The ROCE would fall under the IFRS and US GAAP because any rise in operating profit is
not proportionately associated to rise in capital employed. For example, in the recently
concluded quarterly report BMW has bought forward the question regarding the future
significance of ROCE as the performance indicator. The change in standard of lease would
not significantly impact the cash flow of an organization but would probably impacts its
valuations.
As opinion by (Magli, Nobolo and Ogliari 2018) there are certain industries that
would be impacted under the new IFRS 16. The retail and consumer product companies are
anticipated to be impacted most significantly from the changes in new lease requirements.

5CURRENT ISSUES IN FINANCIAL REPORTING
This is particularly in cases where the leased retail space forms the most important portion of
an organization’s business model. The manufacturing companies would be required to take
into account all the main contracts that is entered by them, particularly the rental of
manufacturing plants, distribution centres and fleet arrangements that forms the part of
distribution networks. As a practical example, Tesco represents £34 billion liabilities on its
balance sheet however it discloses an additional £11.4 billion under future operating lease
commitments.
The airline industry would also be heavily impacted since majority of the airline
companies holds aircraft, ground facilities and terminal space under lease (Laidlaw and
Ljungqvist 2018). As a practical example, the scale of impact is witnessed in American
Airlines as the yearend figures for 2017 stood US $11.7 billion under future operating lease
commitments.
The new standard of lease might lead to renegotiations of current leases to reduce
their impact on the new standard of leases. The removal of off-balance sheet accounting and
rise in administrative weight may lower the attraction of leases. Subsequent to external
transparency on leases, the new IFRS 16 lease model would increase the transparency within
the organization and may attract more economic lease decisions to enable portfolio
optimisation.
Conclusion:
On a conclusive note, there are few companies that have responded that the
application of new IFRS 16 with hindsight by adjusting with the previous year financial
statements while others have undertaken the option of implementing new standard
prospectively but would adjust the overall effect on the retained earnings. In the upcoming
year, the comparability under the new lease model would be challenged and definitely means

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that users would require careful considerations and understanding of implementing the
model.

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References:
André, P., Filip, A. and Paugam, L., 2015. The effect of mandatory IFRS adoption on
conditional conservatism in Europe. Journal of Business Finance & Accounting, 42(3-4),
pp.482-514.
Beuselinck, C., Joos, P.P., Khurana, I.K. and Van der Meulen, S., 2017. Which Analysts
Benefited Most from Mandatory IFRS Adoption in Europe?. Journal of International
Accounting Research, 16(3), pp.171-190.
Christensen, H.B., Lee, E., Walker, M. and Zeng, C., 2015. Incentives or standards: What
determines accounting quality changes around IFRS adoption?. European Accounting
Review, 24(1), pp.31-61.
De George, E.T., Li, X. and Shivakumar, L., 2016. A review of the IFRS adoption
literature. Review of Accounting Studies, 21(3), pp.898-1004.
Giner, B. and Pardo, F., 2018. The Value Relevance of Operating Lease Liabilities:
Economic Effects of IFRS 16. Australian Accounting Review, 28(4), pp.496-511.
Laidlaw, C. and Ljungqvist, M., 2018. The Impact of Leasing Standard IFRS 16: A case
study which examines practitioner’s perception of the change in leasing standard from IAS
17 to IFRS 16.
Li, S., Sougiannis, T. and Wang, I., 2017. Mandatory IFRS Adoption and the Usefulness of
Accounting Information in Predicting Future Earnings and Cash Flows.
Magli, F., Nobolo, A. and Ogliari, M., 2018. The Effects on Financial Leverage and
Performance: The IFRS 16. International Business Research, 11(8), pp.76-89.
Morales-Díaz, J. and Zamora-Ramírez, C., 2018. The Impact of IFRS 16 on Key Financial
Ratios: A New Methodological Approach. Accounting in Europe, 15(1), pp.105-133.

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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.
Pownall, G. and Wieczynska, M., 2018. Deviations from the mandatory adoption of IFRS in
the European Union: Implementation, enforcement, incentives, and
compliance. Contemporary Accounting Research, 35(2), pp.1029-1066.
Temiz, H. and Güleç, Ö.F., 2017. Mandatory adoption of IFRS in emerging markets: the case
of Turkey. Accounting and Management Information Systems, 16(4), pp.560-580.