AASB 16 and its Implications on Financial Reporting of Leases

This essay critically examines the practical implications of the new AASB 16 lease accounting standard, focusing on its impact on financial reporting. The analysis is grounded in the AASB framework, specifically addressing the qualitative characteristics of relevance and faithful representation. The...Read More

Financial Accounting Theory and Practice
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Introduction
The IASB (International Accounting Standards Board) hold the responsibility of developing
accounting standards and conventions that business entities need to follow for developing financial
reports. The IASB has developed a new accounting standard of IFRS 16 for ‘leases’ that business
entities around the world need to follow for reporting their operating and finance leases on the balance
sheet. The IASB has also directed AASB (Australian Accounting Standards Board) to adopt the use of
new accounting standards for leases by developing AASB 16 that will replace previous AASB 117
standards for leases from the year 2019. There has been development of exposure drafts by the FASB
(Financial Accounting Standards Board) and IASB for gaining feedback from the stakeholders
regarding the proposed new accounting standard. In this context, the present essay critically discusses
the practical implications of new accounting standards has considered the fundamental characteristics
of the financial information stated in the AASB framework. This has been done through analyzing the
discussion presented in the article developed by Churynk, Reinstein and Lander (Churyk, Reinstein
and Lander, 2015).
Critical Discussion of Practical Implications of New Leases Standards as per Fundamental
Characteristics of AASB Framework
Two fundamental characteristics of financial information stated in the AASB’s Framework for
Preparation and Presentation of Financial Statements
The AASB framework for the preparation and presentation of financial statements has
presented the conceptual framework of financial reporting used by business entities in Australia for
developing financial reports. The qualitative characteristics of useful financial information as stated in
the AASB framework are relevance and faithful presentation. The financial information is said to be
relevant if it can make a difference in the decision-making of the users such as investors and creditor.
The financial information in order to be relevant should have a predictive and confirmatory value. The
predictive value of a financial information means that it should be able to predict the future financial
growth of an entity (Freeman and Freeman, 2015). On the other hand, confirmatory value of the
financial information should be able to provide feedback about an entity past and present financial
results. The faithful representation of the financial information should be able to represent the
economic phenomena through providing complete, neutral and error-free information. The financial
information should be able to provide complete knowledge regarding the financial phenomena
through providing all the necessary descriptions and explanations (Framework for the Preparation and
Presentation of Financial Statements, 2016).
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Impact of Compliance with the new standard for leases, i.e. AASB 16 Leases on lease accounting and
reporting and business metrics by the lessee and lessor as discussed in Churyk, Reinstein and Lander
(2015), i.e. practical implications
The main objective of the IASB behind the development of new standards for leases is to
eliminate the differences that exist between operating and finance leases and to report them on the
financial statements through the use of similar accounting conventions. The new standards for leases
have eliminated the difference between the operating and finance leases and have directed the
business entities to use only a single lessee accounting model for recognition of leases. This applies to
all leases having time-period of more than 12 months (IASB issues new leasing standard, 2016). The
article ‘Leasing: reducing the game of hiding risk’ presented by Churyk, Reinstein and Lander has
discussed the implications of the FASB and IASB on leases standards. The article has presented the
concerns regarding the new leases standards that can result in increasing the complexity of recording
leasing transactions in the balance sheet. As per the article, the FASB and IASB have proposed to
introduce new lease standards for overcoming the problem of not recording many lease obligations on
the balance sheet. As such, the use of the new proposed standards can result in complete disclosure of
the economics of the lease transactions as per the qualitative characteristic of faithful presentation of
financial information. The article has also presented the discussion regarding the use of similar
accounting methods for recording lease transactions as proposed in 2010 exposure draft in the year
2012. The IASB have directed the business entities to report some lease obligations through the use of
straight-line basis method while others through the use of amortization basis. As such, the recognition
of leases by business corporations would require the use of separate accounting conventions after they
have been initially recorded through the use of same accounting methods. The subsequent
measurement often develops differences that would require adjustment in the financial statements
afterwards. The standard would require significant quantitative and qualitative disclosures about the
lessees and lessors in the financial statements. As such, it can be said that new leases standards often
increases the complexity of recording lease transactions for business entities (Churyk, Reinstein and
Lander, 2015).
Explanation of affect of Compliance with AASB 16 requirements identified in Part (2) on the
reporting of lease information that satisfies two fundamental characteristics specified in the
Framework
As per the qualitative characteristics of relevancy and faithful representation, the new leases
standard has increased the disclosure requirement of leases in the financial statements. The business
entities are also required to report the operating leases in the balance sheet under the new accounting
standard of AASB 16. Thus, the business entities are required to adopt proper classification criteria
for determining the type of leases and therefore causing major changes in the financial reporting
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structure of business entities. The recognition of a particular contract under a lease or a service is very
critical as it determines the identification of the related assets and liabilities (Albert, 2016). Thus, it
can be said that business entities need to implement major changes in their financial reporting system
for complying with the new accounting standards for leases. The increased disclosure requirement
would help in providing relevant and complete information about the leases to the end-users of a
business entity (Dagwell, Wines and Lambert, 2015).
The article has also stated that many financial users, developers and auditors are in support of
retaining the present leasing standard. This is because the new leases standard would increases the
asset and liabilities of a business entity resulting in causing changes in their financial ratios (Singer,
2017). As such, the article has emphasized that whether there is need for adopting new standards or
only there is a need for proper implementation of the existing standards. The article has presented that
there will be improvement in the gross margin, cash flow and EBIT of business entities with the
adoption of new standards but interest coverage and return on assets will be lower. The business
entities that incorporate the use of operating leases to a large extent such as banking,
telecommunication and retail will be largely impacted by the new accounting standards (Churyk,
Reinstein and Lander, 2015).
The practical implications of the new accounting standards discussed in the article have also
considered the qualitative characteristics of the financial information. As per the article, the new
standards will help in meeting the relevance characteristics of the financial information by only
provide relevant information relating to leases and excluding other such information such as variable
lease payments from measurement of leased assets and liabilities. Also, the financial information
would be faithfully presented through the use of new accounting standards for leases. This will be
because the new rules will increase the presentation of key financial metrics of a business entity that
are used to present its financial valuation to the end-users. The inclusion of operating leases also on
the balance sheet would help in providing the end-users complete financial information about the
operating leases that is not required to be reported under the existing leases accounting standards. The
lease transactions would be represented completely without any hiding of materialistic facts about
leases under the proposed accounting standards (Churyk, Reinstein and Lander, 2015).
The practical implications discussed in the article have only considered the qualitative
characteristics of financial information presented in the AASB framework to only a little extent. The
practical implications mainly relate to the impact of new standard on the credit worthiness of business
entities. The implications have discussed the improvement in some of the financial metrics while the
lower returns provided by some of the financial measures under the new standards (Australian
Accounting Standards Board, 2017). The practical change in the financial reporting system of some of
the industries that mainly uses operating leases is also discussed in the practical implications section
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of the article. Thus, the discussion held in the article mainly relates to highlighting the problems in the
adoption of the new accounting standards for leases by business entities. The author in the article have
mainly emphasized on the increasing complexities that will result from the implementation of the new
standard for business entities. It has not adequately considered whether the new leases standards are in
accordance with the qualitative characteristics of the financial information. The article recommends
upgrading the existing accounting standard for leases rather than implementing the new standards for
leases. It has not placed any importance on whether the new accounting standards are in accordance of
the qualitative characteristics of the financial information (Churyk, Reinstein and Lander, 2015).
Conclusion
Thus, the new accounting standard for leases of AASB 16 as discussed in the article would
increase the financial disclosure requirement for leases in the financial reports of business entities.
Thus, the article has proposed that old standard should be modified rather then adoption of new
accounting standards for leases. The practical implications mentioned in the article on the proposed
standards for leases have not adequately considered the fundamental characteristics of financial
information.
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References
Albert, A. 2016. Top 5 biggest changes with the new lease accounting standard (asc 842). [Online].
Available at: https://www.gaapdynamics.com/insights/blog/2016/08/16/top-5-biggest-
changes-with-the-new-lease-accounting-standard-(asc-842)/ [Accessed on: 27 October 2017].
Australian Accounting Standards Board. 2017. [Online]. Available at:
http://www.aasb.gov.au/Pronouncements/Current-standards.aspx [Accessed on: 27
October 2017].
Churyk N. T., Reinstein A. and Lander G. H. 2015. Leasing: reducing the game of hiding risk.
Journal of Accounting and Organizational Change 11(2), pp.162-174.
Framework for the Preparation and Presentation of Financial Statements. 2016. [Online]. Available at:
http://www.aasb.gov.au/admin/file/content105/c9/Framework_07-04_COMPjun14_07-14.pdf
[Accessed on: 27 October 2017].
IASB issues new leasing standard. 2016. [Online]. Available at:
https://www.iasplus.com/en/news/2016/01/ifrs-16 [Accessed on: 27 October 2017].
Singer, R. 2017. Accounting for Leases Under the New Standard, Part 1. [Online]. Available at:
https://www.cpajournal.com/2017/08/23/accounting-leases-new-standard-part-1/ [Accessed
on: 27 October 2017].
Dagwell, R., Wines, G. and Lambert, C. 2015. Corporate Accounting in Australia. Pearson Higher
Education AU.
Freeman, S. and Freeman, J. 2015. Financial Accounting: A Practical Approach. Pearson Higher
Education AU.
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