Effect of NZ IFRS 16 on Company's Financial Health

The report analyzes the effect of new NZ IFRS 16 on the financial health of the company, including changes in financial ratios and lease agreements. It discusses the implications of the new standard on the company's balance sheet, the recalculation of financial ratios, and the impact on potential investors' view of the company's performance and investment reliability.

Running head: LEASES.
Leases.
Name of the student:
Name of the university:
Author Note:

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Executive Summary:
The report is prepared to show the effect of new NZ IFRS 16 on the company and the
financial health of the company. The effect of such changes is summarized with the
recalculation of financial ratios with relevant calculation of capitalized value of lease
agreement. The changes in standard has led to the changes in the principles and formation of
new lease agreement and termination of old operating leases with subsequent effect on the
financial need and obligation of the company. The revised financial ratios has changed
potentials investors’ view regarding company’s performance and the reliability of the
investment made.

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Table of Contents
1. Leases- The warehouse..........................................................................................................3
1.1 Detailed summary of NZ IFRS 16 and its implications on the company........................3
1.2 Journal entries..................................................................................................................3
1.3 Effect of new NZ IFRS 17 on the financial ratios and the Balance sheet........................4
1.4 Effect of new NZ IFRS 17:..............................................................................................5
2. Conclusion..............................................................................................................................7
3. References:.............................................................................................................................8
3. Appendix:...............................................................................................................................9

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1. Leases- The warehouse.
The Lease is a contract where a person pays a sum for use of a property, services etc
for a specified period. It binds both the party i.e. lessee and lessor in a contractual obligation
to perform. The obligation party is dependent upon the terms of the contract. The lessee is
entitled for the use of asset on the payment lease rental and the Lessor is entitled for the
periodic payment of rent from lessee for the use of property. Previously there was two types
of lease agreements, operating lease and finance lease but NZ IFRS 17 has abolished the
definition of operating lease. Therefore, from the implementation of new accounting
standard, all lease agreements will have to be classified as finance lease with corresponding
impact on the balance sheet instead of charging the rentals of operating lease in the profit &
loss account.
1.1 Detailed summary of NZ IFRS 16 and its implications on the company.
The new NZ IFRS 16 has introduced replacing NZ IAS 17. The NZ IFRS 16 comes
into effect from 1st January, 2019. The main changes in it is that all lease are now to be
capitalized. The capitalization should be done based on present value method. The discounted
factor that is to be used to calculating the present value of lease obligation is to be based on
the rate of interest that is to be charged by the lessor. Previously, the rentals of operating
lease is to be charged as expenses from the profit & loss account. Corporates mostly uses
operating lease as a tool for reducing their actual tax liabilities and under-stating their overall
profit but now introduction of new NZ IFRS has resulted into shutting down such doors of
bad practices.
1.2 Journal entries.

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1.3 Effect of new NZ IFRS 17 on the financial ratios and the Balance sheet.
The table shown below states the key financial ratios before and after implementation
of new NZ IFRS 17.
It can be seen from the table that ROA has been decreased from 0.05 to 0.02, which
is the result of increased amount of asset and decrease in EBIT. This happened just because
capitalizing the principal portion and charging the interest portion of rental payment resulting
into increased interest expenses. The resulted ROA is lower than the previously stated ROA.
This can be seen as an early sign of underutilization of assets for generating income.

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From the analysis of interest coverage ratio, it can be interpreted as that the company
lacks in covering its interest expenses as compared to its EBIT. The resultant figure is enough
to explain that the interest burden is taking most of the profits from the company. Therefore,
the company should focus more on ways to reduce such interest burden.
The debt to total asset has significantly increased due to capitalizing the value of the
assets. The resultant ratio interprets that how much asset of the company is a part of debt
financing. The previous ratio tells that the only 54% of total asset is financed by the debt but
new ratio indicates that 70% of total asset is debt financed. The ratio indicates that how much
company owe in terms of total assets to the debt holders of the company.
1.4 Effect of new NZ IFRS 17:
The new standard its own impact on the measurement of the leased assets as well as
financial performance of the company. The new standard has classified all lease in one
category and has introduced universal treatment of lease agreement in the books of accounts.
Previously company used to take advantage of operating lease as an expenditure resulting
into lower profit reported and lower tax liability.
As the warehouse is debt covenant, termination of lease contracts will have legal as
well as financial impacts on the company, which may have extra obligation for the company.
The CFO should consider all the relevant points or areas of effect of termination of such
contracts. Termination of the lease agreement may create bad image of the company or will
divert its obligations generally arise due to termination.
The changed principle has serious impact on the financial ratios. The investors’
perspective regarding valuing the warehouse may change accordingly. Investors mainly rely
on the financial ratios and financial statements, any change in the elements of financial

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statement may change investors view for such warehouse. An increase in debt may tell
another story for Debt-equity ratio used to analyze the debt burden company mostly have.
The new ratios has diverted investors trust from the company as the new ratios indicate poor
financial health of the company.

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2. Conclusion
The new NZ IFRS 16 has affected the overall financial ratios. It has changed the
whole ratios and has revealed major weakness in the financial reporting of the company. It
also changed the recognition of lease expenses in the financial statements. The concept of
operating lease is of no use in the present NZ IFRS 16. So, the retrospective effect should be
made on those operating lease agreement still in operation and these lease should be
converted with the retrospective effect on the income recognition and valuation of assets and
liabilities of the company.

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3. References:
Graham, R.C. and Lin, K.C., 2018. How will the new lease accounting standard affect the
relevance of lease asset accounting? Advances in accounting, 42, pp.83-95.
Hunt, K.G., 2017. BALANCING ACT: HOW THE FASB'S NEW LEASE ACCOUNTING
STANDARD COULD AFFECT BUSINESS PRACTICES. Journal of Property
Management, 82(6), pp.32-36.
Lloyd, S., 2016. A new lease of life. Investor Perspectives.
Paik, D.G.H., van der Laan Smith, J.A., Lee, B.B. and Yoon, S.W., 2015. The relation
between accounting information in debt covenants and operating leases. Accounting
Horizons, 29(4), pp.969-996.
Sommers, G. and Easton, P., 2018. Changes in Financial Accounting for Lease Transactions
will not Affect Equity Valuation. The CPA Journal, 88(6), pp.18-19.
Wong, J., Wong, N. and Jeter, D.C., 2016. The economics of accounting for property
leases. Accounting Horizons, 30(2), pp.239-254.

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3. Appendix:

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