Impact of AASB 16 on Financial Reporting: A Case Study of AMP Limited

Desklib provides solved assignments and past papers to help students succeed.

ACCOUNTING THEORY AND CURRENT ISSUES
1

Abstract
The study has identified the importance of lease accounting and different accounting
standards relevant to it. It has discussed about the old accounting standards of lease
and it has been observed that AASB 117 and IAS 17 had large number of drawbacks.
The study has helped in finding out the reasons for changes in lease standards. On the
other hand it has also shed light on the relation of positive accounting theory. View of
IASB has been discussed and the disclosures for lease in the context of AMP limited
have been outlined. In context of the chosen organisation that is AMP limited it has
been seen that AASB 16 requirements have not been followed.
2

Table of Contents
Introduction...................................................................................................................... 4
1. Old accounting standard for lease and its drawbacks................................................4
2. Necessity of change...................................................................................................5
3. Incorporation of changes in new accounting standard for lease AASB 16..................5
4. Effect on companies...................................................................................................6
5. Lease contract known as operating lease and relation of positive accounting theory
with behaviour of managers.............................................................................................7
6. View of IASB..............................................................................................................8
7. Implementation of AASB 16 and action of entities....................................................8
8. Disclosures of the company regarding leases............................................................9
Conclusion....................................................................................................................... 9
References.....................................................................................................................10
3

Introduction
Accounting for lease as per Australian accounting standards have been observed to be
of critical importance for different companies. This is because it affects the preparation
of financial statements of companies that are associated with real estate and
procurement generally. The study has discussed about the old accounting standards for
lease and this has helped in highlighting limitations of the older version of accounting
standards. The study has helped in understanding the effects of incorporation of the
new changes that have been introduced in new accounting standard for lease. The
study has helped in finding out the reasons for changes in lease standards. On the
other hand it has also shed light on the relation of positive accounting theory. View of
IASB has been discussed and the disclosures for lease in the context of AMP limited
have been outlined.
1. Old accounting standard for lease and its drawbacks
Old accounting standards have been identified to be IAS 17, AASB 117 and others.
Under AASB 117 it has been defined that lease is an agreement that helps in conveying
the lessee about the right to utilize an asset for a specified period of time against a
payment of lump sum amount or series of payments made (James, 2016). This
definition has been found out to be more focussed towards payments associated with
leases and does not define the requirements of leases in detail. In case of IAS 17’s
definition of lease agreement it has been seen that lease has been observed to be an
agreement for transferring rewards and risks. This definition has been found to be
incomplete since it has been seen that more focus has been put more on the risk or
reward to which a lessee or lessor carries.
On the other hand, it has been seen that the components of lease and non-lease were
not accounted for in the balance sheet as per the requirements of AASB 117 (Dogan,
2016). This leads to inaccurate determination of assets and liabilities for the companies.
It has been seen that not including the lease or non- lease complaints as well as other
costs related to it in the balance sheet leads to incomplete production of balance sheet.
The old accounting standard in relation to leases had a requirement where in the
lessors and lessees were needed to recognise leases either as finance or operating
lease. This resulted in an inappropriate accounting for risk and rewards. The previous
requirement of the accounting standard does not help in accounting for assets and
liabilities in an effective way. Moreover while classifying leases as either finance or
operating, lot of time as well as confusion used to be observed. On the other hand the
operating leases are not considered for inclusion in the balance sheet. This impacted
the capital structure of the company. Therefore the shareholders were not presented
with a true and fair view of the financial statements. As per the opinion of Lloyd (2016),
it did not help in meeting the needs of the users of financial statements. In addition to
this it has also been understood that the main limitation lied in the fact that leases were
not considered to be a part of either asset to liabilities if or arised from operating leases.
Therefore it can be understood that there was a requirement for changes so that a true
and fair view of the financial accounts can be presented to the users.
4

2. Necessity of change
The changes have been seen to be necessary because of the following reasons:
● It has been seen that in earlier accounting standards there has been more focus
put on the relationship between lessor and lessee or on the risks as well as
rewards that can be obtained from them. Moreover focus had been on payments.
These led to inappropriate presentation of lease in the financial assets. This is
because the main purpose of leases is to transfer the right to use different assets
that are required for use in business extensively (Joubert, Garvie and Parle,
2017).
● On the other hand, the requirement to classify leases on the basis of financial or
operating terms, lead to misrepresentation of assets in the balance sheet. This
basis has only been decided on the fact that risk and rewards are not transferred
in case of operating lease (Denis and McKeon, 2018).
● Users of financial statements have not been benefited much as they have been
provided with incomplete and misrepresented financial statements.
● In addition to this changes have been seen to be necessary in case of shifting
focus from risk and rewards to the use of assets.
● The changes were required to be introduced in the lease accounting system
because it would lead to accurate measures of assets. Moreover the balance
sheet would then reflect the true view of the debt capacity of the firm.
3. Incorporation of changes in new accounting standard for lease
AASB 16
The changes that have been introduced in the new accounting standards that is AASB
16 have been outlined to be as follows;
● AASB 16 has introduced a model that is related to single lessee. Under this
model of single lessee, requirements to identify or recognise liabilities and assets
for all the leases have been added. The term of such lease should be within 12
months and the assets should not be of low value.
● On the other hand, it has been seen that a lessee is needed to recognise the
right to use assets and lease liability so that payments under lease agreement is
made effectively (Wong and Joshi, 2015).
● It has been seen that changes in regards to right to use of assets should be
measured like any other non-financial assets. For example the measurement
taken for plant and equipments as well as property should also be applied for
measuring right to use leased assets.
● Furthermore, it has been observed that in case of right to use assets depreciation
amount is required to be determined and in case of obligation to pay the lease
rentals, interest amount is required to be calculated (James, 2016).
● Present value basis is required to be used to measure the liabilities and assets
under AASB 16. This is because it would help in determining the actual value of
5

the assets and liabilities (Firth and Gounopoulos, 2017). Moreover the inflation
factor has been taken into account.
● The measurement of present value includes non-cancellable lease payments that
are those leases that are generally linked to inflation. On the other hand it also
includes the payments that are made in an optional period basis.
● AASB 16 has also introduced disclosure requirements in case of Lessees. They
would be required to make decisions regarding information that they would be
disclosing to meet the objective of offering true and fair view of the financial
statements to shareholders.
● Though the requirements of classifying operating and finance leases that were
there in AASB 117 have been kept same, still improvements in terms of
enhanced disclosures have been made. This has been seen to be same in the
context of lessor.
4. Effect on companies
The changes that have been introduced with the help of AASB 16 have significant level
of impact on the firms that involve lease financing to a certain extent. These impacts
have been discussed in detail below;
● The new changes have been found to impact the financial statement positively as
well as the performance of the firms in a positive manner. This is due to the fact
that the shareholders would be able to get a true and accurate view of the assets
and liabilities as well as income statements that are generally affected by lease
payments (Morales-Díaz and Zamora-Ramírez, 2018). This has been seen to be
possible due to the fact that accounting for finance and operating leases have
been removed in the context of lessee. This would help in taking into
consideration operating leases also in the balance sheets.
● On the other hand, it has been seen that costs related to the use of assets that
have been leased would also be included. Benefits related to the use of leased
assets would also be included. Therefore in the view of Öztürk and Serçemeli
(2016), it would help in analysing the extent to which a firm has to bear costs and
the amount of profits it is making from it.
● The effect on companies has been found to be mostly positive. This is due to the
fact that shareholders and other stakeholders have gained more confidence on
the operations of businesses. This has been in turn due to the reason that the
position of businesses at the end of year reflects the true position of assets and
liabilities.
However in spite of the positive changes it also holds disadvantages or negative
impacts for the businesses. These have been explained below in detail;
● It has been seen that, the changes have significantly increased the level of risk
risk related to financial and commercial reporting. It has been so observed
because an organisation would be exposed to more to the external environment
and it would lead the organisation to even outline the issues inherent in front of
the large number of stakeholders. Moreover the complexities within an
organization would also have to be accounted for.
6

● On the other hand, it has been seen that another limitations includes changes in
the rental expenses determination or profile. Earlier it has been seen to include
straight line rental charges. However in case of the new changes, different
method that is more charges in the initial period would be included and less
would be charged for the later part of the years. This would make the charge of
lease payments more of complex nature.
● The EBITDA or earnings before interest taxes depreciation and amortisation
would be impacted positively and this would lead to its increase. However the
actual profit that is the net profit after taxes would be reduced (De George, Li and
Shivakumar, 2016). This would be due to the fact that lease expenses would be
reduced from the EBIT and large amounts of lease rentals as well as interests
would be reduced thus reducing the net profits.
● Another significant effect on the business that is considered to be negative is
found to be in relation to right to use of assets. Right to use assets would be
taken as non-current and lease liability would be treated both as current and non-
current. This would impact the working capital determination (Eaton et al. 2018).
● In addition to this, it has been observed that there would be a substantial level of
impact on the bank covenants this is because there might be rise in breaches.
Hence the companies would have to take a proactive approach in relation to this.
5. Lease contract known as operating lease and relation of positive
accounting theory with behaviour of managers
The firms generally treat lease as operating lease because it follows the requirements
that outlines the conditions. The conditions that are in the opinion of Nuryani, Heng and
Juliesta (2015), sufficient to identify an asset as a operating or capital have been
discussed below;
Capital lease or finance lease are the ones which can be transferred to the lessee at the
end of the lease agreement.
On the other hand, the lease which contains of a bargain purchase option is required to
be treated as capital lease. Moreover it has been seen that the life of the lease must
exceeds 75% of the life of the asset. In this case it is identified to be a capital asset. A
capital lease or finance lease has a present value that exceeds 90% of the fair market
value of the assets (aasb.gov.au, 2019).
In most of the cases, none of the conditions are seen to be met for the companies
largely. Therefore lease contract is treated by them as a operating lease. Moreover it
has been known that most of the organisations hesitate to take up the risk of ownership
of leased assets. In addition to this it has been seen that, the organisations do not
involve in a bargain purchase option most of the time (Hussey, 2018). Therefore it is
understood that to a large extent operating lease is undertaken by the companies.
Positive accounting theory has been seen to be applied in the context of the
managers’ behaviour to adopt methods at the time of changes in accounting standards.
In the opinion of Lloyd (2016), it has been seen that managers get motivated to make
and adopt changes in the production of financial statements. They adopt changes so
that they are able to reflect true view of the financial position the company they are
7

working for. On the other hand they find relevant changes in the financial statements
important and thus act positively. Moreover it has been found out that the managers are
of the view that if relevant changes are not incorporated in the preparation of financial
statements then stakeholders interests would not be met.
6. View of IASB
The view of IASB that AASB 16 would help in making comparisons effective between
large number of companies which play the role of lessor and lessee has been discussed
as follows;
The view of IASB is in line with the changes made in the new accounting standard for
lease that is AASB 16. Comparison between firms that lease assets and the companies
that borrow to buy assets would become simple as the need to classify operating and
finance lease have been changed. In case of lessee companies, there is no requirement
to treat the lease as operating lease and hence take into account all the payments as a
part of balance sheet. This has helped in removing the off balance sheet transactions
and thus comparison of firms within the similar industry would be easily done. Since all
firms will take into account the lease asset, therefore the assessment of financial
position performance would be possible (Morales-Díaz and Zamora-Ramírez, 2018).
For example in the earlier case, it has been seen that some companies used to treat
lease as a part of operating lease. Hence the balance sheets did not reflect the lease
related expenses or incomes (Firth and Gounopoulos, 2017). On the other hand other
companies used to account it as finance lease. However due to the changes
incorporated in the new accounting standard AASB 16, the basis of comparison would
be similar and hence comparison can be done easily.
In case of the lessor companies, it has been seen that no distinction has been done in
regards to finance and operating lease. Thus the companies that provide assets on
leases have to prepare statement as per the new requirements accordingly. Earlier in
similar way of lessee, in certain cases operating lease were considered and certain
companies used to assess it as finance lease (Eaton et al. 2018). However the new
changes would help in making the base similar and therefore comparison can be done
without any problem.
7. Implementation of AASB 16 and action of entities
In case of leasing assets the firms get involved in the risk of ownership as well as
payment of regular lease rentals (Joubert, Garvie and Parle, 2017). Moreover the new
changes that have been incorporated has been seen to eliminate the operating lease to
a larger extent. This means that businesses would be no longer allowed to make off
balance sheet transactions. This would lead to increase in assets as well as increase in
liabilities also. The capital structure of the firm would show that the firms are more
dependable on the debts and less on equities or have high gearing ratios ( Nuryani, Heng
and Juliesta, 2015). Therefore it can be said that this aspects would lead the companies
to buy more assets and less of leasing assets. Organisations would prefer purchasing
assets more in comparison to leasing them because it would not involve payment of
high lease rentals and risk of ownership.
8

8. Disclosures of the company regarding leases
The chosen organisation that is also listed on Australian stock exchange has been
found out to be AMP limited. It has been seen that the company has not followed the
changes required to be incorporated as per AASB 16 (corporate.amp.com.au, 2019). It
has been highlighted in its annual reports that the organisation would incorporate
changes as per AASB 16 from the period starting from 1st January, 2019. It would only
recognise leased assets as a part of the balance sheet as well as the low value assets
acquired on lease would not be recognised. However it has been seen that AMP group
limited has been found to make an estimate or an assessment impact of the lease
rentals for the period of 2019. It has been observed that the estimated impact would be
$200 million to $220 million. The impact assessment suggests that lease liabilities
would increase considerably (corporate.amp.com.au, 2019). On the other hand it has
specified that it would be recognising depreciation expenses to measure the right to use
assets and interest expenses would be used to measure lease liabilities.
Conclusion
The study has identified the importance of lease accounting and different accounting
standards relevant to it. It has discussed about the old accounting standards of lease
and it has been observed that AASB 117 and IAS 17 had large number of drawbacks.
The limitations inherent in them did not let to showcase actual and fair presentation of
financial statements. It has also been understood that changes were required since
distinction between operating and finance lease used to affect the financial statements
negatively. Thus AASB 16 has been introduced and it has impacted the accounts of
large number of companies positively. On the other hand in context of the chosen
organisation it has been seen that AASB 16 requirements have not been followed. Thus
for the financial year 2017-18, it has not reflected a true and fair view of accounts.
9

References
Journals
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.
Denis, D. J., and McKeon, S. B. (2018). Persistent operating losses and corporate
financial policies. Available at SSRN 2881584. 8(11), pp.56-71.
Dogan, F. G. (2016). Non‐cancellable Operating Leases and Operating
Leverage. European Financial Management, 22(4), pp.576-612.
Eaton, T., Nichols, C., Wahlen, J., and Wieland, M. (2018). Leases and Over-
investment. 6(5), pp.96-103.
Firth, M., and Gounopoulos, D. (2017). IFRS adoption and management earnings
forecasts of Australian IPOs. Available at SSRN 2199034. 6(11), pp.56-89.
Hussey, R. (2018). Accounting for Leases and the Failure of Convergence. 9(7), pp.63-
74.
James, M. L. (2016). Accounting For Leases: A Case Exploring The Effect Of The New
Lease Accounting Standard On The Financial Statements. Journal Of The International
Academy For Case Studies, 22(3), pp.152-157.
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. The Journal of New Business Ideas & Trends, 15(2), pp.1-11.
Lloyd, S. (2016). A new lease of life. Investor Perspectives. 7(11), pp.45-61.
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.
Nuryani, N., Heng, T. T., and Juliesta, N. (2015). Capitalization of Operating Lease and
Its Impact on Firm's Financial Ratios. Procedia-Social and Behavioral Sciences, 211,
pp.268-276.
Öztürk, M., and Serçemeli, M. (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. Business and Economics Research Journal, 7(4), p.143.
Wong, K., and Joshi, M. (2015). The impact of lease capitalisation on financial
statements and key ratios: Evidence from Australia. Australasian Accounting, Business
and Finance Journal, 9(3), pp.27-44.
Websites
aasb.gov.au (2019), Accounting Standard For Lease, Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB117_07-04_COMPapr07_07-
07.pdf [Accessed on: 23rd May, 2019]
corporate.amp.com.au (2019), AMP limited, Available at:
https://corporate.amp.com.au/content/dam/corporate/aboutus/files/AMP_2018_AR.pdf
[Accessed on: 23rd May, 2019]
10