Advanced Financial Accounting for Lessee - MyAssignmenthelp.com

Question: Discuss about theAdvanced Financial Accounting for Lessee. Answer: Introduction Lease implies a contract between two parties in which one party agrees with the other to transfer the asset for use on payment of monthly lease rentals. The party which gives the asset on lease is called Lessor while the party which receives the asset for use is called Lessee (Nikolai, Bazley, Jones, 2009). The lease involves special financing arrangement therefore accounting for the Lessor as well as the Lessee becomes a hectic issue. The international accounting standard board had issued IAS 17 to provide for the accounting and financial reporting matters connected with lease accounting. This standard was in force till the time new standard IFRS 16 was issued by the international accounting standard board. The efforts for simulating the financial reporting process have been observed to be taken at the global level. All the countries are undergoing financial reporting convergence process wherein the local accounting standards of the countries are been endeavored to be converged wit h the international accounting standards (ACCA, 2016). As part of the financial reporting transformation process, the international accounting standard board has issued new standard in place of old IAS 17 which provides for accounting treatment of leases. The new IFRS would be effective from the accounting periods beginning on or after January 01, 2019. The companies would be required to carry out lease accounting in accordance with the provisions of IFRS 16 (Ernst Young LLP, 2017). Thus, it is important to gain the knowledge of changes that have been carried through promulgation of the new standard on lease accounting. In this context, a report has been prepared here to provide discussion on the changes in the requirement of IFRS 16 viz a viz IAS 17. Further, the report also discusses the effects of such changes on the financial statements and upon the listed companies. Changes to Accounting Requirements The international accounting standard board has replaced the IAS 17 with the IFRS 16 and the changes will be effective from the accounting period beginning on or after January 2019 (IFRS, 2016). The aim of replacing the old standard has been to curve out the lacunas and provide for better financial reporting framework in terms of lease accounting. The primary difference between the IAS 17 and IFRS 16 is in regards to accounting for operating leases. Under the old IAS 17, the operating leases were not shown on the balance sheet in the books of Lessee and Lessor (IAS 17, 2012). The Lessee were to charge the operating lease as expense in the profit and loss statement and similarly the Lessor were to take the lease receipts as income to the profit and loss statement. However, under the new IFRS 16, the operating leases are also to be classified on the lines of financial lease and thus, the assets and liabilities emanating from the operating lease would be taken onto the balance sheets of Lessee and Lessor. Further, the primary focus of IAS 17 in classifying the lease was on the aspect of transfer of risk and reward while the IFRS 16 focuses on transfer of right to use the asset. Thus, according to IFRS 16, leases are to be capitalized in the books even if the risks and rewards are not being transferred but the right to use the asset has been transferred (PKF International Ltd, 2017). Effects on Financial Statements The IFRS 16 has brought in new provisions, which are different from the provisions contained in the old IAS 17 in regards to accounting for leases (PWC, 2016). The changes in the provisions of lease accounting promulgated through introduction of the new IFRS have significant impact on the financial statements of both the Lessee as well as the Lessor. All the primary components of the financial statements such as income statement, balance sheet, and the cash flows statement would be affected by the changes in the lease accounting. As per the provisions of new standard, the Lessee now would be required to book the finance charge on lease rentals under the finance cost rather than operating expenses as was earlier done under IAS 17. Further, the Lessee would recognize asset in the balance sheet for right to use and liability towards payment of lease rentals at the present value of the minimum lease rentals (Deliotte, 2016). Figure 1: Effect on financial statements of Lessee (EY, 2016) The elimination of finance charge from operating expenses would increase the operating profits of the Lessee. Further, since the finance charges would now be recognized under the finance cost therefore the amount of finance cost would increase (Collings, 2016). The assets total of the balance sheet of the Lessee would increase by the amount of asset recognized for right to use and the liabilities would increase by the amount of liability recognized towards the lease payments. Further, the Lessee will now be required to charge depreciation on the right to use asset recognized in the balance sheet. The charge of depreciation would reduce the operating profits of the Lessee (Collings, 2016). Further, the cash flow from the operating activities and the cash flow from financing activities would also be affected in regards to cash flow statement. The lease payments whether for operating lease or financial lease would now be capitalized. Thus, cash payment of operating lease rentals would now not be part of cash from operations (Lechner, 2016). This will have positive impact on the cash from operations as the elimination of the operating lease payments from operating activities would increase the cash flow from operations. Thus, the cash from operations will increase but the cash from financing activities will decrease. The payment for lease now would be regarded as the financing activity and thus the cash from financing activities would be reduced. Apart from this, many lease contracts has non-lease elements, the Lessee would be required to identify those non-lease elements and treat them separately (Lechner, 2016). Thus, the IFRS 16 has altered the accounting for lease completely for the Lessee; however, the accounting for Lessor is still substantially the same. The Lessor is still required to classify the lease as operating or financing lease and treat them separately. The Lessor would recognize the finance lease the amount of net investment as was earlier done under the provisions of IAS 17 (EY, 2016). The IFRS 16 has also provided certain additional disclosure requirements for Lessee and Lessor. These additional disclosure requirements are expected to change the presentation of the financial statements. The IFRS 16 entails that the companies applying IFRS 16 in lease accounting are required to make all the objective disclosures which are necessary for the investors to understand the financial statements (EY, 2016). The changes in lease accounting carried out through introduction of IFRS 16 will affect the companies which usage the assets on lease basis because the IFRS has changed accounting for lease in the books of Lessee (EY, 2016). The company which gives asset on lease (Lessor) would not be affected by much because the provisions of IFRS 16 in regards to accounting for Lessor are substantially the same as that of IAS 17. However, despite that the Lessor would also be required to comply with the disclosure requirements of IFRS 16. Thus, though the figures may not be required to be adjusted by the Lessor in the financial statements but the presentation will still be required to be changed in term of additional disclosure requirements (Sacarin, 2017). Effects on Selected Listed Company Further, the IFRS 16 is substantially different in regards to accounting for operating lease in the books of Lessee. Thus, whether the IFRS 16 would affect the financial statements of a company would depend upon the fact that whether that company is a Lessee and has that company taken asset on operating lease basis (Bilgin et al., 2017). However, there are some industries which are expected to be affected more severely than the others. For example, the industries such as retail and consumer product, telecommunication, banking and other financial services, metals and mining, and oil and gas are expected to be affected more severely than the others. The provisions of IFRS 16 would be mandatory from the commencement of the financial year 2019; however, the early adoption of the standard is recommended (EY, 2016). In order to assess the impact of new lease accounting standard on the financial statements of a listed entity, UOL Group Limited has been selected. The UOL Group Limited is a leading company engaged in property development in Singapore. The company maintains a portfolio of properties which comprises development properties, investment properties, and hotels. In regards to accounting and preparation of the financial statements, it has been observed that the company prepares its financial statements under Singaporean GAAP (ISCA, 2016). The company applies Singapore financial reporting standard 116 in accounting for lease which contains provisions similar to old IAS 17 (ISCA, 2016). However, if the company adopts IFRS in preparation of financial statements, it will have to comply with the new requirements of IFRS 16 in regards to lease accounting. The primary activities of the company involve giving property on lease to the other entities for use. The company gives property on lease under the operating lease arrangement. The income from the operating lease is accounted for as revenue on straight line basis in the income statement. In regards to operating lease income, the application of IFRS 16 would not have any effect because it also contains similar provisions (UOL, 2016). Standing as Lessor, the company may continue to classify the leased assets as operating and financial lease depending upon the transfer of risk and rewards. Further, the company also has taken assets on lease from other parties. In this regards, the companys accounting policy states that where the company stands as Lessee, the lease is classified as operating or financing lease on the basis of transfer of risks and rewards (UOL, 2016). The lease accounting policy of the company states that in the cases where substantial risks and rewards attached to the asset under lease have been transferred to the company, the lease is classified as financial lease (UOL, 2016). Further, the cases in which substantial risks and rewards attached to the asset under lease are not transferred to the company; the lease is classified as operating lease. It has been observed that in the year 2016 the company had financial lease liability of $3.91 million. Further, it was observe that the company had shown $34.81 million under the non-cancellable operating lease commitments. The liability of $34.81 million under the operating lease commitment has not been recognized in the balance sheet rather it has been just shown under notes to accounts (UOL, 2016). Figure 2: Operating Lease Commitments In case the company adopts IFRS16, it will have to change the accounting policy with respect to assets taken on lease. The IFRS 16 requires classification of assets taken on lease only as finance lease. This implies that the operating lease earlier recognized will have to be changed. Further, the liability of $34.81 million as shown in the notes to accounts will have to be recognized in the balance sheet. The lease payments under operating lease earlier classified as operating expenses will now be required to be classified as financial lease liability. Thus, the charges of operating lease will be required to be eliminated from the income statement and only the finance charge would be debited to the income statement as part of finance cost. Conclusion This paper takes discussion on the requirements of new financial reporting standard viz IFRS 16, which provides accounting for lease transactions. The IFRS 16 has superseded the IAS 17. From the overall discussion, it could be articulated that the IFRS 16 differs from IAS 17 majorly in regards to accounting treatment of operating lease in the books of Lessee. Under the old IAS 17, the Lessee has option to classify the lease as operating lease if significant risks and rewards related to the asset are not transferred. However, this option is not available in the new IFRS 16. As per IFRS 16, the Lessee is required to classify all leases as financing lease. Reference ACCA. 2016. Convergence between IFRS and US GAAP. Retrieved May 26 2017, from, https://www.accaglobal.com/in/en/student/exam-support-resources/professional-exams-study-resources/p2/technical-articles/convergence-between-ifrs-and-us-gaap.html Bilgin, M.H., Danis, H., Demir, E., Can, U. 2017. Regional Studies on Economic Growth, Financial Economics and Management: Proceedings of the 19th Eurasia Business and Economics Society Conference. Springer. Collings, S. 2016. UK GAAP Financial Statement Disclosures Manual. John Wiley Sons. Deliotte. 2016. IFRS 16. Retrieved May 26 2017, from https://www2.deloitte.com/content/dam/Deloitte/sg/Documents/audit/sea-audit-IFRS-16-guide.pdf Ernst Young LLP. 2017. International GAAP 2017: Generally Accepted Accounting Practice under International Financial Reporting Standards. John Wiley Sons. 2016. IFRS 16 Leases Roadmap. Retrieved May 26 2017, 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 IAS 17. 2012. Leases. Retrieved May 26 2017, from https://www.ifrs.org/Documents/IAS17.pdf IFRS. 2016. IRFS 16: Effects Analysis. Retrieved May 26 2017, from https://www.ifrs.org/Current-Projects/IASB-Projects/Leases/Documents/IFRS_16_effects_analysis.pdf ISCA. 2016. Financial Reporting Publication. Retrieved May 26 2017, from https://isca.org.sg/tkc/fr/resources/articles-publications/financial-reporting-publications/financial-reporting-publications/2016/august/frs-116-leases/ Lechner, G. 2016. Der geplante IFRS 16 Leases. Die zuknftige Bilanzierung von Leasingverhltnissen nach IFRS. GRIN Verlag. Nikolai, L.A., Bazley, J.D., Jones, J.P. 2009. Intermediate Accounting (Book Only). Cengage Learning. PKF International Ltd. 2017. Wiley IFRS 2017: Interpretation and Application of IFRS Standards. John Wiley Sons. PWC. 2016. A study on the impact of lease capitalization IFRS 16: The new leases standard. Retrieved May 31 2017, from https://www.pwc.com/gx/en/audit-services/publications/assets/a-study-on-the-impact-of-lease-capitalisation.pdf Sacarin, M. 2017. IFRS 16 Leases- Consequences on the financial statements and financial indicators. Audit financiar, XV, Nr, 1(145), pp. 114-122. UOL. 2016. Annual report of UOL. Retrieved May 26 2017, from https://www.uol.com.sg/investors_and_media/annual_reports