Accounting for Lease: A Critical Review of AASB 16 - HI6025

This report critically examines the transition from AASB 117 to AASB 16 Leases, focusing on the reasons for the change and the impacts of the new standard. The primary driver for AASB 16 was the desire to eliminate off-balance sheet lease liabilities, which were a significant drawback of AASB 117. The report highlights that AASB 16 leads to increased liabilities and a preference for asset purchases over leasing. It also analyzes Woolworths Limited's lease arrangements and their transition to AASB 16, as disclosed in their financial statements. The report covers the drawbacks of the old standard, the necessity for change, specific changes in AASB 16, the effects on companies with significant leases, the tendency to classify leases as operating leases, the relation of positive accounting theory, and the IASB's view on improved comparability.

Running head: ACCOUNTING THEORY AND CURRENT ISSUES
Accounting Theory and Current Issues
Name of the Student
Name of the University
Author’s Note

1ACCOUNTING THEORY AND CURRENT ISSUES
Abstract
The findings of the report shows the main reasons that contributed towards the
introduction of new lease accounting standard AASB 16 Leases from AASB 117
Leases. As per the findings of the report, maintaining off-balance sheet lease
liabilities was the greatest reason for the introduction of new lease standard AASB
16. This report also states that the new lease standard leads to the increase in
liabilities and thus, the companies are preferring to buy assets rather than leasing
them. This report shows that Woolworths Limited has provided all the information on
their lease arrangements including the transition to AASB 16 in their notes to the
financial statements.

2ACCOUNTING THEORY AND CURRENT ISSUES
Table of Contents
Introduction...........................................................................................................................................3
Answer to Question [a]..........................................................................................................................3
i. Critical Evaluation of Old Accounting Standard for Lease...............................................................3
ii. Drawbacks.....................................................................................................................................3
Answer to Question [b].........................................................................................................................4
i. Necessity of the Change.................................................................................................................4
Answer to Question [c]..........................................................................................................................4
i. Changes in New Accounting Standard for Lease.............................................................................4
Answer to Question [d].........................................................................................................................4
i. Effects of New Lease Standard on Companies with Significant Lease.............................................4
Answer to Question [e]..........................................................................................................................5
i. Tendency of the Companies to Classify Most of the Leases as Operating Lease............................5
ii. Relation of Positive Accounting Theory to the Manager’s Behaviours..........................................5
Answer to Question [f]..........................................................................................................................5
i. Explanation of the View of IASB......................................................................................................5
Answer to Question [g]..........................................................................................................................6
i. Explanation.....................................................................................................................................6
Answer to Question [h].........................................................................................................................6
i. Finance Lease..................................................................................................................................6
ii. Operating Lease.............................................................................................................................6
iii. Accounting Policies for Lease........................................................................................................6
iv. AASB 16 Leases and Transition......................................................................................................7
Conclusion.............................................................................................................................................7
References.............................................................................................................................................8

3ACCOUNTING THEORY AND CURRENT ISSUES
Introduction
Lease financing is considered as an important form of financing where the
lessee gets the operating control over an asset for the use of business purpose
(Barone, Birt, and Moya 2014). In the recent years, certain key changes have
occurred in lease accounting because of the introduction of the new lease standard
of AASB 16 Leases (AASB 16). Before the introduction of AASB 16, there was AASB
117 Leases for the purpose of lease accounting for the companies. However, the
presence of certain drawbacks the old lease standards contributed towards the
inception of the new lease standard of AASB 16. The main purpose of this report is
to develop clear understanding on the accounting standard regarding leases. This
report undertakes the evaluation of the old lease standards for the identification of
major drawbacks. After that, this report discusses about the reasons that contributed
towards the change in lease standards along with the specific changes that have
been brought in AASB 16. This report also sheds light on the impact of this new
lease standard on the companies with high significant level of lease financing. Lastly,
this report discusses about different aspects of the lease accounting of one of the
major ASX listed companies, Woolworths Limited.
Answer to Question [a]
i. Critical Evaluation of Old Accounting Standard for Lease
In Australia, AASB 117 Leases is the old accounting standard for lease. The
main aim of this accounting standard for both the lessor and lessee is to provide
them with the correct accounting policies as well as disclosures regarding the leases.
This old accounting standard for leases has classified the leases in two types; they
are Finance Lease and Operating Lease. Accounting to AASB 117, Paragraph 8, a
lease is considered as a finance lease in case it transfers all the risks and rewards
related with it to the owners (aasb.gov.au 2019). The same standard states that a
lease needs to be classified as an operating lease in case it does not involves in the
transfer of its risks and rewards to the owners. The adoption of the old accounting
standard of AASB 117 for leases puts the obligation on the companies to either
identify the leases as the finance lease or operating lease and a major drawback is
associated with this particular regulation for the treatment of finance and operating
lease (aasb.gov.au 2019).
ii. Drawbacks
According to AASB 117, in case an entity classifies the lease as operating
lease, then the lessee is not required to show the lease as neither asset nor liability
in the balance sheet because the lessee is needed to show just the lease payment
as an expenses in the profit or loss. However, some of the operating leases are non-
cancellable in nature and thus, become major liabilities for the lessees and this
liability remains off-balance sheet which does not reflect the true financial position of
the entity (Wong and Joshi 2015). Under this standard, the lessees are needed to
recognize the lease assets and liabilities arising from the lease classified as finance
lease while other assets and liabilities were allowed to stay as off-balance sheet.
This is the greatest drawback in this old lease standard because the recognition of
those not reporting lease assets and liabilities regarding the operating leases in the
balance sheet can lead to misleading information regarding leases which affects the
faithful representation of lease transitions.

4ACCOUNTING THEORY AND CURRENT ISSUES
Answer to Question [b]
i. Necessity of the Change
It can be seen from the above discussion that the old accounting standard for
leases allowed the lessees not to report huge amount of liabilities related to
operating lease in the balance sheet as they were kept off-balance. This aspect
affects the faithful representation of the financial position of the lessees because the
investors and other users of the financial statements remained unaware of those
huge amount of lease liabilities (Dakis 2016). It implies that the old accounting
standard for leases was providing the lessees the scope to hide huge amount of
lease liability from the readers of the financial statements since these liabilities were
not presented anywhere in the financial statements. In the presence of this major
loophole in the old accounting standard for leases, the companies developed a
tendency to classify majority portion of their lease as finance lease because they
would have to only report the expenses related to these leases in the profit or loss
when they could hide huge amount of lease liabilities from the whole world. This can
be considered as an illegal way to show better financial position of the companies. In
the presence of these negative aspects related to the old accounting standard for
lease, it was needed to bring changes regarding these major issues (Dakis 2016).
Answer to Question [c]
i. Changes in New Accounting Standard for Lease
Certain changes can be seen in the new lease standard of AASB 16 Leases
as compared to the old accounting standard for leases. These changes are as
follows:
o The new lease standard of AASB 16 has eliminated the difference between
the operating and finance leases for the lessees. Now, the lessees are need
to recognize a new lease asset that represents the right of using the leased
item for the lease term and a lease liability that represents the obligations for
the payment of rents related to the leased items (pwc.com 2019).
o As per the new lease standard, it is needed for the lessee to make the initial
recognition of a right-of-use asset and lease liability on the basis of
discounted payments needed under the lease while considering a determined
lease term. There will be need for judgment for the determination of lease
term which was not needed in the old accounting standard for leases. It also
includes the direct costs and restoration costs (pwc.com 2019).
o There is not any change in the lessor’s accounting for lease under the new
lease standard of AASB 16 and the lessors are needed to continue reflect the
underlying asset that is subject to lease arrangement on the statement of
financial position for the leases classified as operating leases. For the sale of
leases, there is a lease receivable in the balance sheet and the residual
interest of the lessor, if any (pwc.com 2019).
Answer to Question [d]
i. Effects of New Lease Standard on Companies with Significant Lease
It can be seen from the above discussion that the companies are now needed
to recognize right of use assets as well as lease liabilities in the balance sheet under
the new lease standard of AASB 16. At the same time, the lessees are now required
to recognize the interest on the lease liabilities on separate basis. In the presence of
the old accounting standard for leases, the companies with significant level of lease
financing had the option to keep the huge lease liabilities off-balance sheet (Morales-

5ACCOUNTING THEORY AND CURRENT ISSUES
Díaz and Zamora-Ramírez 2018). However, under the new accounting standard for
lease AASB 16, these companies will be needed to recognize all the lease liabilities
in the balance sheet along with the right of use assets. This will significantly affect
the financial position of these companies by majorly increasing the amount of lease
liabilities in the balance sheet. At the same time, these companies will now have to
recognize the expenses for the payment of lease interest along with the cost of
lease. In the presence of these accounting treatments, the net income of these
companies will be reduced due to the increase in expenses related to interest
payment and cost of lease (Morales-Díaz and Zamora-Ramírez 2018).
Answer to Question [e]
i. Tendency of the Companies to Classify Most of the Leases as Operating
Lease
Under the old accounting standard for lease, the companies developed a
tendency for the classification of most of the leases as operating lease and there is a
specific reason for this. It needs to be mentioned that the old accounting standard for
lease provided the companies with the scope to recognize most of the leases as
operating lease because of the fact that the companies would be able in keeping the
large non-cancellable lease liabilities as off-balance sheet (Fitó, Moya and Orgaz
2013). In this manner, they were able in deterring the recognition of huge lease
liabilities in their balance sheet. This can be considered as the main reason for the
tendency of these companies to recognize most of the leases as operating lease.
The recognition of most of the lease as operating lease helped the companies in not
recognizing huge amount of lease liabilities in their balance sheet (Morales Díaz and
Zamora Ramírez 2018).
ii. Relation of Positive Accounting Theory to the Manager’s Behaviours
The Positive Accounting theory attempts in making good prediction of the real
world events so that they can be accounting transactions. According to the concept
of positive accounting theory, the aim of the companies is the maximization of the
scenarios of their survival so that they can continue their operations in efficient
manner (Boučková 2015). The concept of this theory can be applied in this case. As
per the concept of positive accounting theory, the main aim behind the
management’s action to recognize most of the leases as operating lease is to ensure
the survival of their business through reducing the amount of liabilities. This is
because the increasing amount of liabilities can cast significant doubt over the
companies’ ability to continue as a going concern. Thus, for ensuring survival and
efficient business operations, the companies developed the specific tendency
(Boučková 2015).
Answer to Question [f]
i. Explanation of the View of IASB
According to the expectation of the IASB, the new lease standards of AASB
16 will lead to the improvement of the comparability of the financial information and
there are three reasons that support this view of the IASB. They are as below:
o AASB 16 involves in recognizing the assets and liabilities related to all the
leases in the companies,
o It involves in the measurement of all the lease assets and liabilities in the
same manner, and;
o It leads to the recognition of the rights that are obtained and the liabilities
that are incurred through the lease arrangements (ifrs.org 2019).

6ACCOUNTING THEORY AND CURRENT ISSUES
In the presence of all of these above aspects, the differing operating decisions
made by different firms will be reflected from the financial statements. When a lease
has economic similarity with borrowings for buying an asset, for instance, a new
aircraft lease for more than twenty years, then the reported amount in accordance
with AASB 16 will be same to the amount that would be reported in case the firm
were to buy or borrow the aircraft (Horton, Serafeim and Serafeim 2013). However,
when there is an economic difference between a lease and borrowing for buying an
asset, for instance, a new aircraft’s lease for seven years, then the different
economic decisions will be reflected under the amount reported as per AASB 16.
The reported assets and liabilities will be less than the reported amount in case the
firm had to borrow for buying the aircraft. In this particular case, the right of the firm
to use the aircraft for seven years in considerably different from the rights that the
firm would obtain in case it had to buy the aircraft. Therefore, the recognized amount
as per AASB 16 is predictable to have substantial difference from borrowing for
buying that asset (Cascino and Gassen 2015).
Answer to Question [g]
i. Explanation
It can be seen from the above discussion that the implementation of the new
accounting standard for lease AASB 16 would have certain major impact on the
companies. For example, it can be seen that the implementation of the new
accounting standard for lease will lead to the major increase in the liabilities of the
companies since they will be needed to recognize the liabilities related to the lease.
This aspect will have a major impact on the lease market (Kusano 2018). In the
presence of this new lease accounting standard, it will be profitable for the
companies to buy the assets because of the fact that they will be able in recognising
these assets in the balance sheet. This will increase the asset position of the
company in the balance sheet. However, in case they go for the lease arrangements,
the companies will have to report these lease arrangements in the balance sheet as
the lease liabilities and this will lead to the increase in the liability position of those
companies which is a negative aspect for them. In the presence of these aspects,
the reporting entities will be more likely to buy more assets and lease fewer assets
(Kusano 2018).
Answer to Question [h]
It can be seen from the 2018 Annual Report of Woolworths Limited that the
company has made certain disclosures related to the lease arrangements for the
financial year of 2018; and they are discussed below.
i. Finance Lease
It can be seen from the 2018 Annual Report of Woolworths that the company
does not have any finance lease for the year 2019. The opening balance of finance
lease is $2 million and the company has made the payment of the same
(woolworthsgroup.com.au 2019).
ii. Operating Lease
The Company has also reported on their operating lease obligations. It can be
seen from the 2018 Annual Report of Woolworths that the company has operating
lease obligations of $22,904 million and $24,439 for the years 2018 and 2017
respectively. These operating leases include leases not later than one year, later
than one year but not later than five years and later than five years
(woolworthsgroup.com.au 2019).

7ACCOUNTING THEORY AND CURRENT ISSUES
iii. Accounting Policies for Lease
According to the 2018 Annual Report of Woolworths, the company has
disclosed significant accounting policies related to their leases. As per the policy, the
company classifies the finance lease when the risk and rewards of ownership can be
transfixed and all other risks are considered as opening risk. In addition, the
company recognizes the operating lease payments as an expenses on straight line
basis over the term of the lease. At the same time, the company has recognized the
fixed rate increase to the fixed rental payments on the basis of straight line for the
lease term. In case of the operating lease incentives, the company recognizes them
as a part of the lease expenses on the basis of straight line over the lease term
(woolworthsgroup.com.au 2019).
iv. AASB 16 Leases and Transition
It can be seen from the 2018 Annual Report of Woolworths that company will
apply the new lease standard of AASB 16 on 1st July 2019 with the help of the
modified retrospective method. For this reason, the company will be responsible for
the recognition of the cumulative effects of the adoption of AASB 16 as an opening
balance of retained earnings at 1st July 2019 in the absence of any restatement of
comparative information (woolworthsgroup.com.au 2019). It can be seen from this
specific part of the Annual Report of Woolworths that the company has done the
assessment of the estimated impact of the adoption of AASB 16 on the consolidated
financial statements. According to the assessment of the company, the adoption of
this new standard increases the new lease liabilities from $14 billion to $15 billion. At
the same time, the new accounting standard of AASB 16 will lead to the increase in
the new right-of-use assets from $12 million to $13 million (woolworthsgroup.com.au
2019). It can be seen from this section that the net effects of the new lease liabilities
and right-of-use assets can be seen from the notes of the financial statements of the
company. At the same time, Woolworths has also indicates towards the fact that the
actual impact of the application of the new accounting standard of AASB 16 on the
consolidated financial statements of the company is largely dependent on the future
economic condition that includes Woolworths’s rate of borrowing at 1st July, 2019
(woolworthsgroup.com.au 2019).
Conclusion
The above discussion sheds light on the rationales for the introduction of the
new accounting standard for lease that is AASB 16. The above discussion highlights
the drawbacks of the old accounting standard for lease that is AASB 116 which is
that it provided the lessees with the scope to maintain off-balance sheet operating
lease liabilities and it did not put any obligation on the companies to report these
liabilities in the company balance sheet. For this reason, it was not possible for the
readers of the financial statements to know about these major lease liabilities. In
order to overcome these drawbacks of lease accounting, the new lease accounting
standard of AASB 16. This new accounting standard for lease demands the
commitment of the companies to recognize both the right-to-use assets and lease
liabilities and they need to record them in the balance sheet. The above discussion
also shows the impact of this new lease accounting standard on the companies
having large lease financing because this new lease standard will increase the
amount of lease liabilities of these companies which is harmful for the company’s
financial position. It can also be seen from the above discussion that the
implementation of the new lease accounting standard of AASB 16 will increase the
comparability of the financial information because of the fact that this new standard

8ACCOUNTING THEORY AND CURRENT ISSUES
will measure as well as recognize all the lease assets and liabilities in same manner.
Lastly, the above discussion also shows the transition process that Woolworths has
adopted for the transition to the new lease accounting standard of AASB 16.
References
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literature. Accounting in Europe, 11(1), pp.35-54.
Boučková, M., 2015. Management accounting and agency theory. Procedia
Economics and Finance, 25, pp.5-13.
Cascino, S. and Gassen, J., 2015. What drives the comparability effect of mandatory
IFRS adoption?. Review of Accounting Studies, 20(1), pp.242-282.
Dakis, G.S., 2016. Upcoming changes to contributions and leasing
standards. Governance Directions, 68(2), p.99.
Fitó, M.À., Moya, S. and Orgaz, N., 2013. Considering the effects of operating lease
capitalization on key financial ratios. Spanish Journal of Finance and
Accounting/Revista Española de Financiación y Contabilidad, 42(159), pp.341-369.
Horton, J., Serafeim, G. and Serafeim, I., 2013. Does mandatory IFRS adoption
improve the information environment?. Contemporary accounting research, 30(1),
pp.388-423.
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https://www.ifrs.org/-/media/project/leases/ifrs/published-documents/ifrs16-effects-
analysis.pdf [Accessed 22 May 2019].
Kusano, M., 2018. Effect of capitalizing operating leases on credit ratings: Evidence
from Japan. Journal of International Accounting, Auditing and Taxation, 30, pp.45-
56.
Morales Díaz, J. and Zamora Ramírez, C., 2018. IFRS 16 (leases) implementation:
Impact of entities’ decisions on financial statements. Aestimatio: The IEB
International Journal of Finance, 17, 60-97.
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.
Pwc.com. 2019. [online] Available at: https://www.pwc.com/gx/en/services/audit-
assurance/assets/ifrs-16-new-leases.pdf [Accessed 22 May 2019].
Woolworthsgroup.com.au. 2019. 2018 Annual Report. [online] Available at:
https://www.woolworthsgroup.com.au/icms_docs/195396_annual-report-2018.pdf
[Accessed 22 May 2019].