Accounting Report: Analysis of New Lease Accounting Standard's Impact

This report provides a comprehensive analysis of the new lease accounting standard, examining its impact on financial reporting and the balance sheets of both lessees and lessors. It addresses the shortcomings of the previous standard, particularly the off-balance sheet treatment of leases, and ex...Read More

Running head: ACCOUNTING
Accounting
Name of the University
Name of the student
Authors note

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Table of Contents
Introduction:...............................................................................................................................2
Discussion:.................................................................................................................................2
Answer to question a:.................................................................................................................2
Answer to question b:.................................................................................................................3
Answer to question c:.................................................................................................................4
Answer to question d:.................................................................................................................4
Answer to question e:.................................................................................................................5
Answer to question f:.................................................................................................................5
Conclusion:................................................................................................................................8
References List:..........................................................................................................................9

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Introduction:
During the financial crisis, many organizations are not able to adjust to real economic
situations while complying with current accounting requirements. Economic reality is not
reflected by today’s accounting system. New standard for leases has been issued by
International accounting standard boards that calls for the need of recognising the leases on
the lessees’ balance sheet. The amount of leases is to be recognized as liabilities of leases that
correspond with right of use of assets. Different decisions are taken with respect to
measurement, classification, presentation and recognition of leases for both lessors and
lessees that does not make the new standard fully converged. A dramatic change is presented
to the balance sheet of lessees by the new leasing standard by updating accounting to align
with certain changes in model of lessee and new revenue recognition standard (Bailey, 2013).
Discussion:
Answer to question a:
Significant efforts are not recognized under the current standard of lease as most of
the lease transactions are off balance sheet. Organizations operating sector such as airline,
shipping and retail segments have around three trillion euro’s worth of leases and record of
same is not mentioned in the balance sheet and are labelled as operating leases. Recording
leases value off balance sheet does not indicates that there will not be creating real liabilities.
This makes them unable to quickly adjust to ongoing economic situation. Not recoding the
leases in the balance sheets indicated that such organizations are maintaining lean balance
sheets (Riley & Shortridge, 2013). However, leased liabilities recorded off balance sheets
were quite higher than amount of total debt reported in their balance sheet. All this
contributed to not reflecting underlying economic in a better way.

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Operating leases is not featured in balance sheet of entities under current lease
accounting and there is no representation of many liabilities and assets. Thousand worth of
assets under agreement of operating lease that is nit depicted clearly in financial metrics lead
to understatement of liabilities. This will not give real situation of organization and does not
incorporate the ongoing economic scenario.
Answer to question b:
The off balance sheet of reporting entities under former accounting standard were 66
times greater than their total value of debts reported on balance sheet. In regard to this, there
were critics for guidance on current lease accounting. Reason that criticized is the fact that
current standard allowed the future lease payments and other leased assets to be excluded
from balance sheets of reporting organization. Moreover, for similar economic transactions,
there was considerably different accounting as they used budget line threshold. Standards
require virtual recognition of leased assets and payments that leads to presentation of
deceptive balance sheets and all expenses related to lease were front loaded (Beckman,
2016). For the operating leases as per current standard, there is straight line expense and any
increase in operating lease expenses are included and depreciation and amortization are
included in the computation or measurement of profit. All such expenses are not accounted
for or disclosed in balance sheets and in reality there are increased expense with increase in
value of operating leases. Furthermore, under current leasing standard, there is no need to
recognize the all leases in their balance sheet along with no obligations for future lease
payments. Current lease accounting puts burden on organization for maintaining separate set
of books for the purpose of covenant calculations (Cheng, 2015). All this make look balance
sheet in a better position and making it attractive in investor’s eyes. In reality, there are
increased debt obligations and higher amount of off balance sheets liabilities.

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Answer to question c:
For the airline companies, under the current accounting standard there is no level
paying filed between them. There exist lack of making comparison and Airline Company to
look different from its competitors leases most of its airline fleets. While some other
companies in airline industry borrows or take loan for buying most of its fleet. However, the
real situation is that there exists much similarity between their financial obligations. This is
the reason attributable to the fact that there is no level playing field between such
organizations (DiSalvio & Dorata, 2014).
Answer to question d:
The reason for that the new accounting standard for lease will not be popular with
everyone is due to the profit factor. Two different expenses would replace rent expenses
under new accounting standard for lease. Depreciation expense on leased asset and interest
expenses on leased liabilities and this might make figures of reported operating profit look
better. However, the reported net profit after tax has the possibility of reduction in early years
of lease. It is recognized by IASB that its new standard for leasing will be out to controversy
as there will be disappearance of cosmetic accounting benefits of leasing. Furthermore, for
updating to the criteria of new accounting standard, there will be involvement of additional
cost to companies. Making standard effective would require organizations seeking lease to
explain significant changes in their financial statement to stakeholders and investors (Lin &
Graham, 2017).
Answer to question e:
The current lease standard has missing information regarding leasing and various
techniques are used by investors to add back operating leases on balance sheets. Nonetheless,
rough calculations are done for such adjustments that may be way off the mark. The adding

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back process cannot be done by all investors and many times organization structures their
obligations for lease for their virtual presentation making balance sheet look better in
investor’s eyes (James, 2016). The underlying economics will be better presented by
recognizing the leases as liabilities and assets in the balance sheet. There will be better
informed investment decisions by this new visibility and the introduction of new leasing
standard will bring the main changes that would be useful for investors. This involves
organization currently having large amount of leases off balance sheet would require to
increase their liabilities and assets on balance sheet by making leases amount visible and
leading to improve transparency of asset base and organization’s leverage. There will be
balanced lease versus buy decision management as some important differences would be
noticeable in the income statements. New standard is central to investors in financial
reporting programme that highlights the importance of making informed investment decisions
by building trust in capital market (Meyer, 2013).
Answer to question f:
As per the new accounting standards, organizations are required to do more than
simply converting footnote disclosures relating to operating lease commitments to reflect
lease liabilities and assets. Changes would be brought in the control, process, policies and
system of information technology supporting lease accounting along with administration,
procurement and taxation relating to lease due to the implementation of new accounting
standard. Negotiation of contracts involving leases leads to the consideration of metrics and
financial statements implication (Mellado & Parte, 2017). Different departments across the
company will be involved in this process.
Judgements and estimates:

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Application of estimates and judgement is required as per the new standard and this
can be explained with the help of an instance. Organizations are required to evaluate whether
the definition of lease is meeting the arrangement calls for judgement requirements such as
significant component of service. As compared to current standard, different accounting are
required for treatments as per the revised lease definition. Judgement might require some
other key decisions such as lease term and lease payments including the lease modifications
accounting and evaluation of lease term. There will be increased scrutiny for judgement and
estimates under new standard and this is attributable to the fact that for most of leases, the
associated liabilities and assets will be reported in the balance sheets. Accounting at transition
and post transition regarding leases has a different number of accounting policies involving
the exemption of recognition for low value assets and short-term leases (February, 2016).
There are certain relief from transition as mentioned in the new standard such as reducing the
burden of implementation. Informed decisions would be facilitated as it is dependent upon to
company to understand such options. In order for organizations to ensure consistent processes
and policies concerning judgement and estimates made for lease accounting require them to
update their manuals and policies and at the same time guiding and educating on new
standard (Arrozio et al., 2016).
As per new standard, the present value of lease payments over the term of lease will
be recognized by lessees on their balance sheet as lease liability. Certain variable payments
are excluded from lease payment and the terms that are reasonably certain of being exercised
are included in lease term options. While negotiating the payment and terms of lease, needs
might be reassessed by lessees. Smaller amount of lease liabilities would arise from shorter
term of initial lease and compared to fixed payment, there is higher variable payments
proportion. An organization needs to be acquainted with potential impact of new standard on
financial statements when entering into new leases as per new lease standard. From the

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perspective of presentation of financial statements of organization, the approached for
minimizing the liabilities of leases can be advantageous. However, there are some business
and economic risk associate with such approaches. While making any changes in lease
contracts approaches, organizations should consider such changes in context of principal
commercial requirements. For instance, it can be considered by organization for property
plant to a lower liability of lease from shorter lease term against the longer-term access
security. Moreover, other hesitant that can arise of side of lessors is taking additional risks
related with shorter lease term and making variable payments. However, results of accounting
should not form the basis of taking economic decisions and they needs to be acquainted with
consequences of accounting relating to decisions of their business.
Financial statements and metrics:
Now, looking at metrics and financial statements of lessees, there will be gross up of
balance sheet as per new standard. Compared with current accounting, the new standard
would result in worsening of return on assets and debt ratios. Moreover, there can also be
impact on certain regulatory ratios. Potential impact on financial statements and metric of
company needs to be assessed by organization and they should also evaluate the ways it
would affect the financial performance and position as perceived by stakeholders. The
implication of new standards on the financial statements needs to provide education to
internal as well as external stakeholders. During the transition period as per the new lease
accounting standard, the needs to manage the communication of key performance indicators
to stakeholders needs to be anticipated by company. Organizations are required to identify
any changes that will be brought into the arrangement of debts and compensation of
employees under the new standard. It might he required by companies to evaluate the
arrangement of existing debt and seeking continued use for current lease accounting by
negotiating with creditors (Barone et al., 2014).

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Tax considerations:
There will be additional considerations for tax as per the new lease standard. It
involves understanding the alteration in existing position of tax due to changes in lease
accounting, tracking of differences in tax payment and making adjustments to deferred taxes.
For reflecting the new requirement standard, organization is required to understand specific
tax jurisdictions (Öztürk & Serçemeli, 2016).
Conclusion:
Much needed transparency will be brought by the adoption of new lease accounting
standard on liabilities and assets of organization. Comparability between organization
borrowing to buy and using lease would be facilitated by the implementation of nee standard.
There will be inevitable arise in questions of application and interpretation relating to new
standard implications. Financial metrics of organization will considerably change with the
implementation of new standard that involves change in asset turnover, current ratio,
operating profit, earnings before interest and taxation and debt to equity ratio. Debt covenants
and cost of borrowing will be significantly affected by improved visibility of lease
obligations. Nonetheless, the benefits associated with updating will outweigh the costs
incurred in implementation of standard.

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References List:
Arrozio, M. M., Gonzales, A., & da Silva, F. L. (2016). Changes in the financial ratios of the
wholesale and retail sector companies arising from the new accounting of the
operating lease. Revista Eniac Pesquisa, 5(2), 139-159.
Bailey, E. E. (2013). GAAP and IFRS convergence: The effect on lease accounting.
Barone, E., Birt, J., & Moya, S. (2014). Lease accounting: a review of recent literature.
Accounting in Europe, 11(1), 35-54.
Beckman, J. K. (2016). FASB and IASB diverging perspectives on the new lessee
accounting: Implications for international managerial decision-making. International
Journal of Managerial Finance, 12(2), 161-176.
Bohušová, H. (2015). Is Capitalization of Operating Lease Way to Increase of Comparability
of Financial Statements Prepared in Accordance with IFRS and US GAAP?. Acta
Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 63(2), 507-514.
Cheng, J. (2015). Small and Medium Sized Entities Management’s Perspective on Principles-
Based Accounting Standards on Lease Accounting.
DiSalvio, J., & Dorata, N. T. (2014). Lease accounting change: it's not over yet. Review of
Business, 35(1), 16.
Edeigba, J., & Amenkhienan, F. (2017). The Influence of IFRS Adoption on Corporate
Transparency and Accountability: Evidence from New Zealand. Australasian
Accounting, Business and Finance Journal, 11(3), 3-19.
February, I. (2016). FASB issued its new lease standard, ASU 2016-02, Leases.

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Gross, A. D., Huston, G. R., & Huston, J. M. (2014). The path of lease resistance: How
changes to lease accounting treatment may impact your business. Business Horizons,
57(6), 759-765.
James, M. L. (2016). Accounting for Leases: A Case Exploring the Effect of the New Lease
Accounting Standard on the Financial Statements. Journal of the International
Academy for Case Studies, 22(3), 152.
Lin, K. C., & Graham, R. C. (2017). How Will the New Lease Accounting Standard Affect
the Relevance of Lease Asset Accounting?.
Mellado, L., & Parte, L. (2017). Determinants of corporate lobbying intensity in the lease
standard-setting process. Revista de Contabilidad, 20(2), 131-142.
Meyer, K. (2013). Accounting for leasing transactions: the times they are a-changing.
Financial Executive, 29(3), 19-23.
Öztürk, M., & Serçemeli, M. (2016). Impact of New Standard" IFRS 16 Leases" on
Statement of Financial Position and Key Ratios: A Case Study on an Airline
Company in Turkey. Business and Economics Research Journal, 7(4), 143.
Riley, M. E., & Shortridge, R. T. (2013). Proposed Changes to Lease Accounting under
FASB's Exposure Draft. The CPA Journal, 83(6), 28.