Financial Reporting Analysis: IFRS 16, Onerous Contracts, and IAS 37

This report presents a detailed analysis of an accounting article discussing IFRS 16, focusing on its impact on financial reporting and the application of relevant theoretical frameworks. The analysis includes a description of the article, an investigation of the accounting issues with theoretical application, and a review of a recent exposure draft related to IAS 37 concerning onerous contracts. The report explores the issues resolved in the accounting of onerous contracts through proposed changes in the exposure draft, analyzing the issues identified, the practical application of the standard, and the impact on financial statements. It also examines the conceptual framework of accounting and its qualitative characteristics, emphasizing the importance of relevance and understandability in financial information. The report concludes with a synthesis of the findings, highlighting the significance of IFRS 16 in improving the quality of financial reporting and the role of theoretical frameworks in enhancing the credibility and relevance of financial information. The report also presents a review of an exposure draft on changes to the accounting treatment of onerous contracts, discussing the issues addressed and the proposed solutions.

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Assessment item 2

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Part 1:
Introduction
This assessment aims to present an analysis of an article providing an item of accounting
news published after 1st of June 2019. The analysis is undertaken for the purpose of providing
CEO an in-depth understanding of the accounting issues discussed within the article with the
application of relevant theoretical frameworks. The article selected for the purpose is entitled as
‘IFRS 16 on track for a new lease of life’ published within online website chartered
accountantsanz.com. As such, the assessment initially provides a description of the article and
investigating the issues developed with the use of relevant accounting theories and concepts.
Link to the Article: https://www.charteredaccountantsanz.com/news-and-analysis/news/ifrs-16-
prepares-for-a-new-lease-of-life
Analysis of Accounting Article Selected
The article selected has emphasizes on the impact of new lease standard, IFRS 16, on
financial reporting of businesses. The author within the article has placed importance for the
business entities to adopt consequent remedial action for addressing the changes caused by the
implementation of the new accounting standard. The new standard has caused the removal of
need for business entities to classify the operating leases and has stated that all lessees should
depict their lease liability and a consequent right of use asset for all leases. The IASB has
fostered such changes in the accounting standard for classification of leases and has directed all
the business entities complying with IFRS to adopt the use of this new accounting standard
(Chartered Accountants, 2019). However, there is increasing concern among the business entities
regarding the adoption of the new accounting standard as it is intended to cause complex changes
within the financial reporting system. The adoption of the standard would have a significant
impact on the business performance as it would cause major changes in the ways of measuring
and reporting the financial information. For example, it would have a significant impact on tax
accounting, profit before tax and liabilities position of a company.
Also, there is present a challenge before businesses to adopt significant changes within
their processes and systems for accommodating IFRS 16. This would require providing

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significant training to their finance and accounting team so that they can gain knowledge of the
standard and adequately comply with its needs and requirements. This can result in incurring
significant costs for the companies along with disruption caused in their current financial
reporting system (Gwan, 2019). The commercial considerations that businesses need to take into
account include changes in the reported earnings and presentation of balance sheet items and also
having a significant impact on their forecasting and development of strategies (Spotlight on the
new Leases Standard, 2018).
The article has also illustrated the particular areas that would be significantly affected by
the adoption of IFRS 16 within the financial reporting system of business entities. This includes
changes in identifying which assets are held by way of lease, determining whether the lease
classification complies with IFRS 16, taking decisions regarding the selection of lease tem and
calculating the value of right of use of an asset. These changes would have a significant impact
on the cash flows, income tax expenses and deferred tax resulting in influencing the financial
position of a firm. The firms are therefore required to undertaken tax planning as the tax
provisions such as taxation of financial arrangement depends on the type of accounting standards
that has been applied. As such, the change in the accounting standard would have a major impact
on the tax provisions and therefore firms are required to undertake potential tax planning issues.
As such, it has been suggested within the article that entities should consider a range of issues
such as impact on cash tax due to structuring of its lease arrangement and the ways in which tax
charges can be adequately managed. The changes in an entity taxable profit by the application of
the new accounting standard for leases would impact its economic position and this requires the
business managers to gain an understanding of the effect and take potential actions for tax
planning (Chartered Accountants, 2019).
Application of Theoretical Framework in context of Concepts, Ideas and Facts of Article
The issues discussed within the given article can be adequately explained by the
application of theoretical framework developed by IASB (International Accounting Standards
Board) in context of the standard-setting process. IASB has provided the conceptual accounting
framework to guide the application and development of standard-setting process. The theoretical
framework has provided the qualitative characteristics that lead to enhancing the quality of
financial reporting systems. These qualitative characteristics need to be met by the application of

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accounting standard and policies and thereby making the financial information useful and
pertinent to the end-users. The qualitative criteria provided by the conceptual accounting
framework are reliability, faithful presentation, relevance, understandability, comparability and
timeliness that need to be present within the financial information presented by the businesses to
the end-users. As such, the IASB makes significant changes in its accounting standards and
policies to comply with the qualitative criteria of the conceptual accounting framework.
The changes implemented by the IASB in the accounting standard for treatment of leases
has been undertaken to improve the quality of financial information and makes it more useful for
the end-users in their significant decision-making process. The elimination of classifying the
leases between operating and financing and thus causing the recognition of all leases on the
balance sheet as right of use of an asset and a corresponding financial liability, This has resulted
in causing significant improvements in the financial disclosure as previous accounting standards
for leases that is IAS 17 is dependent on classifying the leases as operating or a finance lease
(Spotlight on the new Leases Standard, 2018). Thus, some leases are depicted on the balance
sheet while some are not stated as rent expense in the income statement and is not depicted on
balance sheet. Therefore, it result in undermining the quality of financial reporting as investors
and other end-users of financial statements are not able to gain an accurate view of lease assets
and liabilities of a firm. As such, the changes are adopted by the IASB in the lease accounting for
making financial reporting for leases to be more relevant and understandable as per the
qualitative criteria’s stated by the conceptual framework of accounting (IFRS Conceptual
Framework, 2018).
The new accounting standards are likely to bring substantial visibility in the lease
commitment of firms and thus protecting the interests of the end-users by reflecting the true
economic position of a firm. As per the qualitative characteristics provided by the conceptual
accounting framework, IFRS 16 is likely to drive improvement within relevancy and
understandability of financial information. The relevance criteria have stated that financial
information in order to be relevant should be capable of making a difference in the decision-
making process of end-users. As such, it needs to have either a predictive or confirmatory value
for making the financial information more relevant. The predictive value should ensure that
financial information needs to anticipate the future outcomes while confirmatory value enables

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users to check and confirm earlier predictions. The understandability of financial information
means that it should be presented in an easy manner to support the decision-making process
(Business Line, 2019).
The classifying of all the assets within the balance sheet would result in improving the
credibility of the financial reporting system as all leases could be depicted clearly. The financial
statement prepared as per new IFRS 16 lease standards can lead in significantly improving the
relevancy and understandability of financial information. This could result in improving the
quality of the financial information by making it more relevant and understandable. As per the
stewardship theory, it is the responsibility of financial accountants to present the financial
information in a responsible manner (Lavi, 2016). The conceptual framework has explicitly
discussed the need for financial information to be presented in a format that helps in ensuring
that future net cash inflows can be adequately stated. It helps in improving the legitimacy of the
financial information by making its more transparent and credible before the end-users. This is
because the users of financial reports need to be present information in a format that enables in
assessing the management stewardship. Thus, it can be said that the application of theoretical
framework of conceptual accounting has enabled in improving the decision-making of end-users
by making the information to be more credible and relevant (Deegan, 2016).
Conclusion
Thus, it can be said from the overall analysis carried out that significant changes
implemented within the accounting standard of IFRS 16 has enabled in improving the quality of
financial reporting. As illustrated within the article, the adoption of IFRS 16 would have a
significant impact on the economic position of a firm by influencing its financial performance
through causing changes within its profitability position. The theoretical framework of
conceptual accounting has adequately explained the need for causing such changes in order to
make the financial information more relevant and understandable and thus improving its
legitimacy before the end-users.

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Part 2: Analysis of recent exposure draft and comment letters
Exposure draft refers to document proposed to introduce new accounting standard or
make necessary changes in the existing accounting standards. Exposure draft is documented and
is opened for the public to review and to comment on the proposed changes, whether they agree
or disagree with proposed changes. IASB and FASB are two prominent international accounting
bodies that regulate the issue and modification of accounting standards. The purpose of this
section of the report is to locate recent exposure draft (no later than 1 year) and make review of
selected exposure draft and comment letters received there on.
The exposure draft selected for the purpose of review is related to proposed changes in
IAS 37. IAS 37 is most important accounting standard related to accounting treatment of
provisions, contingent liabilities and contingent assets.
Selected exposure draft: ED/2018/2 on changes to the accounting treatment of “Onerous
Contracts-Cost of fulfilling a contract” (About: Onerous Contract, 2019)
Section A: Issues resolved in accounting of Onerous Contracts through proposing required
change in exposure draft
The purpose of introducing the exposure draft on Onerous Contracts is to make required
changes in IAS 37 “Provisions, Contingent liabilities and Contingent assets”. The amendment
that has been proposed is related to the make assessment whether contract is onerous and it also
describes the cost of fulfilling the contract. Some practical examples have been suggested to
make assessment whether the cost incurred or to be incurred is linked or not linked directly with
the contract (About: Onerous Contract, 2019).
Onerous contract has been defined under IAS 37 as contracts made under the law and
costs incurred to fulfill the contract (Unavoidable Costs) surpass the total economical benefits
received or to be received under the defined contract. In this regard, IAS 37 also defines meaning
of unavoidable costs, ie net cost or loss of economic resources to fulfill the contract and any
penalties required to bear for not fulfilling the contracts. The issues that has been identified
during the practical application of this accounting standard, is that general meaning of
unavoidable cost has been proposed but generic and practical meaning is still missing. There is
need to provide practical examples of cost that can be included as unavoidable cost and costs that
are explicitly excluded. So, one of the major issue identified is related with the non disclosure of
costs that can be termed as unavoidable cost as defined under Para 68 of IAS 37 and also
examples of each of that costs so that it is easy to identify whether contracts are onerous or not.
The issues identified in accounting treatment of onerous contract reached the IFRS
interpretation committee (Also known as IASB Committee) and requests have been placed to
review IASB 37 in relation to treatment of onerous contract. The issue is mostly faced by the
construction industry as most of contracts are either not completed on time or they face increase

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of raw material cost or other issues. It means there was problem in identification of onerous
contracts as accounting treatment to prove contract is onerous or not is not specific and lacks
some understanding. It has been identified that accounting treatment of onerous contract was first
included in IAS 11: Construction Contracts but afterwards it has been shifted to IAS 37 looking
into the requirement that onerous contract is not specifically related with construction industry
(IFRS Foundation, 2018).
The request to review IAS 37 and to propose necessary changes has been accepted by
IASB Committee. On reviewing it was found that there were different views on inclusion of
costs while estimating the total cost to fulfill the contract and to identify such contracts are
onerous or not. The objective of conceptual framework to promote the comparability of financial
statement looks to be violated due to different accounting treatment of onerous contracts as it
leads material differences estimated the liabilities to be recognised. On this IASB Committee
referred this case to IASB Board to make detailed analysis and propose specific costs to be
included to estimate the cost of fulfilling the contract. Exposure draft ED/2018/2 has been
proposed by IASB Board with all the required changes in IAB 37 (In Brief- Onerous contracts,
2018).
Section B: Outline of views presented in the selected comment letters and areas of
agreement or disagreement with the exposure draft
Exposure draft proposed in relation to amend the IAS 37 contains three major questions
to be answered through comment letters. Questions have been described in below image:
(Source: Exposure Draft. IFRS Foundation, 2018)

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Hundreds of comment letters have been received describing the views on agreement or
disagreement with board proposed changes. Four comment letters from different field have been
selected to make the analysis and present the outline on the views present there in.
Comment letter 1: Send by McCain Foods Limited
(Source: Burton, 2019)
This comment letter is well written and it presents the impact of proposed change in IAS
37 on listed companies. As per views stated in comment letter, company is in agreement with
change discussed in question one but it has asked a detailed clarification on question two on the
inclusion of depreciation and allocation of indirect cost to each contract (Burton, 2019).
Comment letter 2: Israel Accounting Standard Board (IASB)
(Source: Sapir, 2019)

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Israel Accounting Board has reviewed the exposure draft in detail and it has presented its
disagreement with proposed changes in para 68 of IAS 37 due to contradiction with IAS 37
model. Proposed changes clearly signify that there only those costs has to be considered for
calculating the total cost of fulfilling of contract, which is directly related to the contract. There
has been no provision on treatment of cost that is indirect and cannot be avoided due to presence
of contract. Expenses such as wages paid to certain employees that relates to contract but no
specifically included due to the IAS 37 model as it will recognize the future operating losses
which is prohibited under IAS 37.
Comment letter 3: ICAI Institute, India
(Source, Kumar, 2019)
The Institute of Chartered Accountant in India, clearly shows there agreement with the
question 1 and question 2 of the exposure draft. ICAI proposes that modification in IAS 37 will
help to make the things clearer and allows in recognizing the onerous contract directly without
any confusion. Institute has asked further clarification on measuring the onerous contracts for the
purpose to identify the required provisions to be made and treatment of same costs that has been
taken to identify the contract as onerous.
Comment Letter 4: Volkswagen Company

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(Source: Bartölke, 2019)
Volkswagen has reviewed and presents its consent on the proposed modification and
signifies that proposed changes will help to improve the quality and reporting requirement of
onerous contracts. It further clarifies that automobile sector is currently facing issues in
recognizing their ongoing contracts as onerous despite being outdated and reported losses. But
after the clarification on selection of specific costs, it will be easy to identify and treat contracts
as onerous after the simple calculation.
Section C: Assessment of Comment Letters Utilizing Arguments ‘for’ and ‘against’
regulation
The comment letters of McCain Foods and Volkswagen can be stated as against their
regulation. This is because the comment letters from these private companies have primarily
focused on meeting their own personal benefits and have emphasized that there should be less
negative impact of the changes in the accounting standards on their financial reporting system.
As such, they have placed their private interest ahead of public interests as stated by the private
interest theory that states that individuals forms into groups for achieving their self-interest and
thus dominating the regulatory process.
On the other hand, comment letters provided by the Israel Accounting Board and the
ICAI have emphasized on achieving public interest through supporting the regulations as they
would enable in improving the decision-making usefulness of financial information for the end-
users. In this context, public interest theory has stated that regulation should seek to maximize

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the social welfare even if the cost of improving their welfare outweighs the amount of increased
social welfare.
Section D: Use of regulation theories to interpret the actions of authors of comment letters
There are three most important regulation theories that are used to interpret the actions of
authors of comment letters are public interest theory, private interest theory and capture theory.
Public interest theory signifies that regulators must work for the benefit of public as whole
through not providing benefit to any specific class of people. So, only those changes should be
introduce that promote public interest not the private interest according to the public interest
theory. On the other hand, private interest theory is totally contrary to the public interest theory
as it provides that regulators promotes specific class of people or industry to provide some
exclusive benefit and in turn get some benefitted through proposing changes that is only for the
benefit of respective class of people or industry (About US: How we work in the public interest,
2019).
As per the analysis of each of the comment letters, it can be said that, ICAI and Israel
Accounting Standard Board have proposed comment letter which is in public interest as they
promoting public interest over the interest of accountants or any other accounting body.
Whereas, comment letters by Volkswagen and McCain Food Limited talks about the self
interest through seeking the clarification on how to make changes in specific contracts and get
benefitted from the purposed changes.
Lastly, capture theory states that regulations are made for the public interest but
regulating bodies are taking advantage through proposing changes that works for the self interest
and to receive financial or non financial benefits (Deegan, 2014).

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References
About US: How we work in the public interest. (2019). IFRS Foundation. Retrieved on
September 17, 2019, from https://www.ifrs.org/about-us/the-public-interest/
About: Onerous Contract. (2019). IFRS Foundation. Retrieved on September 17, 2019, from
https://www.ifrs.org/projects/work-plan/onerous-contracts-cost-of-fulfilling-a-contract/
#about
Bartölke, I. (2019, 11 April). Exposure Draft ED/2018/2 – Onerous Contracts – Cost of Fulfilling
a Contract. Retrieved on September 17, 2019, from
http://eifrs.ifrs.org/eifrs/comment_letters//527/527_25335_ANDREASGATTUNGVolks
wagenGroupVG_0_CommentLetterVolkswagenAGOnerousContracts.pdf
Burton, R.N. (2019, 11 April). Onerous contracts - cost of fulfilling a contract. Retrieved on
September 17, 2019, from
http://eifrs.ifrs.org/eifrs/comment_letters//527/527_25350_RichardNBurtonMcCainFoods
_0_Onerouscontractscostoffulfillingacontract.pdf
Business Line. 2019. New accounting standard for leases to improve quality of financial info:
ICAI. Retrieved from 17 September, 2019, from
https://www.thehindubusinessline.com/money-and-banking/new-accounting-standard-
for-leases-to-improve-quality-of-financial-info-icai/article26702368.ece#
Chartered Accountants. 2019. IFRS 16 on track for a new lease of life. Retrieved from 17
September, 2019, from
https://www.charteredaccountantsanz.com/news-and-analysis/news/ifrs-16-prepares-for-
a-new-lease-of-life
Deegan, C. (2014). Financial Accounting Theory (4th ed.). McGraw-Hill: Sydney.
Deegan, C. (2016). Financial Accounting. Australia: McGraw-Hill Education Australia.
Gwan, M. 2019. Insights into IFRS 16. Retrieved from 17 September, 2019, from
https://www.grantthornton.com.au/insights/technical-publications--ifrs/insights-into-ifrs-
16/
IFRS Conceptual Framework. 2018. Conceptual Framework for Financial Reporting. Retrieved
from 17 September, 2019, from https://www.ifrs.org/-/media/project/conceptual-