A Comparative Study of AASB 117 and AASB 16 Lease Accounting Standards

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Accounting Theory and Current Issues
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Abstract
A company needs to adhere to different accounting policies and provisions laid down by the
Australian Accounting Standards Boards while preparing and presenting financial statements.
For this purpose, AASB has published several accounting standards to address the issues which a
company might face while implementing these guidelines. Reporting and disclosures were
guided earlier by AASB 117 which require the company to follow a set of rules and guidelines
for measurement, recognition and disclosure requirements of leases assets. These guidelines
were required to be followed by both the lessee and the lessor. But this standard suffered from a
loophole in regards to the treatment of operating lease and thus created an environment of
ambiguity and inconsistency in the presentation of the financial statements. Thus to cope with
the situation and new standard, AASB 16 were introduced to address the loopholes by coinciding
the provisions of the old standard with the IFRS 16 and also requiring more disclosures in the
books of the lessee.
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Contents
Abstract..........................................................................................................................................................2
Critical Evaluation of AASB 117..................................................................................................................4
Need for a change..........................................................................................................................................5
Introduction to AASB 16...............................................................................................................................6
Effect on the Companies................................................................................................................................7
Applicability of Positive Accounting theory in this scenario........................................................................8
Comparability of Companies as per IFRS 16................................................................................................8
Preference for Buying over Leasing..............................................................................................................9
Key Disclosures regarding Leases.................................................................................................................9
Conclusion...................................................................................................................................................11
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Critical Evaluation of AASB 117
AASB 117 deals with the lease liabilities and assets of the company name, their classification,
accounting and their disclosures in the notes to accounts. They aid in set up and implement
accounting policies regarding lease agreements for both lessor and lessee. As per the provisions
of the AASB 117, a lease can be classified into:
Financial Lease: Financial lease in substance is in the nature of a loan provided to another person
where all the risks and returns are transferred substantially along with the asset, leading the
transfer of ownership of the asset to the lessee. Lessee enjoys the benefits of the depreciation on
such assets and even gets an option to purchase the asset at the end of the lease period. The term
of the lease coincides with the operating life of the asset and such that if the lease is terminated
before the decided period if the lessee's fault is chargeable to a penalty.
Operating lease: Other leases other than the financial lease is classified as the operating lease. No
specific definition has been provided in the accounting standard for the same.
Operating leases have been the area of debate in terms of accounting and measurement and
disclosure as per the provisions of AASB 117. The provisions of the standards have promoted
ambiguity and lack of understanding such as:
 Operating lease, like in the case of the finance lease is not disclosed in the balance sheet
and only the lease rentals are charged to the income statement. As the owner of the assets
is not transferred to the lessee, the same cannot be treated as an asset in the books of the
lessee and the lessor still retains the ownership of the asset. And thus, the value of such
assets is disclosed off-balance-sheet, such as in notes to accounts and other
disclosures(Joubert, et. al., 2017).
 Rental income is charged on a straight line basis or any other systematic process in line
with the cost-benefit pattern followed by the straight line pattern. As the lease is
considered as a normal business transaction, the same has to follow the concept of the
cost-benefit accounting suggesting that the expenses incurred over the asset recognized,
should be evenly distributed over the life of the asset or the benefits generated from such
expenses incurred(Sieverding,2018).
Guaranteed Residual value: Also there is a distinction in the calculation of Minimum Lease
Payments for lessee and lessor such that for the lessor, it includes any residual value guaranteed
by the lessee or the person related to the lessee or by a 3rd party capable of discharging the
obligations. Lessee calculates residual value guaranteed only by him and a person related to him.
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Need for a change
Due to inconsistency in the older AASB 117, a new revised standard AASB 16 was introduced
in February 2016 and was to be implemented by the companies and to be reported beginning on
or after January 2019. An effort was made to address all the inconsistencies such that the new
standard required more consistent accounting and measurement of the lease agreements and
more comprehensive disclosures both in the accounts of the lessor and the lessee. Substantial
changes were required such that it was necessary to bring uniformity in the presentation of
financial statements and the disclosures attached to the same(Yoshida, et. al., 2016). A major
concern for the Australian Accounting Standards Board was the need for the true reflection of
the company's true financial position. It was felt that the accounting standard needed to be more
proactive and meet the requirements of the changing accounting dynamics and culture. The
essence of information and disclosure provided in the financial statements should be that it
should be of some value for the users of the financial statements and help them in making the
decision making. Earlier standard although in line with the other standard disclosures and
provisions, they hid the complexities and risk attached to the lease agreements and hence made
their reporting inaccurate and biased. The new standard brought out the hidden issues which
required attention and proper disclosures in the financial statements.
Introduction not only made a sure not only accurate presentation of the financial position of the
company but also brought uniformity in the presentation of the financial performance (Income
Statement) by aligning the treatment of the rental expenses as per the requirements of the
internationally accepted accounting principles(Buchman, et. al., 2016). Although such changes
will have the wide-reaching commercial changes and transition from old AASB to the new one
will require additional disclosures and efforts while preparing the financial statements, such
changes will help in bringing about the required reforms in the accounting aspects and
consistency with the other accounting standards as well. Such changes will mandate the
companies to bring transparency in the valuation of assets and requiring them to disclose the true
value of assets in the books of accounts. Earlier deficiencies lead to the possibilities of the breach
of the bank covenants and thus increasing the chances of the breaches on the part of the lessee.
The new AASB 16 was basically to cease all the controversies surrounding the lease agreements
entered into by the companies.
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Introduction to AASB 16
AASB 16 was introduced as a coping mechanism for all the inconsistency faced by the
companies regarding the lease agreements and thus had all the relevant provisions and the
additional disclosures to overcome deficiencies in the older accounting standard AASB 117.
Such changes are briefly discussed as follows:
 AASB 16 requires the lessee to discard the classification of a lease as either operating or
financial and always account for it as financial lease only. Lessor doesn't need to change
the accounting treatment as such and still classify the leases, but in order to bring
uniformity, the lessee is now required to recognize all leases as the right of use assets in
the balance sheets and such amount shall be capitalized on a yearly basis with the
applicable discounting rate. However, there was an exemption provided to the leases with
a period of fewer than 12 months or leases with low-value assets(Altamuro, et. al., 2014).
 The measurement of the leased asset even if showing as operating lease in the books of
the lessor shall be done at the fair value such that it is discounted to present value using
the appropriate discounting factor. Any expense incurred in acquiring the lease is to be
deducted from the initial amount of recognition of the asset.
 The new AASB 117 also requires the lessee to provide more comprehensive disclosure
for the guaranteed residual value such that the netting off of the non-resources debt is not
permitted anymore. Lessee needs to disclose additional disclosures related to risk
management activities.
 Earlier, lease rentals used to be charged to the income statement on the straight-line basis
such that every amount a fixed amount used to be charged for the period of the lease or
for the period of benefits generation. As per the new provisions, as the lease is to be
classified as a financial lease, lease rentals are varied as per the discounted value of the
asset and more part is expensed out in the earlier years and gradually decreases in the
later years(Andrade, et. al., 2014).
Overall, AASB16 involved improved recognition criteria for lease agreements and their
disclosures.
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Effect on the Companies
In an attempt, to rectify the issues faced by the companies in the classification, measurement and
the disclosure requirements of the company, not only will it help the company in reflecting true
financial performance and the position of the company but will also require extra efforts from
them in the transition period as it will require detailed study and understanding of the new
provisions and their translation into their own accounting and disclosure policies. The changes
that will be witnessed will be as follows:
 Companies will be required to report their financial statements according to the new
accounting standard as the same will be reportable from 1st January 2019 and thus will be
effective for many Australian companies from 30th June 2020.
 Lessees will no longer be required to classify the lease as either operating or financial and
will be taken in the books of the accounts as a right of use asset in the balance sheet and
will be considered as an asset for the lessee. Although for Lessor the classification
doesn’t require any amendments and will continue to classify the same as per the nature
of the leases(Lee, wt. al., 2014).
 The change in the charging of rental expenses in the income statement will result in the
average increase in the Earnings before Interest, depreciation, and amortization and tax
such that now the movement of expenses will be seen below the EBITDA. The increase
is estimated at around 2.5 percentage points.
 The main impact has been felt by the telecom sector such that this sector highly employs
this method of acquiring assets or finances. Assets will show a significant increase of
around $125 billion as right in use assets and on the other hand will increase the liabilities
in the form of gross debts by 15-20%. This might result in the mismatch of the working
capital with the current part of the lease liability in the books of the lessee.
 It helps establish a system of control and check over the lessee's financials as the new
AASB will eliminate to show off-balance sheet disclosures regarding the value of the
assets in the case of operating assets. This will enable more streamlining and capturing of
data(Fitó, et. al., 2013).
 Companies such as telecom companies will need to inform the investors and other
stakeholders of all the relevant changes taking place and provide the transitional effects
on the accounts of the company.
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Applicability of Positive Accounting theory in this scenario
AASB 117 had several loopholes in the accounting of the operating leases for the lessee to
exploit and thus indulging in unfair accounting practices. Assets leased under the operating lease
were not required to be shown in the lessee's balance sheet and were treated as an off-balance
sheet item. This enabled the lessee to manipulate the value of the asset and thus charge more
rental expenses in the income statement(Öztürk and Serçemeli, 2016). Also, the rental income
was charged on a straight-line basis or in some other systematic manner for the period of
operating lease which depicted an unclear and inaccurate financial performance and position of
the company. On the other hand financial lease were treated as the loan taken in substance and
thus required to provide disclosures similar to that of borrowings and had to follow stringent
accounting policies for the same. Thus it was beneficial for the lessee to classify the lease
agreement as an operating lease.
Positive accounting theory is a predictive theory which tries to predict and understands the actual
accounting practices. Basically, it tries to predict what accounting practice a firm adopt and not
what it should adopt. According to positive accounting theory there exists an opportunist market
and perfect completion such that accountants and managers make decisions which are most
beneficial for their own self-interest. They have the perfect knowledge of the market and believe
that the efficient markets tend to reward good news and vice versa and therefore will always
make decisions that will bear good news in the market. As the classification of lease agreements
as the operating lease leads to good news (more profit and less cost), they prefer to classify the
same as an operating lease. The fact that the lease should be classified in a proper manner as per
the provisions of the accounting standards plays no role in this theory(Dogan, 2016).
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Comparability of Companies as per IFRS 16
IFRS 16 requires thatlike financial leases, operating leases shall also require lease assets to be
shown in the Balance Sheet and not treated as an off-balance sheet item. This will allow the
investors and other stakeholders to ascertain the financial position of the company such that it
helps them to analyze actual assets and liabilities of the company and compare for strategic issue
and purposes. A company buying as an asset will report an account for purchase assets in a
different manner than the company opting for leasing of assets. Although in both the cases the
ownership of the asset gets transferred to the company but in the case of leased assets the
ownership is only retained till the period of lease unlike in the case of purchase asset where the
ownership transferred permanently(Kostolansky, et. al., 2012).
Example: Company A purchases machinery for $25000having a residual value of $ 5000. While
the company B leases the same machinery for a total amortized cost of $20,000 with no residual
value. Depreciation will be charged at 10% on SLM basis. It can clearly be seen that in both the
cases the assets will be reported in different values and also the depreciation charged on them
will differ.
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Preference for Buying over Leasing
Normally, business opt for leasing option over the purchasing option as the latter one is more
expensive and requires additional documentation process for acquiring assets. On leasing,
companies need to pay fixed rentals on a periodic basis and get attractive benefits such as
maintenance, scheduled services, etc. As the new AASB16, requires the lessee to include the cost
of the asset as right in use assets and with having a dual impact on the liabilities side as gross
debts. Also, on purchase of assets, the lessee has the ownership of the assets for the rest of its
life, while in the lease the assets will only be available for the term of the asset. Although the
lessee has an option to purchase the asset at a price lower than the fair value of the asset at that
time, it would mean as an unnecessary cost on the part of the company. Operating leases cannot
be taken as off-balance sheet item and hence requires the same treatment as purchased assets
losing its advantage over the buying option(Joubert, et. al., 2017).
As the operating leases are no longer the off-balance sheet items, it reduces the possibility for the
manipulation of the value of assets and thus preventing the company from charging more lease
rentals to the Income Statement. AASB now requires more comprehensive disclosures in
comparison to before and thus each and every detail is needed to be incorporated into the balance
sheet. New AASB makes an effort to curb these fraudulent and unethical activities to make
accounting more transparent and consistent with the other accounting standards and accounting
provisions.
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Key Disclosures regarding Leases
TPG Telecom Limited is a leading Australian telecommunications company providing mobile
telephone services and IT services has taken both finance and operating lease. AS per AASB
116, a finance lease is reported as Other Finance Lease Liabilities at $5.5 million as current
liabilities and $12.4 million as non-current liabilities in the balance sheet, while the operating
leases are considered as off-balance sheet items as Operating Lease Commitments at $136.3
million. The total lease liabilities amount to $154.2 million. As per the new AASB 16, this
amount is to be completely taken in the financial statements and bifurcated into current and non-
current liabilities as per the lease period(TPG Telecom Limited, 2018).
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Conclusion
The aim of the assignment was to understand the drawbacks of the old AASB 117 and changes
that were needed to improve the presentation and disclosure requirement of the
financialstatements. Drawbacks of the old standards have been discussed comprehensively in the
report and what changes were implemented in the new AASB 16 to address those earlier
identified issues. For better understanding, several circumstances have been studied to help the
implications of the changes introduced and also an effort have been made for understanding the
role of IFRS 16 in the comparability of two companies opting for different investment strategies.
In the end, a public company TPG Telecom Ltd. has been chosen for understanding the
drawbacks of the old AASB in real life conditions.
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