Lease Accounting Changes: AASB 117 vs AASB 16 and Aspen Group Case

This report provides a comprehensive analysis of lease accounting, contrasting the former AASB 117 standard with the new AASB 16. It identifies different types of leases and their accounting treatments under both standards, highlighting the limitations of AASB 117 that necessitated the change. The report details the specific changes incorporated in AASB 16, including the separation of lease and service elements, and the inclusion of previously off-balance-sheet liabilities. It assesses the impact of these changes on companies heavily reliant on lease financing, explores reasons behind the classification of finance leases as operating leases, and discusses the improved comparability of firms under IFRS 16. A case study of Aspen Group Limited illustrates the practical implications of the transition, focusing on disclosures made and the effects of moving from AASB 117 to AASB 16. The report also touches on potential shifts in asset acquisition strategies due to the new accounting standard.

ABSTRACT
Leasing is one of the methods of financing the assets of a Company. A lessor accepts to convey
the right to use the asset to the lessee over a lease term upon agreement to pay a rental fee.
Recognition, measurement, presentation, and disclosure of lease are very crucial and should
follow the Accounting Standards outlined by the board authorities. However, due to limitations
portrayed by AASB 117 in recognizing, measuring, presenting and disclosing the lease, the new
model of AASB 16 accounting standard was adopted and companies were required to adhere to
the requirements of new Accounting Standard when accounting for lease. The objective of this
report is to identify types of lease and how they are accounted for under two accounting
standards, the need for change from AASB 117 to AASB 16, the changes made upon transition,
the effects to the companies that rely significantly on lease financing and lastly the case study of
Aspen Group Limited.
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Table of Contents
Introduction.................................................................................................................................................2
Overview of old accounting Standard AASB 117.......................................................................................3
Why Change was necessary.....................................................................................................................4
Changes incorporated in the New Accounting Standard AABS 16.........................................................5
How companies that have a significant level of lease financing have been affected by the change in the
accounting standard for lease...................................................................................................................6
The reason why companies classify most finance lease as an operating lease and how positive
Accounting Theory relates to this behavior of the managers...................................................................7
How the implementation of IFRS 16 has improved the comparability of firms that leases assets and those
borrows to buy assets...................................................................................................................................8
A Case study of Madison Capital............................................................................................................8
Reasons why reporting entities are likely to borrow more to buy assets and lease few assets upon
introduction of IFRS 16 Accounting Standard.............................................................................................9
Disclosures made by ASPEN GROUP LTD on the Accounting for lease and its effects on the move
from AASB 117 to AASB 16................................................................................................................10
Conclusion.................................................................................................................................................11
References.................................................................................................................................................13
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Introduction
A lease is a contractual agreement between lessor and lesse to transfer the right to use an asset in
return for consideration or payment by a lessee. The agreed lease fee is paid periodically or in a
lump sum for a period of time. Lessee may repossess the asset after the rental period according to
the agreements and the kind of lease in question.
The lease can either be categorized into a finance lease or operating lease. Under the finance
lease, the risks and rewards of the contractual asset are substantially transferred from the owner
to lessee. The ownership of the asset is transferred to the lessee after signing the lease contract.
In the finance lease, the lessee has the right to buy an asset at a price less than its fair value as at
the time agreement is made.
On the other hand, operating lease, the lessor remain to bear the risks and rewards after signing
the contract. Example of an operating lease is contingent rent which is recognized as expense on
the side of lessee and income on the side of the lessor.
The main objective of accounting standard AASB 117 of leases is to account and provide
disclosure of both operating and finance lease in the accounts book of lessor and lessee.
For the lessee; the lease is accounted as follows;
 Finance lease is regarded as an asset and at the same time as a liability at a lower value
than fair value.
 Rental fee of a finance lease is composed of a reduction of outstanding liability and the
interest expense.
 The lease asset should be amortized in harmony to the depreciation policy of the asset.
 Operating lease payments are regarded as an expense on the side of the lessee over a
lease period.
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In the books of the lessor;
 The finance lease is treated as receivables and the income recognized based on the rental
period.
 Operating lease assets is treated as an asset in the books of the lessor and must be shown
in the statement of financial position.
 The lessor should include the selling profit or loss of the asset at the period if they could
have sold the asset instead of leasing.
 During sale and leaseback transaction, any excess of proceedings over the carrying
amount is deferred and amortized over the lease term, (Nethercott and Anamourlis, 2009)
Overview of old accounting Standard AASB 117
The lease was either classified as a finance or operating lease. It is an operating lease, it was not
shown in the financial position statement of the books of the lessee as either an asset or liability
but only in the income statement as an expense. This failed to put into consideration that some
leases are not concealable and they represented liability and an asset to the lessee. Therefore the
old Accounting Standards had eliminated most of the liabilities from the financial position of the
lessee.
Secondly, under the old standard of Accounting, there was no difference between operating lease
and service contract and were accounted in the same way simply as an expense in the statement
of comprehensive income. For instance, you may intend to rent a certain commercial space in a
mall of size 20cubic meter in any place where the specific space is to be determined by the
lessor, or you rent the same size of space but you choose a specific place for example ground
floor. In this scenario, the first case does not contain a lease since no asset is identified but in the
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second case, it contains a lease since it has specific asset identification. In the case of the old
accounting standard, the two cases could be treated the same.
When a lessor leases an asset to the lessee under an operating lease, he also provides some
services for instance maintenance, cleaning, and repair. The rental payments are not separated
into lease element and service element under Accounting Standard AASB 117 which is also one
of its drawbacks (Sheet, 2012)
Why Change was necessary:
There was a need for change in the accounting for leases since the old AASB 117 was not
comprehensive enough and did not account for leases in details. For instance;
There was a need to include some liabilities emanating from operating lease in the statement of
financial position which was excluded in the old accounting standard. Even though they were
included in the notes, it didn't show the true picture of the firm and many in financial statements
information users overlook notes except auditors who look in keen details in the additional
information provided in form of notes.
Secondly, there was a need to separate operating lease from a service contract and be accounted
for separately. Such contracts that do not have lease elements should not be treated as a lease and
should be treated separately from the lease which was not taken into consideration in the old
accounting system.
Also, there was a need to separate service element and lease elements in operating lease
payments. For instance, if lessor provides maintenance, cleaning or repair of the asset, the lease
payments are done by lessee should clearly amount attributed to such services separately to the
rental fee which was overlooked in the AASB 117 Accounting Standards, (Farrell, Farrell, and
Wells, 2010)
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Changes incorporated in the New Accounting Standard AABS 16
The separation of lease element and service element- Lease payments was to be categorized into
lease payments and service payment for instance in cases where the lessor had provided some
services to the asset leased by lessee for example maintenance, repair or cleaning.
The new standard supersedes the previous standard and related interpretation and brings about
new lease description that will be used to determine whether a transaction is a contract or a lease.
In case a contract doesn't have a specific asset attached to the contract, it is regarded as a service
contract. The contract will qualify to be termed as a lease if the lessee has control over the
identified asset and can obtain substantial benefit from the said asset for a period of time.
Inclusion of some liabilities into the financial position which is been omitted through the use of
the old accounting standard AASB 117.
The lease should not be described as either finance or operating lease at inception and the new
IFRS prescribes a single mode of accounting for each lease for the lessees.
There is the elimination of "off balance sheet" accounting for lease requiring the capture of more
data on the new standard than the under the previous standard.
The asset in the new accounting standard is determined as right-of-use assets and corresponding
liability of the same assets in the statement of financial position of the lessee.
The assets will be subjected to depreciation and liabilities to amortization within the agreed lease
period.
The accounting for finance lease in accounting standard AASB 117 is similar to that of IFRS 16
however it has the following exceptions.
When the leased term is less than 12 months that's short term lease and when the leased asset is
of low quality for example computers and furniture, (Dakis, 2016)
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How companies that have a significant level of lease financing have been affected by the
change in the accounting standard for lease.
The number of expenses in the first years under IFRS 16 will be more than under IAS 17, the
rental period elapses, total expenses under New IFRS 16 accounting standard will be less than
that under IAS 16. Therefore upon adoption of new accounting standard, the company shall
record low profit in the first years which will increase with time due to amortization of liabilities
and depreciation leased assets at a decreasing amount. The new model leads to a load of
expenses at the beginning of the lease and a few expenses at the end of the lease contract.
Under the new model of accounting will result to depreciation on right to use assets and interest
on lease rather than the current (straight-lined) operating lease expenses leading to the increase in
EBIT and even and even a significant change in EBITDA.
Because of a high-level analysis of operating lease disclosure, it has led to the removal of lease
cost from the operating expense thus increasing the EBITDA margin of telecom operators by
2.5%.
The requirement of the new model to include right on use asset in the financial statements led to
need for new consideration on how to define capital expenditure, for instance as the addition of
carrying amount that is, after addition of right on use asset PPE or investing cash flows in PPE.
The New model has led to a record of more assets in the statement of financial position of the
lessee and the corresponding liability records as opposed to IAS 17. Thus the financial position
of a company upon the use of IFRS 16 is stronger than under IAS 16.
The companies that significantly rely on lease financing have to take a lot of time to come up
with a system that will enable them to gather and analyze information that will help them meet
the requirements of the new model. For instance, given the new ‘on balance sheet' accounting
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applying to almost all leases under the new Standard, lessees will be required to capture more
data than in the previous case. Ultimately this will raise the need for more sophisticated systems
of accounting and more advanced control to track, analyze and report lease information in time.
(Mohd Nasir, Eves and Yusof, 2011)
The reason why companies classify most finance lease as an operating lease and how
positive Accounting Theory relates to this behavior of the managers.
Most businesses categories finance leases as an operating lease. For instance, a company engages
into a lease agreement where maintenance and insurance is the duty of lessor and due to this
effect, the lessee insists that the lessee is an operating lease because of insurance and
maintenances. This is in accordance with traditional IAS 17 without taking into consideration the
useful life of the assets, its fair value and the lessee has the right to purchase back the asset upon
elapse of the lease. If an asset qualifies any of the above requirements, it qualifies to be termed as
a finance lease under the new model. The management basing their argument on positive
Accounting Theory take it as an accounting policy choices where identity has freedom on the
kind of accounting theory to use.
Positive Accounting Theory tries to make a good prediction of the world and translate them to
accounting transactions. Under Positive Accounting Theory, the firm will want to maximize the
choices of their survivals and thus it will want to reduce costs associated with the contract
making them classify most of their finance lease as operating lease because finance lease have
more cost implications as compared to operating lease, (Mohd, Eves and Yusof, 2011)
The theory recognizes that the new circumstances will call management to be flexible in
choosing the accounting theory however this may lead to management acting in favor of their
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own personal interest. Therefore in choosing the accounting policy, it should ensure there is the
minimization of contract cost as well as providing flexibility in the time of changing
circumstances that is into consideration opportunistic behavior.
How the implementation of IFRS 16 has improved the comparability of firms that leases
assets and those borrows to buy assets.
A Case study of Madison Capital
The lease and loan are both forms of financing an asset of an organization whoever their benefits
differ. The following are the differences between the two.
In loan, rates are normally floating and are determined by the prime figure, for instance, LIBOR
and the index keep on fluctuating, thus causing changes on the payments done monthly by an
organization thus making it difficult budget cash. However, this is beneficial during low-interest
rates. On the other hand, lease unless the lessee has special provision, the payments are fixed for
a term of the lease. Fixed payments make cash flow management and budgeting easier.
Loan finances 60-80% of the cost of the asset excluding soft costs such as shipping, installation,
and training whereas 100% financing of asset under the lease including the soft cost for example
shipping, installation, and training.
Banks charges other fees like application fee, commitment fee, originating fee, funding cost to
boost their rates of return which an extra cost to the lessee while in the lease, such kind of extra
cost are limited in accordance to transaction size and documentation.
Terms of contract in the loan are less flexible which is important when looking for a standard
term. Under the lease, one chooses the terms of the contract, the purchase option and the down
payments to make since terms are flexible.
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Banks do not finance the assets that they don't under and think that they have less collateral
while under lease financing is done to most type of assets.
The loan application is long and tedious, and creditworthiness is reviewed after submission of all
financial packages required while under the lease, the financing of up to $100000 can be
approved upon simple application.
Bank takes a lot of time to make credit decision like a week or more as compared to lease
whereby the approvals are made the same or next day.
Banks require the securities of their loans eg real estates, equipment, inventories which act as
collaterals of the loan as opposed to lease whereby the security is the asset leased.
Banks usually require the borrower to keep certain financial ratios and report them to the bank
either quarterly, semiannually or annually whereas there are no restrictions under the lease, (Xu,
Davidson, and Cheong, 2017)
Reasons why reporting entities are likely to borrow more to purchase assets and lease few
assets upon introduction of IFRS 16 Accounting Standard
The introduction of a new model of accounting for lease will require entities to include operating
lease assets and corresponding liabilities in the balance sheet thus showing the high position of
financial status than earlier reported which attract taxation and increased regulatory by state
authorities. This will make entities to opt for buying assets from borrowed cash rather than
leasing the assets.
The legal ownership of e assets acquired through borrowing is held by the borrower while in
leasing the even though the lessee may purchase the leased asset after the lease term, the legal
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ownership belongs to the lessor until the elapse of the lease term, (Mackenzie, G. and Hart, G.,
2008)
Companies will be required to take a lot of time to come up with a system that will be able to
cater all the requirements of the accounting standards of leasing hence forcing some entities to
opt for borrowing rather than leasing assets.
Every leased asset have to be treated separately and thus increasing accounting activities of the
firm thus causing the firm to evade such kind of transactions which might be termed to be
uneconomical.
Need to separate service contract with an operational lease may increase the workload of a
company thus upon the introduction of IFRS 16 will force them to reduce leasing of assets.
Removal of lease cost from operating cost thus increasing the EBIT, this will because firms
taxed more than earlier scenarios.
Using the old accounting standards that are IAS 17, a lease that qualifies to be a finance lease
could be recognized as the operational lease for if maintenance and insurance are to be done by
the lessor even if it qualifies other requirements of finance lease. Upon introduction of IFRS 16,
such loops were closed and any lease that possessed one of the characteristics of finance lease
was termed accordingly, (Wong and Joshi, 2015)
Disclosures made by ASPEN GROUP LTD on the Accounting for lease and its effects on
the transition from AASB 117 to AASB 16
Aspens various offices under non-cancelable operating lease, in addition, the company leases
properties under non-cancelable leases on which it operates accommodation services. Operating
expenses for the year $0.149 million (2017 $0.097).
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The new model of accounting standard has suppressed AASB 117 on the recognition,
measurement, presentation and disclosure requirements of the lease. The standard requires less33
to recognize assets and liabilities for all leases unless the lease period of the lease is twelve
month and below or involve lease asset of low value. However, on the side of the lessor, he
continues to classify leases as either finance or operating lease posting no significant change in
the transition from AASB 117 to AASB 16, (Joubert, Garvie and Parle, 2017)
If the ASPEN GROUP adopted the new standard as from management estimates a degree in
retained earnings of $1.14 million. Assets would increase by $4.45 million and liabilities would
increase by $5.62 million
The transition from AASB 117 to AASB 16 has led to increasing of assets and liabilities
presented in the financial position of the group.
The operating lease commitment within one year has increased by $237000 due to single lease
accounting which required each lease to be recognized and ready on use assets and
corresponding liabilities be disclosed, (Ferguson and Leech, 2007)
Conclusion
The new Accounting standard for lease will have significant impacts on the entities that
significantly depend on lease financing. There will change in financial indicators as new assets
and liabilities will be introduced in the financial statement and expenses and income will be
broken down into lease rental element and service element. Companies will have a hard time
coming up with a system that will enable them to gather and analyze the information required by
the new standard. Other companies will opt for borrowing rather than leasing assets and thus
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affecting the lease market. However, the new Accounting standard for lease is much better and
solves the limitations of AASB 117 (Farrell, Farrell and Wells, 2010)
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References
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.
Ferguson, I. and Leech, J., 2007. Forest valuation and the AASB 141 accounting standard. Australian
Forestry, 70(2), pp.125-133.
Farrell, B., Farrell, H. and Wells, P., 2010. ROCKET SCIENCE: READING FINANCIAL
ACCOUNTING STANDARDS. Irish Accounting Review, 17(2).
Wong, K. and Joshi, M., 2015. The impact of lease capitalization on financial statements and key ratios:
Evidence from Australia. Australasian Accounting, Business and Finance Journal, 9(3), pp.27-44.
Xu, W., Davidson, R.A. and Cheong, C.S., 2017. Converting financial statements: operating to
capitalized leases. Pacific accounting review, 29(1), pp.34-54.
Mackenzie, G. and Hart, G., 2008. Finance lease taxation: surviving the TOFA tsunami. Austl. Tax F., 23,
p.165.
Dakis, G.S., 2016. Upcoming changes to contributions and leasing standards. Governance Directions,
68(2), p.99.
Nethercott, L. and Anamourlis, T., 2009. The relevance of accounting and business principles in
consolidations. Tax Specialist, 13(2), p.112.
Mohd Nasir, A., Eves, C., and Yusof, Y., 2011. The Profiling of Property, Plant & Equipment (PPE)
Contributions in Australia and Malaysia Public Listed Construction Companies. In Proceedings of 2011
International Conference on Construction and Real Estate Management (Vol. 2, pp. 769-773).
Sheet, B., 2012. General Purpose Financial Report.
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