Holmes Institute HI6025: Accounting for Lease - A Critical Review

This report presents a critical review of accounting for leases, focusing on the transition from AASB 117 to AASB 16. It analyzes the drawbacks of the old standard, the rationale for the change, and the incorporated changes in AASB 16. The report explores how companies with significant lease financing are affected, including implications for financial statements, balance sheets, and cash flows. It examines the classification of leases, positive accounting theory, and the IASB's view on comparability. The report also delves into the potential effects on the leasing market and includes a summary of key disclosures from an ASX-listed company's annual report. The analysis covers transitional provisions and the impact of the transition to AASB 16, providing a comprehensive understanding of the evolving landscape of lease accounting.

Accounting For Lease 1
ACCOUNTING FOR LEASE: A CRITICAL REVIEW
By Student’s Name
Course Name
Course Title
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Accounting for Lease 2
Abstract
Leasing is a vital activity widely utilized for both long-term and short-term financial
obligations for many companies. As a result of inescapabilty of leasing, it is fundamental to
deliver comprehensive and complete financial statements to user. This enables them to gain
full insight into a given firm’s leasing obligations. This paper presents a critical view of
accounting for lease, outlining the implications of the new AASB 16 on companies. This
evaluation is centred on data collected from existing literature and information from the
Australian Standard Board Website, academic literature and journal articles. The views in this
report incorporate a critical comparison of the AASB 117 and AASB 16, and state the
rationale for changes relative to the old accounting standard. The new accounting standard
was formulated due to evident limitations in the old accounting standard.
Keywords: AASB 16, AASB 117, Lease Liability, Right-to-Utility, Financial Leases,
Operating Leases

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Table of Contents
Abstract......................................................................................................................................2
Table of Contents.......................................................................................................................3
Introduction................................................................................................................................5
Critical evaluation of the old accounting standard for lease specifically highlighting the
drawbacks...................................................................................................................................5
Why was the change necessary?................................................................................................6
What changes have been incorporated in the new accounting standard for lease AASB 16?...7
How will companies that have significant level of lease financing be affected by the change
in the accounting standard for lease?.........................................................................................7
In the former accounting standard for lease (AASB 117) both operating lease and finance
lease were allowed, why did companies have a tendency to classify most of the lease contract
as operating lease? How does positive accounting theory relate to this behaviour of
managers?...................................................................................................................................9
According to the IASB, the implementation of IFRS 16 (the IFRS version of AASB 16) is
expected to improve comparability between companies that lease assets and companies that
borrow to buy assets. Explain this view of the IASB with suitable example..........................10
The implementation of AASB 16 might have an effect on the leasing market if companies
decide to buy more assets and as a result, lease fewer assets. Provide possible explanation as
to why after the implementation of AASB 16, reporting entities might be more likely more
assets and lease fewer assets....................................................................................................11
Select the latest (2017 – 2018 financial year) annual report of an ASX listed company.
Summarise the key disclosures the company has made on its accounting for leases including

Accounting for Lease 4
on the transitional provision and effect of the transition to AASB 16 from AASB 117.........12
Summary/Conclusion...............................................................................................................18
Bibliography.............................................................................................................................19

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Introduction
This paper presents a critical view and insightful evaluation of the AASB 16, which
has supplanted the old leases accounting standard, AASB 117. The main themes that will be
analysed in this research are the critical comparison of the old and new accounting standard
and reasons for the change. Moreover, this analysis will consider the features of the old
accounting standard and its drawbacks, including the differences in these accounting
treatments like, the presentation of the balance sheet, classification and the transitional
provisions to lessee and lessors accounting. The enhancement of versions and drafts of every
accounting stage will be considered in reference to the need for change by the IASB. Through
the presentation of a practical aspect on one of the ASX listed company, this report will
evaluate and summarize the key disclosures and accounting leases for businesses in Australia.
Critical evaluation of the old accounting standard for lease specifically highlighting the
drawbacks
The old accounting standard (AASB 11) for leases classified relative leases as
financial or operating leases.1 This standard composes of the balance-sheet categorization and
treatment of all leases as financial. This standard’s drawback is evident from its exemption
applicable to less than twelve months (short-term) leases, including assets with a low value.
2The projected aim of the standard was to recognize the relevant leases as right-to-utilize
assets placing them into a balance sheep. AASB 117 necessitated that for companies to
execute payment in future, there was need to represent its requirement, including recognition
of various financial liabilities as payments of leases executed over a stipulated timeframe.
Moreover, there was no considerable transitional provision designed for the relevant lessors
since the lessor model in the old accounting standard decelerated the disclosure process.
1 AASB authoritative pronouncements service. (2001). Melbourne, Vic.: The Board.
2 Caster, P., Scheraga, C. and Olynick, M. (2018). The impact of lease accounting standards on airlines
with operating leases: Implications for benchmarking and financial analysis. Journal of Transportation
Management, 28(1), pp.15-23.

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Another drawback of the old accounting standard is its conduct of the residual
valuation assurance compared to the new standard.3 The AASB 16 removes all the leveraged
leasing models evident in the old standard, which permitted the consideration of non-resource
debts. As for risk management obligations, the old accounting standard did not demand the
disclosure of addition information (like leases subject or residual interests on various assets)
to align with lessee and lessors accounting models.4
Why was the change necessary?
The categorization of leases as operative implied that companies had fundamental
assets that are vital for their entity operations, which had not been recorded in their respective
financial statements. Moreover, the concomitant liabilities were understated. Financial
statement users like the banks and analysts regulate their financial statements targeting
operative lease assurances note in executing decisions whereby these regulations are
normally incorrect.5 Thus, any leases representing a company (i.e. all agreements in
accordable to the definitions of leases) were purposed to be documented in the balance sheet
as non-current right-of-utility asset with respective liabilities leases. These lease liabilities
were categorized into non-current and current components. A company’s income statement
that denoted the relevant profit or loss values will indicate the expense of the lease as
depreciative in reference to the right-of-utility, including the interest of the liabilities for
leases instead of rent expenses indicated as operative expenses.
3 Ibid.
4 Jackson, D. (2018). Gauging the development of innovative capabilities in Accounting and Finance
students: can they drive the national innovation agenda?. Accounting & Finance, 41(23), pp.20-33.
5 Cheung, E., Evans, E. and Wright, S. (2008). The adoption of IFRS in Australia: The case of AASB
138 (IAS 38) Intangible Assets. Australian Accounting Review, 18(3), pp.248-256.

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What changes have been incorporated in the new accounting standard for lease AASB 16?
The new AASB 16 substitutes the operating and finances concepts for the lessees, which will
necessitate the respective lessees to identify their leases on balance sheets.6 The fundamental
change in the standard implies that operative leases will be denoted and financial situations of
entities and councils will include more liabilities and assets. The AASB 16 reserves the
ideology of finance and operating leases for respective lessors. According to the 2018/2019
LGMFR edition, there is the need to include the pendent accounting standard disclosure
relative to the implications of the AASB 16. The LGMFR 2019/2020 edition necessitates an
update to consider the rations of AASB 16.
How will companies that have significant level of lease financing be affected by the change
in the accounting standard for lease?
Companies have been affected considerably in terms of the lease financing. The
AASB 16 leases have attained a wide-ranging coverage, however, the implication on
companies to likely to be evident off accounting functions. Entities may thus require an audit
since the new standard is aimed at recognizing both the lease liability and right-to-utility in
consideration to the functions that were initially the operating lease. Resultantly, the balance
sheet is speculated to gross up considerably enhancing the debts indicated and asset base.
Private entities in Australia are needed to have an audit as long as they attain two third of
sizing criteria according to the Corporation Act 2001: $25 Million in revenue, $12 Million in
assets and fifty workers.7 Some of the entities previously considering in the threshold of the
assets would notice that the new accounting standard is meant to increase the basis of their
assets to a measure in accordance to first-time audit.
6 Demir, Z. and Bas, E. (2017). The effect of tas 17 "leasing" standard and implementation of the new
IFRS 16 "leases" standard on the airline companies. Pressacademia, 3(1), pp.153-173.
7 Song, X. (2016). Changes in lease financing practice during lease accounting standard overhaul (2005-
2014). American J. of Finance and Accounting, 4(3/4), p.309.

Accounting for Lease 8
Acquisitions and mergers for companies may also be more challenges since the
implication of the AASB 16 presents a challenge for businesses that engage in M&A
obligations. The application of the new standard transits various key metrics applicable in the
assessment of acquisition activities and transactions.8 Stated cash flows will also be affected
and presented differently whereby operating leases would be considered as operative
expenses. Cash flow transaction will be categorized between the principal of repayment that
would be in the investments cash flow and the lease liabilities interest included in financing.
The front loading expenses are another effect of the new accounting standard, which
will be designated towards the old lease parts instead of recognizing them as convectional
line base. Moreover, this effect may be compounded considering the implication of the new
accounting standard of an entity’s revenue. Financial statement would be designed on
rectified retrospective base that does not necessitate the reaffirmation of proportional
financial periods. This implies that for instance, financial statements for 30 June 2018-2019-
2020 have been designed on three various bases, which makes it complicated to track
financial performance over multiple years.9
In the former accounting standard for lease (AASB 117) both operating lease and finance
lease were allowed, why did companies have a tendency to classify most of the lease contract
as operating lease? How does positive accounting theory relate to this behaviour of
managers?
The classification of leases as operating leases is centred on the aspect to which
rewards and risks incidental to assets ownership is applicable on the lessee or lessor.10 The
old standard differentiates between operating and finance leases, whereby the latter is
8 Demir, Z. and Bas, E. (2017). The effect of tas 17 "leasing" standard and implementation of the new
IFRS 16 "leases" standard on the airline companies. Pressacademia, 3(1), pp.153-173.
9 Dogan, F. (2015). Non-cancellable Operating Leases and Operating Leverage. European Financial
Management, 22(4), pp.576-612.
10 Ibid.

Accounting for Lease 9
considered when it transfers all the rewards and risks incidental to assets ownership on lessee
or lessors. The tendency to classify lease contracts as operating lease also reflects on risks
and rewards subsidiary to possession from lessees and lessors.
Positive accounting is based on contractual interpretation of the entity, which is
considered as the nexus contract that facilitates the performance and formation of business
contracts. In consideration to this view, the accounting activities of a firm exist to control the
costs of contracts through an establishment of ex ante agreements between variable groups.
The new accounting standard transits accounting considerably for lessees and removes the
categorization of lessees as finance or operating leases. Resultantly, leases are ‘highlighted’
through the recognition of right-to-utility and lease liability assets on balance sheets. There is
a minor transitional provision for lessors whereby the visibilities of entities are enhanced
based on lease commitments, which might have a positive reflection on financial reality. The
new standard also makes it appealing for financial statement users to distinguish entities for
asset leases with those that borrow funds to purchase assets hence formulating more level-
playing segment.
According to the IASB, the implementation of IFRS 16 (the IFRS version of AASB 16) is
expected to improve comparability between companies that lease assets and companies that
borrow to buy assets. Explain this view of the IASB with suitable example.
The implementation of the IFRS 16 has been considered after IASB’s discussion over
lease accounting. IASB introduced an accounting framework considered as the capitalization
models that involves the comprehension of lease operation in balance sheets.11 In reference to
the current operating lease, other that evaluating leases expenses, companies will possibly
recognize lease assets (i.e. pendent assets and right-to-utility assets) and leases liabilities for
11 Aasb.gov.au. (2019). Australian Accounting Standards Board (AASB) - Home. [online] Available at:
https://aasb.gov.au/ [Accessed 2 May 2019].

Accounting for Lease 10
current valuation of lease transactions in the future. According the old accounting standard,
the activities designed for future transactions after the operating lease arrangements are not
evaluated in the balance sheets despite an entity might have been committed to these
transactions.12 IASB targeted to include lease liabilities and the right-to-utility asset on
balance sheets.
Example: Under the IFRS 16, when a company accepts to enter into a lease
obligation, it is supposed to recognize the right-to-utility assets and the lease liabilities. The
debt liability for the firm is earlier denoted as the current valuation of future lease
transactions in the lease timeframe. Right-to-utility is earlier recognizes as the valuation that
equates the liability in addition to concepts like lessee’s earlier direct finances, pre-
transactions executed by lessors, approximate restoration costs, elimination and
disassembling; and additional incentives attained from lessors.13
The most vital effect of implementing the standard for Australian entities will evident
on the balance sheets leases, which enhances the lease liabilities and assets. Moreover, key
the significant financial ratios like the leverage ratio are speculated to transit. Entities with
materials off the balance sheets lease will be considerably affected by the subjective costs
like the process set-ups and systems set-ups, defining the rates of discounts on the current
valuation base when assets and liabilities are evaluated. Moreover, these companies will be
able to communicate to third parties regarding the transiting report data. Nonetheless, the
transactions will considerably vary in entities contingent to the size of the leasing portfolio.
Companies (for example. retailers, estates, and construction & property companies) with
abundant and high value lease will be substantially affected. The implementation of the new
12 Ibid.
13 Lu, M., Shan, Y., Wright, S. and Yu, Y. (2018). Operating cash flow asymmetric timeliness in
Australia. Accounting & Finance, 1(4), pp.1-29.

Accounting for Lease 11
standard necessitates similar information to that of the AASB 117, which only exempts
discounting rates.
The implementation of AASB 16 might have an effect on the leasing market if companies
decide to buy more assets and as a result, lease fewer assets. Provide possible explanation as
to why after the implementation of AASB 16, reporting entities might be more likely more
assets and lease fewer assets.
The AASB 16 based on financial institutions is speculated to make analysts and banks
accounting more realistic through enforcement actions to recognizing credit losses in the
present and in the future. By transiting from incurred losses to expected losses, companies are
aligned to mitigate problems during financial crises whereby entities will have more assets
and lease fewer assets for economic stability.14 Moreover, this enables financial institutions to
capitalize loans effectively.
Select the latest (2017 – 2018 financial year) annual report of an ASX listed company.
Summarise the key disclosures the company has made on its accounting for leases including
on the transitional provision and effect of the transition to AASB 16 from AASB 117.
Being an ASX listed company, the Elsight Limited Company is strategized to account
for disclose finances and operating leases in its financial statement to lessees and lessors. The
entity has critically recognized its operating segments centred in its internal audits reports
revised and utilized by the chief operating offers in decision-making.15 The key disclosures
are significant to the company since they enable the directors to assess the organization’s
performance to determine its resource allocation.16 The sole-operating sector is dependent on
14 Sheraga, C. and Caster, P. (2014). Distortions in the measurement of the efficiency of financial
leverage strategies in the airline industry when operating leases are ignored. Journal of Transportation
Management, 25(1), pp.21-36.
15 Steenkamp, N. and Steenkamp, S. (2016). AASB 138: catalyst for managerial decisions reducing R&D
spending?. Journal of Financial Reporting and Accounting, 14(1), pp.116-130.
16 Graham, R. and Lin, K. (2018). How will the new lease accounting standard affect the relevance of
lease asset accounting?. Advances in Accounting, 42(25), pp.83-95.

Accounting for Lease 12
the representation of associated financial statements. Shared-centred transactions are
evaluated at a considerable service and goods valued realized or the fair valuation of equity
frameworks provided. When the company determines a considerable valuation of services
and goods, a record of when the goods and services were received is documented.
Figure 1: Associated Financial Statement Position of the Company as at 31 Dec 2018
Figure 2: Associated Cash Flow Statement Ended 31 Dec 2018