Implications of IFRS 16 on Lease Accounting and Financial Ratios

The adoption of International Financial Reporting Standards (IFRS) is a significant move in the world of international finance, aimed at enhancing financial transparency and comparability across borders. This analysis explores the various advantages such as increased consistency, investor confidence, and streamlined reporting processes that IFRS brings to global markets. However, it also delves into the challenges faced during adoption, including implementation costs, training needs for accounting professionals, and variations in legal environments. The convergence towards a single set of global standards is a complex process requiring coordination among nations with diverse economic backgrounds. This study further investigates how IFRS impacts financial reporting, corporate governance, and market efficiency. By analyzing different case studies and scholarly articles, such as those by Bhat et al. (2014) and Florou & Kosi (2015), the assignment provides a comprehensive understanding of the implications of IFRS adoption for businesses, investors, and regulators worldwide.

Running head: ADVANCED FINANCIAL ACCOUNTING
Advanced financial accounting
Name of the university
Name of the student
Authors note

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ADVANCED FINANCIAL ACCOUNTING
Table of Contents
Part A:..............................................................................................................................................3
Requirement i).................................................................................................................................3
Requirement ii)................................................................................................................................3
Requirement iii)...............................................................................................................................3
Requirement iv)...............................................................................................................................3
Requirement v)................................................................................................................................3
Requirement vi)...............................................................................................................................3
Requirement vii)..............................................................................................................................3
Requirement viii).............................................................................................................................3
Part B:..............................................................................................................................................4
Requirement i).................................................................................................................................4
Requirement ii)................................................................................................................................4
Requirement iii)...............................................................................................................................4
Requirement iv)...............................................................................................................................4
Requirement v)................................................................................................................................4

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Part A:
Requirement i)
Fair fax media limited has conducted the impairment of assets such as investments that
accounted for using the method of equity. Such investments are tested for impairment at each
reporting date when there is indication of impairment. At the end of each reporting period, assets
that suffered impairment are reviewed for reversal impairment. Some of the intangible assets of
organization such as trade names and mastheads having indefinite lives are tested on annual basis
for impairment. Goodwill is also tested for impairment on annual basis along with other assets
such as radio licenses, database, software and websites. The indication of existence of
impairment is provided due to occurrence of one or more events in relation to any particular
assets (fairfaxmedia.com.au 2018).

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Requirement ii)
The process of allocation of such assets that is goodwill and intangible assets to cash
generating units does impairment testing of indefinite lives of intangible. It is required by group
to assess recoverable amount of cash generating unit in association with making considerable
judgments regarding the factors such as forecasting of cash flows, conditions of industry, decline
and growth rate, terminal growth rate and discount rates. Assets that are impaired through testing
of cash generating unit involves property, equipment and plan worth $ 1.1 million and
intangibles worth $ 14.7 million (fairfaxmedia.com.au 2018). Impairment of other assets such as
plant, equipment and property is carried by reviewing the carrying value of such assets on annual
basis whether they are exceeding the recoverable amount or not. Present value of expected future
cash flow forms the basis of estimating the recoverable amount. Amount of impairment of plant
and equipment along with intangibles is recorded at $ 28.9 million. Total amount of impairment
for investments, intangibles and property, equipment and plants for the financial year 2016 and
2017 is recorded at $ 1153087 million and 34124 million respectively (fairfaxmedia.com.au
2018).

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Requirement iii)
Recognition of impairment charge is done in any particular reporting period, when the
carrying value of assets is more than their recoverable amount. The impairment expenses have
been recorded during financial year 2017 of $ 1.5 million and 186.1 million in year 2016 on
plant, equipment and property. Assessment of recoverable amount of assets as identified by
indicators has resulted in total impairment charge of $ 14.4 million (fairfaxmedia.com.au 2018).
Requirement iv)
For determination of impairment, Fair fax media limited conduct the impairment testing
by estimating the carrying values of liabilities and assets. Determination of carrying values is
based on assumptions and estimates regarding future events. Computation of value in use forms
the basis of recoverable amount determination of cash generating unit. Making of assumptions
makes management to use the methodology of discounted cash flow. Assumptions have been
made about discount rate, terminal cash flow forecast, forecasts of cash flow, terminal growth

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rates and terminal cash flow forecasts. Any sort of changes in assumptions might lead to
impairment, as it would cause the carrying amount to be more than their recoverable amount.
Furthermore, assumptions are made by management in relation to earnings multiple, forecasted
revenue and any recent investments that are made by third parties (fairfaxmedia.com.au 2018).
Requirement v)
Practice and involvement of subjectivity in the methodology of impairment testing may
fail to produce reliable and relevant benefits, as the information might be skewed or inaccurate.
Some of the organizations do the allocation and measurement of reporting unit in conducting
annual impairment testing of goodwill might allow for subjectivity and possible earnings
management. Subjectivity in the valuation process is also attributable to unobservable and
observable inputs. Estimates and extents of subjectivity will affect the impairment testing
accuracy (Alfredson et al. 2015). Management making judgments in respect of information and
inputs has the likelihood of exercising subjectivity that might not provide users with appropriate
depiction about impairment.
From the analysis of section of key and audit matters of Fair fax limited, it has been
found that auditors make the assessment whether organization meets the criteria of incorporating
substantial subjectivity in the process of impairment testing (fairfaxmedia.com.au 2018).
Therefore, after evaluating this particular aspect, it can be said that Fair Fax limited has
exercised some degree of subjectivity and performed the testing methodology opportunistically.

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Requirement vi)
Conducting the evaluation of impairment testing methodology of Fair Fax limited, it is
ascertained that testing process is interesting and surprising. All the information concerning the
impairment is presented by properly segregating it in different sections. One interesting fact
about the impairment was that recognition and measurement of each individual assets whether
intangibles and tangibles are presented separately. Accounting policy used in estimation of
recoverable and carrying amount of all assets is explained in detail. All the impaired assets are
provided with estimates recoverable values that are based on assumptions made by management
(fairfaxmedia.com.au 2018). The auditor’s report also assesses the impairment of assets and
whether the methodology meets the requirement of AASB 136 of Impairment of assets”.
Requirement vii)
Group has conducted the sensitivity analysis relating to its cash-generating unit for
assessing the requirement of conducting impairment if there recoverable amount is lower than
their carrying amount. Estimates and judgments regarding the assets impairment are assessed for
the adequacy of information. Impairment of Fair Fax limited also involved related party loan
receivable, equity accounted investments along with intangible assets (fairfaxmedia.com.au
2018).
Requirement viii)
Hedge accounting of group takes into account hedges of fair value of recognized
liabilities and assets or commitment of firms. Determination of interest swap fair value is done
by referring to market values of similar instruments.

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Computation of fair value is done by discounting future cash flows by interest rates
concerning liabilities with profiles of similar risks. Fair value of financial instruments is
estimated by various methods such as quoted process, inputs for liabilities and assets that are not
based on apparent market data and inputs other than quoted prices are within several levels. Fair
value of items of sales investment is done by evaluation of exchange traded listed share prices
(fairfaxmedia.com.au 2018).

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Part B:
Requirement i)
The main factor that is associated with not reflecting economic reality under the former
lease standard is related to incentives given by companies to classify lease contracts as operating
lease. Principle underlying the standard does not obliges company to disclose the leases
liabilities and assets under operating lease in the balance sheet. Rather they are disclosed as
expenses relating to rental arrangement in the notes to financial statements and this keep the
balance sheet profiles unchanged (Espinosa et al. 2015). In reality, companies might have actual
liabilities concerning lease that might be more than the lease reported off balance sheets. It is
estimated by IASB that out of $ 3.3 million worth of lease, only 25% of lease commitments is
reported on balance sheets (Christensen et al. 2015). Therefore, the actual worth of lease
commitments is not disclosed and this is the reason why the existing standard does not reflect
true economic reality.
Requirement ii)
One of the major flaws of IAS 17 is associated with the incentive given to company for
treating lease as operating lease. Treating lease as operating lease does not increase the balance
sheet as the expenses concerning such lease are mentioned in the notes of financial statements.
On other hand, financing lease impacts the balance sheets as it gives rise to liabilities and assets.
Organizations have their debt to equity ratio worsen if they treat lease as financing lease and it is
considered more favorable to classify lease as operating lease rather than financing lease (Bhat et
al. 2014). Therefore, organization that classifies lease as operating will have actual lease

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commitments and liabilities that might be more than the total amount of debt that is represented
in the balance sheets. It is prepared for enabling their financial position to look more attractive to
investors that they essentially are. Total liabilities of companies might be more than on balance
sheets liabilities and the flaw of former standard helps in explaining why the debt reported on
balance sheets is 66 times more than off balance sheet liabilities.
Requirement iii)
Former lease accounting standard IAS 17 had ongoing controversy related to
classification of lease as operating and financing lease. Under the existing or former standard, it
is not essential for organization to reveal their operating lease commitments on balance sheets as
against operating lease. Airline companies either lease most of their aircraft fleets or they
purchase their fleets, and this might make look financial position of organization different
(Kajüter and Meinhövel 2016). It can be explained with the help of an instance, German airline
Lufthansa buys most of their fleets and its competitors Emirates airlines acquires most of their
fleets by leasing them and this might create difference in financial position of such companies.
However, in actual there might be similarity between financial position. Companies leasing few
of their aircraft fleets have higher leverage and assets base against companies having lower or
leasing few of their aircraft fleets (Feldmann and Le 2017). This depicts why there was no level
playing field between airline companies under the former lease standard.
Requirement iv)
Some of the companies especially who relies more on operating lease will have their
financial position being influenced considerably with the implementation of the new lease
accounting standard. Knock on effects of new standard is affecting several key performance
indicators, as balance sheets will be more expanded due to recognition of leased liabilities and

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assets. Now days, credit given by banks are associated with debt covenants that are tied to
various financial ratios (Donkersley et al. 2017). Hence, there needs to be a renegotiation of
existing debt covenants. Organizations might be keen on using short-term lease, as it would not
influence the balance sheet to a considerable extent. Increase in size of debt structure and balance
sheets would lead to organizations facing difficulties in receiving credit and experience problems
with creditors. Consequence of higher cost of transition and administrative burden on
management is another reason for making new lease standard unpopular. Alterations in lease
accounting will need educational efforts from top-level management and all way to
organization’s local parts as most of lease contracts are entered on local level (Bassemir 2017).
Some of the administrative burden on organization will be witnessed in terms of increased cost
and complexities of reporting, updating of accounting system and installation of new IT system.
Increased investment will be needed on part of management in new system and consumption of
time, as they will have to make detailed estimation concerning lease that is right to use and lease
liabilities compared to former lease standard.
Requirement v)
Application of new lease standard IFRS 16 makes it mandatory for all companies in
essence for all leases to make the disclosure of all leased liabilities and assets on their balance
sheets at the present value of future lease payments that are not avoidable. Recognition of
interest payable on leased liabilities and depreciation related to lease assets are depicted in the
income statement. New standard will have impact on some key financial ratios are highly crucial
to some companies. Investors will be provided with the information about the change in structure
of debt in the annual report of company. Disclosure of operating lease on the balance sheets will
have considerable impact on operating profits, asset turnover, interest cover, cash flows and

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other financial ratios (Findeisen and Adolph 2016). It would help in depicting actual scenario
and financial position of companies and there will be decision that is more informed since this
will lead to actual reflection of lease commitments. For evaluation of financial performance of
any business requires outsiders of companies and users of financial statements to make
guesswork and rough computation and calculations for estimating actual lease commitments in
the existing lease standard. Such process might lead to occurrence of errors and there exists
possibility of reflection of financial scenario that does not exist. IFRS 16 will help in brining
much needed transparency and facilitating comparisons between different companies (Florou and
Kosi 2015). There will be clear and enhanced understanding of actual liabilities relating to lease
commitments. Furthermore, new standard implementation will help in better allocation of capital
and making analysts and investors with enhanced leasing methods and will help in making
balanced leased versus buy decision on part of management.