HI6025 Accounting for Leases: A Critical Review of AASB 16

This report critically examines the new accounting standard AASB 16 for leases, comparing it with the old standard, AASB 117, to identify changes and impacts on the lease market. It discusses why the changes were necessary, the new changes incorporated in AASB 16, and the reasons companies classify lease contracts as operating leases. The report also explores the relation between positive accounting theory and managerial behavior, how IFRS 16 advances comparability between firms, and the potential effects of AASB 16 on the leasing market. Furthermore, it briefly touches on Abacus Property Group's annual reports and the principle of earned income. The document is contributed by a student and available on Desklib, which provides study tools and resources for students.

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AASB 16
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Abstract
The purpose of this report is to understand the accounting standard for lease by critically
examining the new accounting standards for lease AASB 16 and comparing it with the old
accounting standards.
The study enable one to find out the changes the new accounting standards has brought about,
impacts of the changes to the lease market. It also gives reason as to why managers use the
different kind of accounting method, it also gives an insight about the positive accounting theory
and how it relates to the mangers decisions on use of particular accounting method.

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Table of Contents
Abstract......................................................................................................................................................2
Introduction...............................................................................................................................................4
Critical evaluation of AASB 117...............................................................................................................5
Drawbacks.................................................................................................................................................5
Why the changes were necessary.............................................................................................................6
New changes incorporated in the new leasing standard AASB 16.........................................................6
Reasons why companies have a tendency of classifying most of lease contract as operating lease......8
Relation between positive accounting and behavior of managers........................................................10
How enactment of IFRS 16 will advance comparability between firms that lease assets and those
that borrow to buy...................................................................................................................................11
Effects of AASB 16 on the leasing market incase companies decide to buy more and lease less.......11
Annual Reports of Abacus Property group...........................................................................................11
The principle of the earned.....................................................................................................................13
How is the monthly determination of first category income................................................................14
Conclusion................................................................................................................................................15
References................................................................................................................................................17

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Introduction
Accounting methods are them rules a company follows in reporting revenues and expenses.
Throughout the years, the methods of accounting have improved and have gone through
significant changes to cater for the changing and developing world.
The AASB 117 is a standard in accounting which was issued and made applicable in Australia.
This standard was formulated to outline the accounting procedures that would be adhered by the
lessor and lessee when they enter into a contract of lease.
In recent years, this accounting principle AASB 117 for lease accounting has been retracted and
improved to a newer version known as AASB 16 introduced because the former had several
limitations.

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Critical evaluation of AASB 117
The AASB 117 is a standard in accounting which was issued and made applicable in Australia.
This standard was formulated to outline the accounting procedures that would be adhered by the
lessor and lessee when they enter into a contract of lease.
In recent years, this accounting principle AASB 117 for lease accounting has been retracted and
a new improved version known as AASB 16 introduced because the former has major draw
backs.
Drawbacks.
The rules of accounting provided under AASB117 did not disclose the different types of leases
that were newly developed on the balance sheet.
The model of accounting that was followed under AASB117 did not show the accounting
information that was needed to cater for stakeholders’ needs and also other financial statements
users.
This accounting standard made it hard and complex to disclose requirements that were related to
the transactions in the lease and also the amounts made it hard for any organization to follow
these rules.

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Why the changes were necessary
Unlike rules provided by AASB 17, the rules provided by AASB 16 are simple, this standard of
accounting uses layman’s language which is easy to understand and implement as compared to
the provisions of AASB 117 which are not easy to implement.
The amount reported in the financial statement in regard to assets and debt would be increased
which would lead to an increase in the leverage amount that is reported. The accounting based
covenant of debt will have consequences because of the increased amount leveraged for the
organization.
Lease expenses in AASB 16 are reported in a way that they tend to be front loaded. That is most
of the expenses will be put in the first few years of the lease matching with the depreciation
expense charged on accelerated basis. Hoyle,, Schaefer and Doupnik,(2015) This will have an
influence with the profits reported in the financial statements for each year.
New changes incorporated in the new leasing standard AASB 16
The new IASB lease regulation requires firms to include the greater part of leases in the balance
sheet, so they will identify the new assets and liabilities. Leases offer an important and flexible
source of financing for many companies.
However, the current accounting standard makes it difficult for investors and other third parties
to obtain an accurate picture of a firm’s leasing assets and liabilities, especially for industries
such as the airline industry, retail trade. and transportation. There was a concern about absence of

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clear information broken down by the tenant companies in relation to their obligations for lease
contracts and the fact that there were high off-balance payment commitments.
This new scenario is the one that will produce a "significant" change in the balance sheet of
companies, fundamentally among those specialized in renting commercial premises, renting
hotels, renting airplanes or renting land for wind farms, which could go from having a very low
level of leverage at a very high level, therefore you will see an increase in your leverage.
As it currently stands, all the companies under that have a substantial level of leasing will be
affected these changes, it is estimated that they have an estimated 3.3 trillion USD value of
leased assets from which about 85% of these assets are not included on their balance sheet, due
to this investors have been forced to often overestimate their liabilities due to the unreliable
calculations.The new accounting standards will end the assumptions involved when coming up
Joubert, Garvie and Parle (2017) with the company’s lease requirements , it will provide the
desirable transparency on the firm’s assets and liabilities and also enable organisations that
borrow to buy and leasing companies to compare amongst themselves.
The leasing will possibly have substantial impact on the entities which may not be immediate but
will be obvious. These changes give a more precise representation of the financial situation of
the business, reflects on its liabilities and come up with important financial information for the
sake of investors and shareholders.

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The standard will modify the ramework of the expenses. Instead of it being a rental expense
there will be more at the beginning years and less the advancing in years hence having an
influence on earning profile.
Due to the probable financial reporting faults, the proper use of an asset will be non-current
while the lease liability will be differentiated between current and non-current.
Another impact will be that there will be more companies that will now qualify as a large
proprietary company in addition to the right of use assets on their balance sheet increasing total
asset and possibly the need for auditing the financial statements to be lodged.
Considerable influences with bank covenants which can cause possible gaps if companies are not
hands on about approaching their financiers.
Reasons why companies have a tendency of classifying most of lease contract as operating
lease
The categorization of lease, implemented in AASB 117 standard was founded due to the
intensity to which threats and returns related to rights of the asset being leased lies with the
lessor or the lessee. De Simone (2016) Such risks include obsolescence, diffrences caused by
changing commercial enviroment and loss. The returns included appreciations and profits over
the assets economic life.
A lease is classified as finance when:
If the lease handsover the possession of the asset to the renter at the end of the agreement

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If the renter of the asset has an option to buy the asset at a lower fee as compared to the fee
indicated on the date the choice can be excersiced and at the start of the agreement, it is
reasonably definite that the option will be implemented. The ease agreement is for major part of
the economic life of the asset even if Wong, and Joshi,( 2015) the title is not transferred.
An operating lease is a contract that allows for the use of the asset but does not transfer the
ownership rights of the asset. the operating lease are accounted as off balance sheet financing
because the leased assets and the possible associated liabilities of future rent payment are not
included on the company’s balance sheet.
Operating lease is more popular as most companies have a tendency of classifying their lease
contracts as operating lease for a number of reasons
The company does not bear the risk of obsolescence as there is no transfer of ownership.
In case the equipment is technological, it is likely to be outdated quickly. Incase this happens the
company does not bear such risks.
The lease payments are tax deductible. A lease allows the company to deduct the payments as
operating expenses during the period in which it is paid, interests and costs of depreciations can
be deducted when the item is purchase therefore firms in a lower tax bracket are more likely to
classify a lease as an operating lease.
Operating leases provide greater flexibility to companies as they can replace and update their
equipments more often, hence the company can generate cash flow with the continuous update of
equipments.

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Relation between positive accounting and behavior of managers
Positive accounting theories is concerned with forecasting actions such as choices of accounting
policies by companies and companies response to these proposed accounting standards. The
accounting treatment for leases can be easily be influenced by self-interested managers, hence
the need for the positive accounting theories that predicts such actions. Öztürk and Serçemeli
(2016) Positive accounting is crucial when dealing with lease accounting since how a lease is
recorded on a company financial statement brings about the difference of whether an employee
will achieve their set goals or not.
The positive accounting theory looks into the efficiency of the company by looking at ways
through which managers show the real presentation of the firm’s performance especially the
self-interest managers who only adapt accounting standards that only for their individual benefit
in the sense that the firm also benefits. Kusano, Sakuma and Tsunogaya( 2016) It looks at the
different theories that explain what intentions make the managers choose a specific accounting
methods over another. These theories are:
Administrative compensation hypothesis, this states that administators who have tied up
inducements to the firm mostly manipulate the figures to try and show a better performance
than it really is.
Debt equity hypothesis states that mangers show enhanced profits with the intention of showing
improved performance and readiness to pay the debts it may have gathered in the business , the
more the debt, the likelihood of the managers to use accounting methods to show accounting
profits.

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Political hypothesis assumes that the firm show the firm’s profit much less by using different
accounting approaches so that the firm does not entice political attention from politicians who
often have interest on high profit industries.
How enactment of IFRS 16 will advance comparability between firms that lease assets and
those that borrow to buy
According to IASB the implementation of IFRS 16 is expected to drastically improve the
comparability of organisations that lease assets and those that borrow assets to buy, the IASB is
aware that the comparison is crucial to the stakeholders and analysts Xu, Davidson and Cheong
(2017).The absence of information from the balance sheet about the leases mean that stakeholders
and analysts cannot compare companies without making adjustments hence airline 1 has more
influence and a better asset base compared to the second airline when actually the reverse is true.
Effects of AASB 16 on the leasing market incase companies decide to buy more and lease
less.
Adoption of IFRS 16 has potential to give rise to behavioral changes that will upset the leasing
market. Xu, Davidson, and Cheong (2017) For instance, the fact that the lessee accounting
requirement in IFRS 16 provides a greater comparability between the lessees and the leasers ,
companies may decide to buy assets rather than leasing them.
For instance the companies decide to buy assets rather than lease them, there will be a significant
change in the economy since buying of assets uses a large amount of money. Buying assets such
as airpcraft requires a large amount of money to be drawn out of the company finances as
compared to leasing of the same asset.

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With the new accounting standards there will be an increase of assets in the balance sheet and a
decrease of financial liabilities on the same. Assets will increase since they are not being leased
and the small growing companies cannot afford to buy the same assets hence an increase in
assets in the balance sheets. Such cases will cause affect the leasing markets.
Annual Reports of Abacus Property group
This section covers annual reports of Abacus property group which is a company listed in the
ASX and deals with property. Lin, and Graham, (2018) The company has leased some of its
properties for commercial use. The biggest change in the area concerns the unification of lease
types. The current rule says that there are two types: financial and operational leasing. The first
recognizes the contract in the balance sheet of the lessee; already the second, recognizes the
value of leasing as a rent.
Accounting standards understands that all leases are recognized within the Company's Balance
Sheet. The new standard also offers exemption from leases of up to one year or whose values are
very low.
The new tax obligations are part of significant changes for the accounting industry. De Simone
(2016) Therefore, you need to prepare and adapt your company within the established deadlines.
At first it may sound cumbersome, but its management will flow much better after the