Analysis of Finance Lease Disclosures and Accounting Standards

This report delves into the complexities of finance lease disclosures, particularly focusing on the impact of the new AASB 16 accounting standard. It begins with an overview of the standard, contrasting it with the previous AASB 117, and highlights the key changes, such as the requirement to recognize operating leases on the balance sheet as assets and liabilities. The report evaluates the drawbacks of the old standard, such as a lack of transparency and comparability, and explains the necessity for the changes introduced by AASB 16. It examines how companies with significant lease financing are affected, including the impact on their financial statements and decisions related to asset purchases and lease classifications. The report also explores the reasons behind companies' past tendencies to classify leases as operating leases and how positive accounting theory relates to this behavior. It concludes by analyzing the transition effects of AASB 16 and its implications for financial reporting, using the Commonwealth Bank of Australia 2018 Annual Report as a case study. The paper anticipates that most companies will look for ways to address the impact that will be brought about by the implementation of the new standard.

DISCLOSURES FOR FINANCE LEASE
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Table of Contents
Accounting Standard for Leases..................................................................................................................3
Abstract...................................................................................................................................................3
Introduction.............................................................................................................................................3
Evaluation of the AASB117..................................................................................................................4
Drawbacks...............................................................................................................................................4
The Necessity for the Change..............................................................................................................6
Changes that Have Been Incorporated in the New Accounting Standard for Lease AASB 16..............7
How Companies that have Significant level of lease Financing get Affected.......................................9
Reason companies had a Tendency to Classify Most of the Lease contract as Operating Lease.......10
How Positive Accounting Theory Relates to this Behavior of Managers............................................10
Why Companies Might Buy more Assets and Lease few...................................................................12
Commonwealth Bank of Australia 2018 Annual Report....................................................................12
The Effect of the Transition...............................................................................................................13
Conclusion.............................................................................................................................................13
Bibliography...........................................................................................................................................14

Accounting Standard for Leases
Abstract
AASB lately issued a new standard AASB 117 that will apply to all reporting entities
from January 1 2019. This new standard creates a difference in the model that is used when
recording and reporting on leases. The new changes in the leases will entail recognizing the
operating leases on the statement of financial position as either assets or liabilities and as a result,
many companies’ financial statements will be affected significantly. The effect will vary
according to the different decisions each management will undertake to address these issues.
This paper looks at the changes that are brought about by the new standard and how the
companies will react to these change. In general, it is anticipated that most companies will look
for ways to address the impact that will be brought about by the implementation of the new
standard.
Introduction
The AASB 16 which has been introduced removes the difference that existed between
finance and operating leases and it requires the recognition of the right use of assets and the
arising lease liabilities for the leased properties. This new standard was introduced as a result of
lack of transparency by reporting firms as they opted to recognize most leased assets and
liabilities inform of operating leases so that they can avoid reporting huge amount of liabilities in
their financial statements. For most reporting entities the new standard will take effect in 2019 -
2020 financial years. The new standard will ensure that there is consistency in the cash flows of
the reporting entities which will allow comparability and transparency.

Evaluation of the AASB117
AASB 177 creates a distinction between a finance lease and an operating lease.
According to this standard, the classification of an asset as either a fiancé or operating lease
depends on whether the risks and rewards associated with that kind of the leased asset lie with
the lessor or lessee. These accounting standards oblige that the lease payments under the
operating lease be recorded as an expense using the straight-line method during the lease period1.
The finance lease is recognized as either a liability or an asset the statement of financial position.
Operating leases under the old standard are not reported in the financial statements but are just
reported in the disclosures and footnotes. This standard classifies leases as either a finance or an
operating lease during the inception of the lease.
Drawbacks
AASB 117 did not obligate the lessee companies to report the assets and liabilities that
were acquired in their statement of financial position. This information was instead put in the
footnotes. As a result, it made it difficult for the users of financial information and other
investors to accurately to account for the companies’ correct amount of expenses which made
them overestimate or underestimate the financial obligations of those companies hence making
wrong judgments.
AASB 117 made it difficult for external financial users and investors to conduct
comparisons of businesses that were buying leases and those that were selling the leases. This
was due to the inability of the lessee companies to report that information in their balance sheet
which made the information inadequate for useful decision making.
1 "Accounting For Leases: Presentation And Disclosures | Insights". 2018. Bakertilly.Com.
http://www.bakertilly.com/insights/accounting-for-leases-presentation-and-disclosures

Under this standard, both the lease and non-lease components were reported and included
in the leased asset. This made it difficult to actually categorize what really constituted to the
lease components.
Under the AASB 117, many companies chose to use operating leases so as to avoid the
burden of recognizing the assets and liabilities on the balance sheet2. Operating lease gave most
managers the opportunity to avoid reporting huge liabilities and making their companies appear
rich which attracted most investors. This was due to the fact that the financial statements did not
portray the real outlook of business performance.
The recognition of leases under finance lease category in AASB 117 is very complex.
This makes the recognition of finance leases difficult and sometimes leading to inaccurate
recognition and reporting of figures. The complexity leads to consumption of a lot of time in the
calculation of the leases. The complexity in accounting for finance leases makes most managers
opt using operating leases which makes them avoid reporting their debts
In the AASB 117, some leases are non-cancellable. These non-cancellable leases are not
reported anywhere in the financial statements except in the footnotes. This made it difficult to
recognize such assets or liabilities by the external users of the financial information.
The measurement of the finance lease is not specified under this standard as you can use
the fair value or the present value of the minimum payments of the leases. It does not, therefore,
offer consistency while looking at the lease obligations in the financial statements. Different
measurement approaches inhibit transparency and the financial statements cannot be easily
compared to each other.
2 Accounting Standards". 2018. Aasb.Gov.Au. http://www.aasb.gov.au/Pronouncements/Current-standards.aspx.

The Necessity for the Change.
In simple terms, we can say that the change was necessary in order to assist in the
elimination of off-balance sheet financing. The change was necessary to facilitate the
enhancement of transparency and the comparability of the statement of financial position by
incorporating all the elements in the balance sheet.
The change was necessary in order to assist companies while defining what constituted to
a lease as the non-components of a lease were separated. This new standard gives much weight
on the difference between a lease and a service and a result only important information will be
reported in the financial statements.
This new standard makes both an operating lease and a finance lease to be regarded as
important because even if a company decides to use either of the two they will still report it as an
asset or liability in the statements of financial position. This will make both buying and selling a
lease be an important decision that any company can decide to take as these transactions will be
reflected in their financial statements.
Reporting for both operating and finance lease will be simple as they will be calculated
using the same way. Also, both will be required to appear in the statement of financial position
which will mean that the financial statement users and investors will have enough information to
make decisions concerning the companies. The level of inaccurate conclusions will reduce as the
external users will not have to come up with estimates on the financial obligations of companies
as all information will be reported in the financial statements.

The new standard requires that the finance lease be measured using the present value. It is
more specific and gives a consistent way of calculating finance leases for all companies3. This
will allow easy comparisons of the financial obligations of both the lessee and the lessors due to
a systematic way of arriving at figures. Measurement using the present value will also give a
very consistent technique when dealing with finance leases.
The change was also necessary so as to give the disclosures on leases much focus so that
it can include additional information that can give the financial statement users a clear picture of
the company4. The new standard will require companies to state on the correct use of the leased
asset or liability. The change gives more meaning to the reporting of leases as more information
will be disclosed on both finance and operating leases and this will indicate a true picture of the
type of lease.
Changes that Have Been Incorporated in the New Accounting Standard for Lease AASB
16
The instalments paid by the borrowers on the leased assets will show a reduction of the
company's liabilities as all the instalments will be incorporated in the balance sheet.
The new standard removes rent which was being classified as an operating lease. Leases
will be recorded as depreciation expense instead to represent their right to utilize assets and they
will report interest expense.
3 "Australian Accounting Standard AASB 16 Leases | Regulation Impact Statement Updates". 2018.
Ris.Pmc.Gov.Au. https://ris.pmc.gov.au/2016/04/19/australian-accounting-standard-aasb-16-leases
4 Davern, M., Gyles, N., Potter, B., & Yang, V .(2019). Implementing AASB16 revenue from contract with
customers:The preparer perspective. Accounting Research journal, (Just accepted), 00-00 December,
A.I.C.D.”Target practice

Cash flows under the new standard will be reported differently. Operating lease will not
be reported as an operating expense instead of the cash outflow will be divided into interest on
the liability from the lease and the principal amount
Both the reporting for finance and operating leases will be similar as now the operating
leases will be reported as either assets or liabilities.
The new standard also requires that the operating leases be reported separately from the
interest expense and depreciation of leases.
More focus in this standard will be on the controller of the leased asset and the lease
components be reported for in the statement of financial position5.
The focus will not be on the operational perspective on the lessor interaction but it will
shift to the deal types that will be under negotiation. The lease type will have a low effect on the
accounting point of view.
Measurement of leases based on fair value will be removed. The liabilities or asset of the
finance lease will only be measured using the present value. The measurements will therefore not
relate to the lease minimal payments and they will instead relate to the payments that have not
been paid or remaining.
There are also some changes with the disclosures whereby the companies will be required
to provide additional information which will state if the lessee has elected not to apply the new
standard and the leases of low-level value. The elections will only be for short period leases and
those leases with low value and the information disclosed in the financial statements. The
5 Zeff, S.A., Radcliffe, V., & Gunz, S(2014). Accounting and auditing activities of the Ontario securirties
commission, 1960s to 2008 part3 the fifth chief accountant, 1996-2008. Accounting Perspectives 13(4), 223-252.

variable lease payments that will not be included in the valuation of lease liabilities will also be
treated in the same way.
Under the new standard, the classification of the lease will not be mandatory as it has
introduced a new model that will be used in all leases.
The right to use an asset will be reported at the date when it begins and the obligation is
reported at the date of the agreement between the lessee and the lessor.
How Companies that have Significant level of lease Financing get Affected.
The companies with huge leases will feel the big impact of these new standards. Those
companies with portfolios of leases at every stage will also get a bigger impact. The charges will
remain the same but the impact will be felt high in the financial statements. Companies that have
great financing from leases will have to report huge numbers of liabilities in their statement of
financial position6. This is due to the fact that all information will have to be reported in the
statement of financial position. If a company has a lot of financial obligations, it will have to be
disclosed to the public.
Reporting that information on the statement of financial information will also reduce the
amount of profit as the liabilities will reduce cash flows hence the profits will go down. The
companies will have a lot of assets but on the contrary, they will appear more indebted.
The new standard might cause those companies to conduct new budgeting and planning
to some extent7. Companies will have to set some controls that will enable them to avoid most of
the financing from leases so as to be at least more sensitive to the outlook of their financial
6 "IAS 17 — Leases". 2018. Iasplus.Com. https://www.iasplus.com/en/standards/ias/ias17.
7 Brumm, L & Jacqui ,L.(2019). New leasing accounting standard. Taxation in Australia 53(8), 449

statements. Most of them will have change on their financial evaluations and decisions so they
avoid producing statements which are not attractive to investors.
Companies that have a high level of lease financing will also experience a lot of
difficulties while looking for borrowings. As the operating leases will be categorized as liabilities
and the debt to equity ratio will be affected indicating the company’s inability to make more
profits8. This will make lenders and investors not to invest in those companies as their money
will be at risk. The debt ratio will indicate the company’s inability to generate more income for
profit and settlement of obligations.
Those companies will have a movement below EBITDA. This will cause financial
reporting anomalies in the financial statements. This can cause a mismatch between the working
capital with the current liability funds and anon current assets which may bring about substantial
effects and approaching the financiers here will be difficult as the financial statements will
indicate company’s insolvency9.
Reason companies had a Tendency to Classify Most of the Lease contract as Operating
Lease
This was due to the fact the operating leases gave the companies the opportunity to avoid
recognizing assets and liabilities in their statements of financial position. The companies enjoyed
reporting this information as footnotes and as a result the true picture of the financial
performance of companies got hidden, companies used the operating leases to hide their financial
obligations.The financial statement users got difficulties in estimating the information some
overestimating and some underestimating ending up making inaccurate financial decisions.
8 Joubert, M., Garvie, L.,& Parle, G(2017). Implications of the new accounting standards for leases AASB 16( IFRS
16) With the inclusion of operating leases in the balance sheet. The journal of new business ideas and trends, 15(2),
1-11
9 Diaz- Leon, E.(2012). Actors are not like zombies. In proceedings of the Aristotelian society(Hardback)vol.112,
No 1pt1, pp. 115-122). Oxford, Uk Blackwell publishing limited

Some companies did not include those big amounts of debts in their financial statements
portraying a wrong picture with a high level of assets and few liabilities. The companies gave
difficulties in comparing those companies with each other or those buying or those selling and
therefore they could easily get finance from their financiers and investors10. Companies could
also not recognize the correct use of particular leased assets.
How Positive Accounting Theory Relates to this Behavior of Managers.
Positive accounting theory tries to figure out the good projections and events and
translate these projections into accounting transactions in favour of the business. They do so by
determining the type of accounting policies the firm will utilize in reporting in order to give
attractive results. Positive accounting theory relates to the behaviour of managers in classifying
most leases as operating leases so that they can avoid putting large figures of liabilities in their
balance sheet11. Managers project the future of their companies and determine that using the
operating lease to classify their leases will make them attract more investors with their financial
statements. The managers recognize the existence of economic consequences if there are more
liabilities in the statement of financial positions and therefore they try to look for ways that they
can use avoid such outlooks in their financial statements12.
The Implementation of AASB 16
10 Song, Xiaofei. 2016. "Changes In Lease Financing Practice During Lease Accounting Standard Overhaul (2005-
2014)". American J. Of Finance And Accounting 4 (3/4): 309. doi:10.1504/ajfa.2016.10001603.
11 Peach, K.,& Collins, S.W (2017). Invitation to comment on ED 277 Disclosure requirements for tier 2 entities.
12 Knubley, Rachel. 2010. "Proposed Changes To Lease Accounting". Journal Of Property Investment & Finance 28
(5): 322-327. doi:10.1108/14635781011069936.

The implementation of this standard can make the financial statement users see clearly
the impact of operating leases and have a significant basis whereby they can compare the
companies13. Companies under this standard will be required to disclose both assets and
liabilities arising from operating leases. Disclosing the operating leases in the statement of
financial position will have a very big financial effect as the leasing will recognize the right use
of assets. Both companies that lease assets and those that borrow will indicate in their financial
statements allowing the financial statement users to easily compare their performance14.
For example, if a company acquires land under a lease and decides to recognize it as an
operating lease it will record the lease as a liability in the statement of financial position and the
non-lease components will be recorded differently. The leasing company will record that
transaction as an asset in the statement of financial position.
Why Companies Might Buy more Assets and Lease few.
After the implementation, the reporting entities will be likely to purchase more assets and
lease few. This is due to the fact that all leased properties will be brought to the balance sheet. If
a company leases more property it will appear to have more assets but on the other hand, the
liabilities will be more. Also under the new standard, leased assets reporting in the statements of
financial position will affect the profitability of the companies which will create a bad outward
look to the investors and financiers. The recognition of leased assets in the statements of
financial position and their corresponding liabilities will have a major impact in the gearing
ratios which will make companies to avoid acquiring more leases. Those companies that borrow
13 Mills, Jones. 2017. "Thoughts On The Impact Of Changes To AASB 16?". Intelligent Investor.
https://www.intelligentinvestor.com.au/thoughts-on-the-impact-of-changes-to-aasb-16-1878181.
14 Wappett, C.(2017) Finance laws makes another makeover for PPS leases. With more changes likely. Proctor the
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