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HI6025 Accounting Theory and Current Issues Assignment - Holmes Institute, Australia
Assessment Title - Accounting for Lease: A Critical Review
Purpose: This assignment aims at developing a clear understanding of students on Accounting standard for lease. Students are required to critically examine the new accounting standard for lease financing AASB 16. They will have to do research on relevant literature and demonstrate understanding and critical evaluation of key issues and different provisions on accounting standard for lease financing. They will have to refer and base their discussions on a complete understanding of AASB 16 Accounting for Leases.
Answer - Accounting for Lease: A Critical Review
The following data is based on the history of Australian accounting standards. It compares the difference in old methods and the new one. The changing in accounting standards have made many changes in the Australian financing company. Although company belonging from every legalized industry was affected, the effect on the financing company was significant. Towards the end, the financial data of a company, which is registered under the Australian share market, have been discussed.
An accounting standard is a methodological declaration that cliques out the mandatory accounting for specific kinds of transactions and proceedings. The accounting necessities mark the grounding and demonstration of being financial accounts. Accounting standards in Australia were initially established by the qualified accounting bodies and were enforceable under their encryptions of integrity. From 1966, the eligible institutions mutually functioned the Australian Accounting Research Foundation (AARF) (Aasb.gov.au, 2019). Eventually incorporated both the Accounting Standards Boards (ACSB) and the Public Sector Accounting Standards Boards (PSASB). At the flinch of 1984, the Ministerial Council recognized the Accounting Standards Review Board (ASRB) for Companies and Securities. This system functioned under the Companies Act 1981 (CWLTH) and equivalent State-run/Region Encryptions. The ASRB and the occupation's AcSB amalgamated in 1988, with the ASRB enduring to labor meticulously with the PSASB. The ASRB was re-established underneath the Australian Securities Commission Act 1989 and in 1991 was retitled the Australian Accounting Standards Board (AASB).
The AASB's standards then functioned under the Corporations Law. In 2003, the FRC dispensed a full calculated track to the AASB in kith and kin to the harmonization of Government Finance Statistics (GFS). They generally accepted Accounting Principles (GAAP) broadcasting in the communal segment. These Boards functioned meticulously together in formulating standards for private subdivision and public subdivision organizations. These statistics will be beneficial to possessors, stockholders, creditors, specialists, staffs, managers, and others in the creation and estimating verdicts about the distribution of rare commercial possessions. When businesses and supplementary organizations observe with accounting standards, their general-purpose financial accounts should be another equivalent than they would else be. This permits stockholders and supplemental operators of the financial statements to the improved association of the organizations.
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Question - Critical evaluation of the old accounting standard for lease specifically highlighting the drawbacks.
Concluded the preceding two eras, the international financial scene has endured a noteworthy revolution. This progress has been attributable, in part, too spectacular variations in the corporate and partisan environments, increasing worldwide race, the growth of more market-based financial prudence, and rapid industrial developments. At the same time, the biosphere's commercial centers have fully-fledged progressively unified. Australia has accepted IFRS Standards in the meantime 1 January 2005. However, merging with Standards supplied by the Board and its prototype, the IASC Board, had been happening since 1996. Acceptance from 2005 was concluded application of IFRS 1 First-time Implementation of International Financial Reporting Standards. There is a sum of drawbacks, both immense and slight, between IFRS (International Financial Reporting Standards, formerly known as International Accounting Standards (IAS)) and the Australian Accounting Standards on the matter as at 31 March 2003 (Ifrs.org, 2019).
These journal summaries the main drawbacks that occurred between Australian GAAP and IFRS as at 31 March 2003 and the consequence of projected fluctuations at that time. In this reverence, both cliques of standards are presently in a state of instability, mainly those dispensed by the IASB, who is now undertaking a sum of critical ventures.
If a business dispenses its financial accounts separate of the market, Generally Accepted Accounting Principal must be carried out. In case of a company's stock being openly operated, the financial statements must follow the guidelines conventional by the U.S. Securities and Exchange Commission. Irrespective of the country under which the company operates, United States security exchange commission provide excellent and simple accounting principle for everyone to follow. GAAP reports effects the returns acknowledgment, balance sheet, element cataloging, and unresolved share dimensions (Investopedia, 2019). If a financial account is not equipped using GAAP, stockholders should be careful. Besides, some businesses may practice both GAAP- and non-GAAP-compliant procedures when broadcasting economic outcomes. GAAP protocols necessitate that non-GAAP methods are recognized in financial accounts and other communal revelations, such as press announcements.
The idea of IFRS is to preserve constancy and transparency all over the financial ecosphere. IFRS empowers the capability to see precisely what has been trending with a business and permits trades and specific stockholders to make refined monetary verdicts.IFRS is standard in the European Union (EU) and numerous nations in Asia and South America, but not in the United States. The Securities and Exchange Commission will not shift to International Financial Reporting Standards in the near term but will remain to study a suggestion to permit IFRS statistics to complement U.S. financial filings. Republics that profit the greatest from the standards are those that demeanor a proportion of international corporate and capitalizing.
The chief variance between the two arrangements is that GAAP is rules-based and IFRS is principles-based. This disengage demonstrates itself in precise facts and understandings. Fundamentally, IFRS rules deliver much less complete aspect than GAAP. Subsequently, the academic context and principles of the IFRS consent more room for clarification and May frequently necessitate great revelations on financial accounts. On the other hand, the solid and spontaneous principles of IFRS are extra rationally complete and may perhaps well characterize the business side of commercial transactions.
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The similarities and difference between GAAP and IFRS
Perhaps the utmost prominent exact alteration between GAAP and IFRS comprises their conduct of accounts. IFRS guidelines prohibit the use of last in, first-out (LIFO) inventory accounting systems. GAAP guidelines permit for LIFO. Mutually systems allow for the first-in, first-out technique (FIFO) and the subjective average-cost system. GAAP does not allow for inventory reverses, while IFRS licenses them under convinced circumstances. The significant additional variance is that GAAP necessitates financial accounts to embrace a report of comprehensive income. IFRS does not contemplate comprehensive income to be a key component of presentation and consequently does not require it. These variance verdures some room for mingling possessor and non-owner movement within IFRS-based financial accounts.
Why was the change necessary?
The change was needed because the Australian Accounting Standards Board (AASB) has made considerable variations to tenancy accounting with AASB 16 Leases, with the headline alteration being the elimination of the dissimilarity between functioning and economics leases for renters with maximum tenancies now impending on balance sheet. AASB 16 will hypothetically have noteworthy influences on entities, which may not continuously be instantly apparent at first view.
The innovative leasing standard is probably going to distress nearly all the corporate to some extent. The imperative entity with the innovative standard is to be practical and to be organized. Beneath the modern accounting standard, the responsibility to make forthcoming outflows under an operational lease planning is not comprised on the balance sheet even though the business is dedicated to those future expenses. The apprehension of many investors was that the system did not stretch an exact replication of the business's factual financial situation.
The variations to the accounting standard (which smear to broadcasting periods opening on or after 1 January 2019) will outcome in the presence of lease accountability and a right of practice benefit on the balance sheet. In other words, the corporate will now comprise the expenses of use of the leased possession and the related paybacks on its balance sheet. The AASB 16 variations give a further precise illustration of the financial situation of the corporate by entirely reflecting all its accountabilities, and delivers more valuable statistics in commercial broadcasting for stockholders and investors, but there is a weakness (Chua, Cheong and Gould, 2012).
The variations will significantly upsurge the level of marketable and financial broadcasting risk given the upsurge in difficulty and the concealed matters, which may ascend on applying the new standard. Primarily, the new rule will verify the side view of the expenditure. Moderately than being a straight-line rental expenditure, there will be extra expensed in initial years and fewer in later years, influencing incomes side view. It will also source hypothetically significant upsurges in metrics such as EBITDA. Relatively than a productive rental expenditure, there will now be a crusade of investments beneath the EBITDA line, which has a variety of asocial matters. In accumulation to the conceivable financial reporting irregularities, the right of practice possession will be non-current whereas the lease accountability will be divided between current and non-current (Bryce, Ali, and Mather, 2015).
This discrepancy could source matters with working investment with partially current accountability backing a non-current possession. There may also be considerable influences with bank agreements, which could lead to conceivable fissures if businesses are not practical about impending their investors. Another impact could be that other corporations will now succeed as big-trademarked corporations with the addition of the right to use possessions on their balance sheet cumulating whole possessions and hypothetically necessitating inspected financial accounts to be lodged.
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Question - What changes have been incorporated in the new accounting standard for lease AASB16?
Under existing rules, renters account for lease transactions either as functioning or as finance tenancies, dependent on multifaceted guidelines and trials which, in exercise, practice 'bright-lines' consequential in all or nothing being recognized on balance sheet for occasionally cautiously comparable lease transactions.
The influence on a renter's commercial broadcasting, possession financing, IT, structures, procedures, and panels is probable to be considerable. Several establishments lease a massive sum of big-ticket objects, counting cars, workplaces, power plants, merchandising stores, cell towers, and airplanes.
Therefore, renters will be significantly pretentious by the new lease's standard. The lessors' bookkeeping mainly remains unaffected. However, they might see an influence on their corporate model and lease goods due to variations in requirements and behavior.
The innovative standard will distress effectively all regularly castoff financial proportions and presentation metrics such as gearing, possession turnover, current ratio, interest cover, EBITDA, EBIT, functioning profit, net revenue, EPS, ROCE, ROE, and operational cash flows. These variations may distress loan agreements, credit scores, and copying costs, and might upshot in other behavioral changes. These influences may oblige several organizations to reconsider specific 'lease versus buy' conclusions.
- Balance sheets will grow, gearing ratios will upsurge, and critical rates will decline. There will also be a variation to both the expenditure character (rent expenditures substituted with devaluation and interest outflow) and acknowledgment outline (quickening of lease expenditure comparative to the acknowledgment outline for functioning leases nowadays).
- Units leasing 'big-ticket' possessions - counting real estate, industrial apparatus, airplane, Eurostar, ships, and expertise - are projected to be critically pretentious. The influence for units with many trivial leases, such as tablets and personal computers, minor kinds of stuff of workplace equipment and mobiles might be less as the IASB bids an exception for low-value possessions (assets with a worth of $5,000 or less when original). Small value possessions summiting this exception do not have to be recognized on the balance sheet.
- The price to contrivance and endures to fulfill with the new lease's standard could be noteworthy for maximum renters. Predominantly if they do not previously have an in-house lease information structure.
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Renters and lessors may want to contemplate renegotiating or rearrangement of current and forthcoming leases.
- Corporate and lawful edifices supportive of the contracts should also be reconsidered to appraise whether these last to be operative (for example, cooperative projects and superior resolve entities).
- Lessor accounting remains mostly unaffected from IAS 17; however; lessors are predictable to be pretentious due to the altered wants and behaviors from clienteles, which influences their corporate model and lease goods.
The inescapable influence of these guidelines necessitates businesses to renovate their commercial procedures in several areas, counting finance and bookkeeping, IT, procurement, tax, capital, lawful, processes, commercial real estate and HR.
Question - How will companies that have a significant level of lease financing be affected by the change in the accounting standard for lease?
After the change in the lease system, almost every industry within the country will be affected virtually. However, when it comes to the companies, nearly every single lease will be forced to go under the balance sheet. It will also change the profile of expenses under economic and practical changes. Almost for every company operating within the country of Australia, the new changes have either been in effect or will be in fact during the year 2019. It is not a surprise that most of the companies are not ready for the changes.The companies will be likely to see changes in the EBITDA. The changes are going to affect the minor and medium businessperson properly. The earnings before interest and tax are expected to go higher than ever before. According to PwC(2019), there could be an increase in EBITDA as high as 13%. On the other hand, for an average listed under Australian Legislation Company, there would be a debt increase by 22%. It may become effective immediately after the renewal of critical leases.
It is the responsibility of the company to make a good forecast on the lease position based on hard evidence and useful data. Any bad choices by the company will only result in minimizing earnings volatility. The stakeholders need to have complete knowledge of the matter so that their approval on the subject gets permitted; this helps the company to stay stable in the market.
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Question - In the former accounting standard for lease (AASB 117) both operating rental and finance lease were allowed, why did companies tend to classify most of the lease contract as an operating lease? How does positive accounting theory relate to this behavior of managers?
In the former accounting, standards for lease the operating and financial lease were allowed, and the companies tended to classify most of the lease contract as an operating lease because of its nature and behavior. In the following discussion, a better understanding of the working and financial lease have been conducted
Any other lease, which is not commercial lease was meant to be treated as an operating lease under AS19. Therefore, the question comes forward what exactly is a business contract and how do you classify a commercial lease. In the below discussion the classification of the commercial lease has been discussed(Cleartax.in, 2019).
Financial lease signifies a type of contract under which all the possible risks and rewards are transferred to other assets. However, the title of the assets need not be transferred immediately. The example of a financial lease is;
- If there is a lease and it gets transferred to another contract towards the end of the lease term
- A leasing term is directly responsible for the complete economic life of an asset, irrespective in the transfer of title
- Lease asset defines a specific nature; for example, an ambulance a lease owner can use such asset without having to do much work on it.
- Lease term that signifies the present value of the minimum lease payments is equal to or substantially covers the fair value of the leased asset.
A positive accounting theory always helps the company to reconcile efficient securities market theory with economic consequences. The manager still understands what to expect from the accounting theory and makes his decision based on his or her presumption.
Question - 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.
IASB made accounting standards for both the situation (the company who chose to buy an asset or the company who decided to lease an asset). However, there are some circumstances where renting a piece of equipment showed profitability for the company. For example, a part of machinery with a depreciated value of $100 and can be used for the next five years is on a lease of $5 annually. On the other hand, a company chose to buy a piece of machinery having a face value of $5,000 and a depreciated value of $100 after six years.
Here the value of the machinery with a depreciated value of $100 is far more appealing for the company than the other. IASB makes specific rules for each of the above scenarios that help the company's managers and directors to create sound decisions regarding their choices. The IASB puts a number behind the situation, and the managers and the directors are responsible for choosing the option that they wanted.
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Question - The implementation of AASB 16 might influence the leasing market if companies decide to buy more assets and as a result, lease fewer assets. Provide a possible explanation as to why after the implementation of AASB 16, reporting entities might be more likely more assets and lease fewer assets.
Historically buying an asset is more profitable than renting an asset. However, there are certain situations where leasing of the asset provided excellent benefits to the leaser. The lease provider always looks for making a higher amount of money from the lease, but in the end, the product continuously gets returned.
On the other hand, when a company buys a product, after its use for the specified time, he carries the rights of the product, making him the owner of the product. The product can be sold after the purpose for which it was purchased and make money. That is the main reason why people tend to understand that buying a product is more profitable than leasing a product. However, hiring a product has always been cheaper compared to purchasing a product. Therefore, leasing of a product will never go out of the system.
Question - Select the latest (2017 - 2018 financial year) annual report of an ASX listed company. Summarise the critical 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.
The company Wesfarmers Company is one of the most reputed companies in the country of Australia. Over the years, it has a more significant market in its field again, and now this company leads the industry. Over the period between 2017 and 2018, this company has made revenue in billions. The total revenue for the year 2018 by this company stood at $66,683 million. The depreciation of the company and earnings before interest and tax stood at $5,259 million (Wesfarmers.com.au, 2019). The net profit before tax stood at $2,604 million. The company did not make any amount of lease from any or the company. It has its machinery for which depreciation is charged.
Universal purpose financial statements that conform to accounting standards should be extant impartial in the commercial place, commercial presentation and currency drifts of an organization. The above discussion is based on the economic changes that have taken place in Australia. The advantages and disadvantages of the matter have been discussed.In the end, an Australian company has been chosen to demonstrate the revenue and the accounting data that is provided in the public domain.
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