Evaluation Of The Impacts Of AASB 16 Leases On Financial Reporting
Background
Substantial changes have been made by The Australian Accounting Standards Board (AASB) for lease accounting with the introduction of AASB 16 Leases. By considering the increasing significance of the introduced standard present study aims to evaluate provisions of this standard in contrast to previous standard AASB 117 Leases (Joubert, Garvie and Parle, 2017). The study will include a description of lease accounting as per both standards in Myer Ltd. Further, it will describe the potential impact of the new standard on financial position and performance and improvisation in the financial reporting process through the introduction of AASB 16. On the basis of the analysis, recommendations will be provided to companies for an accounting of leases in a better and convenient manner.
Myer Holdings Limited has operations as departmental stores and is based in Australia. The stores of the company provide different categories of product that are inclusive of women, men, children apparel and other general merchandise goods.
The Group continued to review their prevailing store portfolio in order to make improvement in their productivity. Additionally, the store exists has made an announcement for Logan, and they have also declared that they would not review the leases at the Hornsby, Colonnades and Belconnen. According to the AASB 117 Leases, the rentals upon the lease are expensed on the lease term based on the straight line. Furthermore, the most of the stores, as well as warehouses, are leased by the Group as per the uncancellable operating leases, which have the expiring period from 1 to 30 years. In addition, the leases have different terms, renewal rights and clauses of escalation (Annual Report of Myer, 2017). Based on renewal, the terms of the lease are further-renegotiated, plant, property and equipment lease wherein a considerable amount of risks, as well as reward ownership, are obtained by the lessor, and the same are categorized as operating leases.
However, the lease incentives gained with the entrance in the operating leases are recognizable as deferred income and are further done to amortization on the leasing term. Thus, the payments held for the operating leases are chargeable to the P&L statements on the basis of the straight line during the leasing period.
It can be said that, by considering the annual report of 2016 the company, operating lease are not part of the financial statements. Therefore, disclosures for the leases are off-balance sheet items covered under, note to the account of plant property and equipment (Annual Report of Myer, 2016). According to the AASB 117 Leases, in the previous year, the accounting of leases by the Group was done by considering the total rental on these leases which are being done on expenditure during the lease term based on the straight line. The presentation of incentive or continuation of the lease is done as deferred income, and the same is reversed on a straight-line basis over the term of leasing.
Lease Accounting under AASB 117 and AASB 16
The recognition of a leased asset is required by the new model, with its parallel lease liability, for each and every lease that have a term of over 12 months, and the separate recognition of the depreciated charge on the asset which is leased from the interest expenditure over the lease liability. Annual Report of Myer, 2017. Additionally, the current operating lease expenditure which is recognizable in the income statement will be substituted with the charges on financial and depreciation terms. The total amount of $9.1 million onerous lease provision was recognized by the Group in regards with the additional excess space determined. Various lease agreements for the store are inclusive of cash contributions offered by the lessor, and the recognition of the current operating lease expense is done in the income statement with the replacement of depreciation and finance charge.
Leases in which the Group has considerably of all ownership of risks and rewards are categorized as financial leases. In accordance with the AASB 16 Leases which was released in the year by the AASB (Australian Accounting Standards Board). Further, this standard alleviates the categorization among the operating as well as finance leases and make the introduction of a singular lessee accounting model. Furthermore, there are also some amounts of changes held in the Group’s accounting over the lease’s life. Thus, it will lead in recognition of the front-loaded expenditure pattern for the majority of the leases, even when continuous yearly rentals are payable (Henderson and et al., 2015). The company being a lessee with considerable operating leases portfolio, the adoption of the AASB 16 is likely to create a materialistic impact over the consolidated financial statements of the Group at the transition in future time to the scale that currently leases are categorized as operating leases required to be taken on the balance sheet.
With this aspect, the Group is considering the procedure of conducting an assessment over the impacts created by the new standards and reforms that will help in offering an assumption of the financial impact when completed (Dakis, 2016).
It can be said that, by considering the annual report and financial performance of the company, if the company complies and adheres with the given provisions and standard provided by the AASB 16/IFRS 16 and make proper recognition, classification, Measurement, presentation and disclosures of leases (Steenkamp and Steenkamp, 2016). It is asserted that financial information is meaningful when it is reliable and provides a faithful representation of all aspects, and the same meaningfulness is improvised if it is timely provided, understandable, viable and verifiable (Conceptual Framework for Financial Reporting, 2018).
Under the AASB 16 (IFRS 16), the new leasing standards need firms to come up with a higher amount of operating leases held on the balance sheet. As per the present accounting standards, the mandatory requirement to consider future payments, and under the same operating lease agreements is not comprised over the balance sheet. Also, even the firm is committed towards the same future expenses. The consideration of most of the stakeholders is that this is not helpful n providing a correct picture of the exact financial position of the company.
Potential Impact of the New Standard on Financial Position and Performance
Equipment and Property leases are recognized previously as off-balance sheet item, and the same accounting is done as right-of-use (ROU) asset and lease liability, bringing a higher amount of transparency regarding the lease commitments and key financial metrics of the company. Further, the lessor accounting will be highly unchanged under the current lease standard. In contrary to this, the adoption of the new lease standard is likely to place challenges related to financing and operations over the financial reporting.
The updated standard of lease will make changes in the profile of the expense, instead of a straight line rental expenditure, there will be the presence of more expensed in the initial years and lowered in the following years, affecting the profile of earnings, In addition, it will also possibly cause higher increments in the metrics like EBITDA (IFRS 16 – the new leases standard, 2016). Instead of the operating rental expenditure, now there will be expense change under the EBITDA line which potentially poses a variety of related issues.
Additionally, to the potential financial reporting differences, the ROU assesses will be stated as a non-current asset while the lease liability will be distributed among the non-current and current assets. Further, this difference can possibly bring issues in terms of working capital with partial funding by current liability to a non-current asset (Leases A summary of IFRS 16 and its effects, 2016). So as to ensure the accurate retaining of leasing data, the companies must consider the systems, procedures, impact mitigation, leasing strategies, credit ratings, tax accounting, impairment testing and all related process with better supervision.
Conclusion and recommended action
By making a comparison of both the standards, the conclusion can be drawn that changes introduced in new standards lead to the more accurate presentation of financial position as all liabilities and assets are clearly represented. Further, this will provide more viable and comparative information to investors. However, these changes will make a substantial increase in financial reporting and commercial risk due to increase in complexity and hidden issues related to the implementation of the new standard.
Companies are recommended to use all data for an accounting of leases as introduced changes will have a far-reaching impact on business process, controls and systems of lessees. The company is required to account for all leases in the balance sheet for which they are required to consider a cross-functional approach for implementation of the provision of the new standard. Further, transition accounting will require retrospective effect of prior reporting. Therefore, IAS 8 accounting policies, changes in accounting estimates errors are to be applied for the purpose of adjustment of equity in the start comparative period in which provision of new lease standard will be implemented.
References
Joubert, M., Garvie, L. and Parle, G., 2017. Implications of the New Accounting Standard for Leases AASB 16 (IFRS 16) with the Inclusion of Operating Leases in the Balance Sheet. Journal of New Business Ideas & Trends, 15(2).
Henderson, S., Peirson, G., Herbohn, K. and Howieson, B., 2015. Issues in financial accounting. Pearson Higher Education AU.
Dakis, G.S., 2016. Upcoming changes to contributions and leasing standards. Governance Directions, 68(2), p.99.
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.
Annual Report of Myer, 2017. [pdf]. Available from < https://www.annualreports.com/HostedData/AnnualReports/PDF/ASX_MYR_2017.pdf>. [Accessed on 1 October 2018].
Annual Report of Myer, 2017. [Online]. Available from <https://www.annualreports.com/Company/Myer-Holdings-Ltd>. [Accessed on 1 October 2018].
Annual Report of Myer, 2016. [pdf]. Available from < https://investor.myer.com.au/FormBuilder/_Resource/_module/dGngnzELxUikQxL5gb1cgA/file/Myer_Annual_Report_2016.pdf>. [Accessed on 1 October 2018].
Conceptual Framework for Financial Reporting 2018 (online). Available from < https://www.iasplus.com/en/standards/other/framework>. [Accessed on 1 October 2018].
IFRS 16 – the new leases standard, 2016. [pdf]. Available from < https://www.pwc.com.au/assurance/ifrs/assets/ifrs16lease-brochure.pdf>. [Accessed on 1 October 2018].
Leases A summary of IFRS 16 and its effects, 2016. [pdf]. Available from < https://www.ey.com/Publication/vwLUAssets/ey-leases-a-summary-of-ifrs-16-and-its-effects-may-2016/$FILE/ey-leases-a-summary-of-ifrs-16-and-its-effects-may-2016.pdf>. [Accessed on 1 October 2018].