Financial Accounting of IFRS Assignment

HỌC VIỆN TÀI CHÍNH
VIỆN ĐÀO TẠO QUỐC TẾ
Institute of International Finance Education
D U A L D E G R E E P R O G R A M M E - D D P
ESSAY
Title of the essay: IFRS 16: why it was issued and its impact on financial
reporting in practise
Course name: ADVANCED FINANCIAL ACCOUNTING & ADVANCED MANAGEMENT ACCOUTING
Academic Year (Semester): 2019-2020 (Semester 1)
Student Full Name: Pham Vu Anh
IIFE ID: DDP0203003
Class Code:
Teacher:
Word count:
Hanoi, December 2020

Financial Accounting
LIST OF ACRONYM
Acronym Meanings
1 SOFP Statement of Financial Positions
2 IFRS International Financial Reporting Standard
3 IASB International Accounting Standard Board
4 IAS International Accounting Standard
5 SOPL Statement of Profit & Loss
6 EBITDA Earnings before Interest Taxes Depreciation/Amortisation
7 FASB Financial Accounting Standards Board
I. INTRODUCTION
Leasing now a popular product in business financing is used in many countries all
around the world. According to Taylor (2011), leasing is the biggest foreign source of
financing, higher than loans from financial institution or commercial mortgages. This judgment
leads to demand for a standard array to report this account in SOFP. On 1 January 2016, a
new accounting standard about lease IFRS 16 was published by IASB and in effect for
companies that report under IFRS since 1 January 2019. It replaced the old leasing standard
IAS17 and had a significant impact on reporting lease contract. This coursework will examine
the reasons for this replacement and discuss the impact on Financial Reporting in practice.
Keywords: IFRS 16, lease accounting standard, IASB, impact financial reporting
II. ANALYSIS
A. Why IFRS 16 was Issued?
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Financial Accounting
According to IASB chairman Hans Hoogervorst:
“These new accounting requirements bring lease accounting into the 21st century, ending the
guesswork involved when calculating a company’s often-substantial lease obligation. The
new standard will provide much-needed transparency on companies’ lease assets and
liabilities, meaning that off balance sheet lease financing is no longer lurking in the shadows.
It will also improve comparability between companies that lease and those that borrow to
buy.”
To specify, under IAS 17, the lessee classifies the lease contract to operating lease or
financial lease. If the lease was classified as an operating lease, only lease payments are
treated as an expense on SOPL and It does not have any impact on account in SOFP.
Therefore, numerous non-cancellable operating leases were represented as an asset (or
liability) but these accounts were disclosed in the note of SOFP mandatory. It is difficult for the
financial statement’s intended user to pay attention to this information.
B. The Impact on Financial Reporting in practice
1. The forecast of impact before IFRS 16 in effect
After 1 January 2016, there are many studies discuss about the result will be happened.
According to the anylysis of IASB, the one has developed this new lease standard, shows that
IFRS 16 has a significant impact on the balance sheet and performance indicator in the
companies classifying leases as an operating lease.
1.1 Effect on balance sheet:
↑ Lease asset
↑ Financial liabilities
↓ Equity
IFRS 16 requires a company to report on the balance sheet lease assets and lease
liabilities for all leases (other than short-term leases and leases of low-value assets).
The actual effect on a company’s reported equity will depend on the company’s
financial leverage, the terms of its leases and the ratio of lease liabilities to equity. This in turn
depends on the proportion of assets the company owns, the proportion of assets leased and
how the company finances its operations.
1.2 Effect on Income Statement
↑↑ EBITDA
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Financial Accounting
↑ Operating profit & Finance cost
↔ Profit before tax
For companies that have material off balance sheet leases, IFRS 16 is expected to
result in higher profit before interest (for example, operating profit) compared to the amounts
reported applying IAS 17. This is because, applying IFRS 16, a company presents the implicit
interest in lease payments for former off balance sheet leases as part of finance costs. In
contrast, applying IAS 17, the entire expense related to off balance sheet leases was included
as part of operating expenses. The size of the increase in operating profit, and finance costs,
depends on the significance of leasing to the company, the length of its leases and the
discount rates applied.
1.3 Effect on Cash Flow Statement
↑ Cash Flow from Operating activities
↓ Cash Flow from Financing activities
↔ Total Cash Flow
IFRS 16 is expected to reduce operating cash outflows, with a corresponding increase
in financing cash outflows, compared to the amounts reported applying IAS 17. This is
because, applying IAS 17, companies presented cash outflows on former off balance sheet
leases as operating activities. In contrast, applying IFRS 16, principal repayments on all lease
liabilities are included within financing activities. Interest can also be included within financing
activities applying IFRS
Table 1. Change on Key Financial Metrics
Change Effect
Recognition of an asset that
was previously unrecognized
Higher asset base, which will affect ratios such as asset
turnover.
Recognition of a liability that
was previously unrecognized
Higher financial liabilities, which will affect financial leverage
(gearing).
Recognition of depreciation
and interest instead of
operating lease expense
Higher operating profit at initial time, but total expense for
period remain the same.
Table 2. Effects on Key Financial Ratio
Ratio What it
measures
Common method
of
calculation
Expected
effect Explanation
Leverage Long-term Liabilities/ Equity ↑ Increase because financial liabilities increase
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Financial Accounting
solvency (and equity is expected to decrease).
Interest
cover
Long-term
solvency
EBITDA/ Interest
expense Depends
EBITDA will increase applying IFRS 16 as will
interest expense. The change in the ratio will
depend on the characteristics of the lease
portfolio.
Current
ratio Liquidity Current assets/
Current liabilities ↓ Decrease because current lease liabilities
increase while current assets do not.
Asset
turnover
Profitabilit
y Sales / Total assets ↓ Decrease because lease assets will be
recognised as part of total assets
EBIT
(Earning
s
before
interest
and
taxes)/
Operatin
g
profit
Profitabilit
y
Various methods—
Profit that does not
consider earnings
from investments
and the effects of
interest and taxes
↑
Increase because the depreciation charge
added is lower than the expense for off-
balance sheet leases excluded.
EBITDA Profitabilit
y
Profit before interest,
tax, depreciation and
amortisation
↑ Increase because expenses for off balance
sheet leases are excluded.
Profit or
loss
Profitabilit
y
As reported applying
IFRS Depends Depends on the characteristics of the lease
portfolio and the tax rate.
EPS
(Earning
s
Per
Share)
Profitabilit
y
Profit or Loss /
Number
of shares in issue
Depends
Depends on the effect on profit or loss, which
depends on the characteristics of the lease
portfolio and the effects on tax.
ROCE
(Return
on
Capital
Employe
d)
Profitabilit
y
EBIT / Equity plus
financial liabilities Depends
EBIT will increase applying IFRS 16 as
will financial liabilities. The change
in the ratio will depend on the
characteristics of the lease portfolio.
ROE
(Return
on
Profitabilit
y
Profit or Loss /
Equity
Depends Depends on the effect on profit or loss, which
in turn depends on the lease portfolio
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Financial Accounting
Equity)
Operatin
g
cash flow
Profitabilit
y
Various methods—
Cash
flow from operating
activities do not
include cash related
to
equity and
borrowings
↑
Increase because at least part of the lease
payments (those payments relating to the
principal) will be moved to the financing section
of
the cash flow statement.
As can be seen, the result was consistent. The only factor could flactuate the result is
the change on the lease portfolio.
Following this result, on 12 February 2018, José Morales-Díaz & Constancio Zamora-
Ramírez (2018) reaffirmed the impact of IFRS 16. Furthermore, they use a more
comprehensive sample with 646 European Quoted Companies which has operating lease
expense.
In general term, 3 keys financial matrix is total asset, total liabilities and operating
profit remained the trend with Meryem Öztürk & Murat Serçemeli (2016) but it not consistent.
The result has a big different related to sector of the entity.
The most affected sectors are those in which the ratio operating lease expense
divided by total liabilities (lease intensity) is higher, basically the retail, transportation, hotels,
and software and services sectors. In the case of the first three this is due to the ‘offbalance
sheet’ finance level they maintain, and in the case of software and services this is due to the
small size on the balance sheet.
Additionally, the result can be different from entities in the same sector because of
scale of off-balance sheet items.
2. The result after IFRS 16 in effect
According to Jonathan & Momtahira (2020), a compare between the result of forecast
and empirical evidence.
Forecast Actual
Similar
Total asset ↑, total liabilities ↑, EBITDE ↑ but the result has
a huge variation in magnitude because of sector
Leverage ratio ↑
Different D/E ratio increased but with
median effect equal tha the
D/E ratio increased for all
companies, with a median
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effect observed on total
liabilities
effect larger than the
median effect observed on
total liabilities => negative
effects on equity
III. CONCLUSION
In conclusion, IFRS 16 not only have a significant impact on reporting Financial
Statement but also on decision making, forecasting Financial statement (Anh 2019). Some
findings add to the debate on the usefulness and informational content of lease capitalization
and suggest that the changes might have been beneficial to users of financial statements
such as analysts, either by increasing the utilizable information or reducing the need for
manual adjustments. The standard need to be observed more time to assess these effects
and how an entity mitigates the effect of IFRS 16.
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IV. REFERENCE
 Taylor, J., 2011. "The history of leasing", Finance and Business Institute
 Morales-Díaz, J., Zamora-Ramírez, C (2018). The Impact of IFRS 16 on Key
Financial Ratios: A New Methodological Approach" in Accounting in Europe
vol. 15 no. 1, pp. 105-133
 Meryern, O., Murat, S., 2016. “Impact of New Standard “IFRS 16 Leases” on
Statement of Financial Position and Key Ratios: A Case Study on an Airline
Company in Turkey” in Business and Economics Research Journal vol. 7
no.4, pp.143-157
 International Accounting Standards Board (2016). Effects analysis. IFRS 16
leases. London: IFRS Foundation (January)
 Andrey, O., 2019. “Impact of the New Zealand Equivalent to the International
Financial Reporting Standard 16 Leases (NZ IFRS 16) on Financial
Statements of Listed Companies”
 Pham, T., T., A., 2019 “The impact of IFRS 16 on Financial analysis forecast:
Empirical evidence from european company”
 Jonathan, S., Momtahira, R., 2020 “Implication of IFRS 16 Adoption: Evidence
from Swedish publicly listed firm”
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