Advanced Issues in Accounting: Impact of AASB 16 on Companies

This report examines the implications of the new AASB 16 accounting standard for leases, focusing on the changes it brings to financial reporting. The introduction of AASB 16, which eliminates the distinction between finance and operating leases, necessitates the recognition of right-of-use ass...Read More

Running head: ADVANCED ISSUES IN ACCOUNTING
Advanced Issues in Accounting
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Author’s Note

1ADVANCED ISSUES IN ACCOUNTING
Abstract
Introduction of the new accounting standard for lease, AASB 16 Leases, will bring many
changes in lease accounting and reporting of the companies by eliminating the classification
of finance and operating leases. This requires the companies in recognizing right-of-use
assets and lease liabilities in the balance sheet while reporting depreciation expenses of these
assets and interest expenses of these liabilities in the income statement. The main reason for
introducing this new accounting standard for lease is to eliminate the deficiencies in the
former lease standard that did not require the companies in reporting large amount of
operating leases in the balance sheet; as a result, it was not possible to assess the actual
economic reality of the companies.

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Table of Contents
Introduction................................................................................................................................3
Understanding on Lease Arrangement.......................................................................................3
Issues in the Former Accounting Standard for Lease................................................................3
Leases Currently Listed in the Financial Reports of the Selected Companies..........................4
Harvey Norman......................................................................................................................4
Myer.......................................................................................................................................5
Impact of the New Accounting Standard for Lease on the Selected Companies.......................5
Harvey Norman......................................................................................................................5
Myer.......................................................................................................................................5
Short-term and Long-term impact of Changes to Reporting for Lease.....................................6
Why the New Accounting Standard for Lease may be Unpopular............................................7
Conclusion..................................................................................................................................7
References..................................................................................................................................8

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Introduction
In the recent years, accounting for leases has attracted key attention of the investors,
accounting bodies and regulation setters due to its major significance in financial reporting.
Leases can be considered as a special arrangements between two parties for gaining access to
use certain assets in exchange of something of monetary value. This is a crucial aspect in
financial reporting because it create major impact on the income statements and balances
sheets of the companies. One key reason for the lease accounting to come under the spotlight
is the introduction of the new accounting standard for lease that is AASB 16 Leases by the
International Accounting Standards Board (IASB). This new accounting standard for lease
has changed the landscape of lease accounting completely with the removal of some existing
rules while adding some other rules in their place (Wong & Joshi, 2015). Analysis of
different aspects of this new lease standard while discussing the deficiencies of the old lease
standard that largely contributed to the introduction of the new one is the main objective of
this report. This report discusses about the lease arrangements of two Australian companies
and the impact of new lease standard on them. Moreover, this report also discusses about the
short and long-term impact.
Understanding on Lease Arrangement
A lease can be considered as a contract in which the owner of an asset or property
allows another party to use his/her asset or property in exchange of money or other assets;
therefore, the first party is called as the lessor and the second party is called as the lessee.
There are two types of lease arrangements; they are Finance lease and Operating leases. In
case the risks and rewards associated the asset or property is fully transferred to the lessee,
then it is called a finance lease; financial leases are also considered as the capital leases.
Therefore, operating lease is considered when the risks and rewards associated with the asset
or property stay with the lessor; thus, it is considered as same as the rental contracts.
Companies are required to report the finance leases in the balance sheet where the operating
leases can be kept off-balance sheet (Giner& Pardo, 2017).
Issues in the Former Accounting Standard for Lease
Under the former accounting standard for leases, leases need to be recognized as
either finance leases or operating leases. In case the leases are classified as finance leases,
they are needed to record in the balance; but when the companies categorize the leases as
operating leases, then it is not needed to show them in the balance sheet as they need to be

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shown as lease payments just as expense in the income statement (Giner& Pardo, 2018). By
taking advantage of this rule, companies use to classify more than 80% of their lease as
operating leases so that they can be avoided recording in the balance sheet. This can be
viewed as a potential understatement of the lease liabilities as the companies have millions
worth of liabilities under the operating lease agreements that do not show up clearly in the
financial metrics. In this manner, it is not possible to assess the actual economic condition
and financial standing of the companies that does not reflect economic reality (Kusano,
Sakuma &Tsunogaya, 2015).
As per the above analysis, the former accounting standard for leases provides the
opportunity to the companies to understate a huge amount of lease liability arising from the
operating leases by not reporting them in the balance sheet. In this manner, a company having
a huge amount of operating lease liabilities can maintain a lean balances sheet by not
reporting them. It is also not possible for anyone to check and verify the same in the presence
of the rules. For this reason, the companies did not have to report large lease liabilities in the
balance sheet that were 66 times greater than the reported liabilities (Grant, 2016).
Under the former lease standard, a company that is financing most of its assets
through operating lease appears to have better financial position than a company that is
buying most of its assets, even they have the same obligation. Due to this, it is not possible to
compare the financial position of the former company with the financial position of the latter.
Therefore, even if both of these companies operate in the same industry, it will be unjustified
to bring comparison between them. Hence, there is no playing field between these companies
(Pardo &Giner, 2018).
Leases Currently Listed in the Financial Reports of the Selected Companies
Harvey Norman
The 2019 annual report of Harvey Norman shows that the company has both
operating and finance lease commitments as the lessee. The main aim of the entity for
entering into operating lease is acquiring access to retain property and warehouse facilities;
and it adjusts the rental payments in accordance to the general
agreement(investor.myer.com.au, 2020). As per the 2019 annual report, total operating lease
liabilities of Harvey Norman in 2019 and 2018 are $693,554,000 and $689,219,000
respectively. The present value of minimum lease payments for finance lease in 2019 and
2018 are $3,564,000 and $4,264,000 respectively (investor.myer.com.au, 2020).

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Myer
Myer has only reported operating leases in the 2019 annual report as it has mentioned
the presence of majority of operating leases for stores and warehouses expiring within 30
years(static1.squarespace.com, 2020). The total amount of committeemen for minimum lease
payments under non-cancellable operating leases in 2019 and 2018 are $2,427,902,000 and
$2,537,556,000 respectively. As reported by the company, total rental expenses related to
operating leases in 2019 and 2018 are $228,268,000 and $231,787,000
respectively(static1.squarespace.com, 2020). As per the accounting policy of Myer for leases,
it classify the leases as operating leases where a major part of the risks and rewards
associated with the property, plant and equipment are retained with the lessor. Moreover, the
company charge the payments made under operating leases to the income statement on
straight line basis (static1.squarespace.com, 2020).
Impact of the New Accounting Standard for Lease on the Selected Companies
Harvey Norman
Under the new standard for lease that is AASB 16 Leases, Harvey Norman will be
required to adopt the new lease accounting requirement in order to identify and measure the
lease and it will require the company to recognize lease assets and liabilities in the balance
sheet. It will be required to recognize right-to-use assets and lease
liabilities(static1.squarespace.com, 2020). Carried amount will be used for measuring the
right-of-use assets and it will measure the lease liability in net present value of future
payables under the lease. The balance sheet of the company will be impacted by $500 million
to $550 million for the recognition of right-of-use assets, $505 million to $555 million for the
recognition of lease liabilities and derecognition and classification of currently recorded
amount(static1.squarespace.com, 2020). Depreciation on right-of-use assets and interest on
lease liabilities will replace the lease expenses in the income
statement(static1.squarespace.com, 2020).
Myer
Alike Harvey Norman, Myer will also be required to record the liabilities of leases
and assets associated with the leases that are right-of-use assets in the balance sheet due to the
adoption of AASB 16; it will no longer be involved in categorizing the the leases. Impact of
the adoption of AASB 16 on Myer’s balance sheet include the recognition of right-of-use
assets between $1,350,000,000 and $1,550,000,000; recognition of lease liability between

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$1,800,000,000and $2,000,000,000;derecognition of deferred income and lease provisions
between $90,000,000 and $110,000,000; increase in deferred tax assets between $95,000,000
and $115,000,000; and decrease in net assets between $200,000,000 and
$300,000,000(investor.myer.com.au, 2020). Impact on the income statement include decrease
in depreciation expenses between $115,000,000 and $135,000,000; increase in finance costs
between $80,000,000 and $100,000,000; decrease in operating lease expenses between
$200,000,000 and $220,000,000; and decrease in net profit before tax between 0 and
$15,000,000(investor.myer.com.au, 2020).
Short-term and Long-term impact of Changes to Reporting for Lease
Analysis of the selected companies shows that the adoption of AASB 16 will create
short-term and long-term impact on the reporting of leases and this will create impact on the
financial statements and gearing ratios.
Impact of Financial Statements – Under AASB 16, the requirement for the business entities
will be the recognition of right-of-use assets and lease liabilities in the balance sheet. This
will lead to higher expenditures in the areas of interest and depreciation as compared to the
rental for the leases; this will impact the profit and loss. In the earlier stage, net profit will fall
due to interest payable on lease liabilities, but once the liability is paid, there will be
reduction in interest expenses. Higher accounting expenses at the start of the lease will not
contribute to higher tax deductions as the local tax legislation will govern the lease rentals
(ifrs.org, 2020).
Impact on Gearing Ratios – Balance sheet of the companies will grow due to the
recognition of right-of-use assets and lease liabilities and therefore, gearing ratio will also
enhance. Increase in gearing ratio means increase in total debts and liabilities which will
make the companies highly leveraged and risky. As a result of this, there might be increase in
the violation of loan agreements as the companies will have to pay increased interest due to
increase in liabilities. Credit ratings of the companies may be affected with these changes
along with other behavioural changes of stakeholders (deloitte.com, 2020).
Impact on the Industry – Introduction of AASB 16 will affect the retail industry in which
both Harvey Norman and Myer operate. Since leasing real estates is a core business of the
retailers, AASB 16 will require substantial judgment for determining and reassessing an
economic incentive of the retailers for renewing a retail lease location. Under the new
standard for lease, it will be require for the retailers to put systems in place for estimating and

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remeasureing variable payments linked to an index at the spot rate for each reporting period.
Moreover, it will require the retailers to separate the lease and non-lease elements such as
separate service charges from lease elements with many landlords(pwc.com, 2020).
Why the New Accounting Standard for Lease may be Unpopular
The new accounting standards for lease has certain negative effects, risks and
challenges for the companies. Recognition of right-of-use assets and lease liabilities will
increase the overall liabilities of the firms; and thus, the firms will be considered as highly
leveraged and unattractive to the investors (ifrsbox.com, 2020). Recognition of right-of-use
assets and lease liabilities will allow the companies in incurring depreciation expenses and
interest expense that will be higher than lease rental payments; and this will decrease the net
profit which is an unfavourable condition for the companies. Adoption of this lease standard
is a costly matter for the companies which will increase their overall expenses. Companies
will have to face three challenges while adopting the standard; that are recognition of lease
data, implementing the right system at place and brining improvement in the whole lease
accounting process (pwc.com, 2020). In the presence of all these aspects, the new standard
for leases may not be popular among the companies.
Conclusion
Introduction of AABS 16will eliminate the classification of operating and finance
lease as the companies will be required to recognize right-of-use assets and lease liabilities in
the balance sheet; and the associated depreciation expenses and interest payment will replace
lease rental payments. Analysis of the latest annual reports of Harvey Norman and Myer
shows that both the companies have classified their leases as operating and finance lease; but
they are going to adopt AASB 16 in the coming year for adopting a single lease mode. The
potential effects of adopting AASB 16 have been disclosed by both the companies. This new
accounting standard for leases will increase the balance sheet by reporting right-of-use assets
and lease liabilities and this will increase the leverage ratios. Moreover, net income will be
reduced due to the increase in depreciation and lease interest expenses. As this new standard
comes with many risks and challenges, there is a high probability that it may not be popular
among the companies.

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References
Giner, B., & Pardo, F. (2017). Operating lease decision and the impact of capitalization in a
bank-oriented country. Applied Economics, 49(19), 1886-1900.
Giner, B., & Pardo, F. (2018). The Value Relevance of Operating Lease Liabilities:
Economic Effects of IFRS 16. Australian Accounting Review, 28(4), 496-511.
Grant, C. T. (2016). No more hiding lease liability: the FASB's new leasing standard ends the
use of multiyear leases for off-balance-sheet financing. Strategic Finance, 98(1), 40-
48.
IFRS 16 Leases vs. IAS 17 Leases: How the lease accounting changed - IFRSbox - Making
IFRS Easy. (2016). IFRSbox - Making IFRS Easy. Retrieved 16 April 2020, from
https://www.ifrsbox.com/ifrs-16-ias-17-leases/
Ifrs.org. (2020). Effects Analysis International Financial Reporting Standard: IFRS 16
Leases. Retrieved 16 April 2020, from
https://www.ifrs.org/-/media/project/leases/ifrs/published-documents/ifrs16-effects-
analysis.pdf
Investor.myer.com.au. (2020). ANNUAL REPORT 2019. Retrieved 16 April 2020, from
http://investor.myer.com.au/FormBuilder/_Resource/_module/dGngnzELxUikQxL5g
b1cgA/file/Myer_Annual_Report_2019.pdf
Kusano, M., Sakuma, Y., &Tsunogaya, N. (2015). Economic impacts of capitalization of
operating leases: Evidence from Japan. Corporate Ownership and Control, 12(4),
838-850.
Pardo, F., &Giner, B. (2018). The capitalization of operating leases: Analysis of the impact
on the IBEX 35 companies. Intangible Capital, 14(3), 445-483.
Pwc.com. (2020). Impacts of the new leasing standard – beyond accounting. Retrieved 16
April 2020, from https://www.pwc.com/us/en/audit-assurance-services/accounting-
advisory/assets/pwc-impacts-of-the-new-leasing-standard-beyond%20accounting.pdf
Pwc.com. (2020). IFRS 16: The leases standard is changing Are you ready?. Retrieved 16
April 2020, from https://www.pwc.com/gx/en/services/audit-assurance/assets/ifrs-16-
new-leases.pdf

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Static1.squarespace.com. (2020). Harvey Norman HOLDINGS LIMITED 2019 ANNUAL
REPORT. Retrieved 16 April 2020, from
https://static1.squarespace.com/static/54803162e4b08e1b8a472201/t/
5dac405a64fbcd1ae7b3bd58/1571569849947/HVN+2019+Annual+Report.pdf
Wong, K., & 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), 27-44.
Www2.deloitte.com. (2020). New IFRS 16 Leases standard The impact on business
valuation. Retrieved 16 April 2020, from
https://www2.deloitte.com/content/dam/Deloitte/nl/Documents/mergers-
acquisitions/deloitte-nl-ma-ifrs16-impactonbusinessvaluation1.pdf