Impact of the New Lease Standard-Free-Samples-Myassignmenthelp.com

Question: Demonstrate the Impact of the new lease standard on the Financial reporting of both lessee and lessors. Answer: Introduction: The report is prepared for demonstrating the impact of the new lease standard on the financial reporting of both lessee and lessors. Impact of the new leased standard has been discussed in context of different industries. A new standard on lease that is IFRS 16 is published by International accounting standard boards (IASB). The new standard uses a single model by bringing most of the leases for lessees on balance sheet and thereby eliminating the difference between financing lease and operating lease (Collis et al., 2017). However, the distinction between financial and operating lease is retained and lessors accounting largely remain unchanged. It is so because the liabilities of company is potentially understated as there might be thousands worth of assets held by company under agreements operating lease are not incorporated clearly in the financial metrics. Rationale behind the introduction of new lease standard IFRS 16: Under the existing lease standard, the lease transactions are accounted by lessee as either operating or financial lease depending upon the tests and complexities of rules. The use of bright lines in practice resulted in nothing or all being recognized on the statement of financial position. The previous lease standard that is IAS 17 does not require operating lease to be featured on balance sheet of reporting entity. This has the consequence that the actual worth of liabilities and assets are not represented on the financial statements of entity. It is estimated by IASB that the total worth of commitments pertaining to lease stood at US $ 3.3 trillion and 85% of them do not appear on the balance sheet of entities (Osei, 2017). This has posed problems to the investors and other financial analysts as they cannot analyze and compute the actual worth of liabilities and assets since true economic reality is not presented. Implication of new lease standard for lessee and lessors: Leasing is the most widely used and an important financial solution used by most of organizations. The wide usage of leasing is attributable to the fact that companies are not required to incur large flow of cash for accessing and using equipments and property. Financial statement of lessee will be substanti8ally impacted with the introduction of new lease standard. In addition to financial reporting, there will also be considerable impact on system of information technology, assets financing, control and other processes. A vast number of items are leased by many companies such as power plant, offices, cell towers, retail stores and aircraft. Therefore, the new lease standard would greatly affect the lessee. However, the accounting of lessors will largely remain unchanged. Nevertheless, due to change in behavior and needs, they will experience impact on their products and business model. Impact on lessee: All the commonly used performance metrics and financial ratios such as asset turnover, current ratio, gearing ratio, earnings before interest and taxes, net income, earning per share, return on capital; employed, return on equity, interest cover and operating cash flow will be virtually affected by the new lease standard. There could be behavioral changes experienced by lessee as such impact on financial ratios will have considerable affect on borrowing costs, loan covenants and their credit ratings. Many organizations might be compelled by this impact to make reassessment of their certain lease versus buy decisions. For most lessees, the cost of implementation and compliance with the new lease standard would be significant and such costs would be more significant if the organization does not have an in house lease information system. There will be reduction in capital ratios and growth in balance sheet and consequently, increase in gearing ratio. In addition to this, changes will also be experienced in recognition and expenses pattern. Recognition pattern is about the acceleration of expenses of lease in relation to recognition pattern for operating leases today. Expenses pattern is related to replacement of rent expenses with depreciation and interest expenses (Sacarin, 2017). Entities that are likely to be greatly affected by IFRS 16 are those leasing big ticket assets such as manufacturing equipment, real estate, train, aircraft, ships and technology. There could be less impact for entities with several small leases such as small items of office furniture, personal computers, tablets and telephones. It is so because exemptions are offered by IASB on low value assets with a value of $ 5000 or less and such assets meeting the exception are not required to be realized on balance sheets. Impact on lessors: The existing and future leases by lessee and lessors needs to renegotiated and restructured. There should be reassessment of legal and business structures supporting leases for evaluation whether such leases are effective to organization in the current scenario such as special purpose entities and joint ventures (de Albuquerque et al., 2017). Compared to IAS 17, the lessors accounting would remain unchanged considerably under IFRS 16. However, due to changes in behavior and needs of some customers, it is expected that lessors would be affected in terms of lease products and business models. Judgment of management will be required for the application of estimates to determine standalone prices and identification of components for meeting the requirement of IFRS 16 to separate lease and components of non lease items and allocation of considerations to separate components. Lessees for separating lease and non lease components might not currently have data for which lessors might need to provide information to customers for lessee and lessors. It is required by both lessee and lessors to determine whether the right to use an asset is a component of separate lease in their contracts if the underlying assets are highly interrelated and dependent or if the lessee can benefit from the use of assets either with other resources or on its own (Joubert et al., 2017). Balance sheets will be grossed up by the new standard implementation and will change the presentation of cash flow and income statement. In the income statement, interest expense and rent expense will replace the rent expenses. This will have the consequence of increasing front load expenses and this would result in decreasing equity and earnings immediately when entering into lease as compared to operating lease. Given the fact that, operating lease have historically been off the balance sheet, requirement of lease data will increase. Additional data collection will be required for due to increased disclosure. A more expensive and different disclosures are required at both quantitative and qualitative level. Types of companies that is likely to be affected by the new lease standard: Every industry uses lease as its financial function for accessing the assets that are leased by them. Some of the industries that are heavy users of leases are retailers, professional services, airlines, wholesale, healthcare, entertainment, logistics and transport and telecommunication. Across all the industries, new standard will have considerable affect but the impact will differ. Retailers- Retailers are heavy users of real estate as they use lease options for stores. Implementation of new lease standard will have major impact on their renewal options, separation of lease and non lease components and payment options. The core business of retailer is to lease real estate and substantial judgment is required while retailers having economic incentive when renewing retail lease locations for reassessment and determination (Zeghal Lahmar, 2016). Moreover, retailers are required to separate lease elements from service charges due to implementation of new standard. Transport and logistics- Entities in logistics and transport often lease items such as train, aircraft, vehicles, trucks and real estate. Leases are often used in such industries for revenue generating activities. Substantial judgment would be required by reporting entities when they have economic incentive for renewing lease (Morales Zamora, 2017). Assets in this industry are leased combined with other services. In order to account for lease separate from service elements, lessees would be required to unbundle lease information and bundling of products by lessors. Telecommunication- A vast number of big ticket items such as cell towers, network equipment, fiber optic cables and satellite transponders are leased by telecom entities. For telecom entities, lease determination can be judgmental and complex. It is need to be determined by telecom entities whether physical distinct portion of an asset is controlled by leases. Due to need of unbundling multiple elements arrangement provided to customers, telecom entities would be required to combine the new standard of revenue recognition and new leases standard by considering both the standard interdependencies that would make it cost efficient (Demir Bas, 2017). Real estate and equipment lessors- Equipment and real estate lessors industry may not be considerably affected in their won accounting. However, due to change in the behaviors of customers, new lease standard would impact business model. For equipment and vehicle lessors, the lessees changing needs are more important compared to real estate. There would be greater workload for lessors and opportunities would be offered by changing new dynamics for new services and products. New lease standard would accelerate new development in the market such as increased focus on the services matters (Czajor Michalak, 2017). This would call shift in traditional business models of lessors. Conclusion: The implementation of new lease standard IFRS 16 will considerably change the accounting for leases of lessees and have far reaching implications on operations and finances of companies. Regardless of the industry in which entities are operating, IRFRS 16 requires lessees to recognize most of leases on their balance sheet. It can be inferred from the analysis of the implication of new lease standard that accounting of financial reporting of lessee would change significantly to lessors accounting treatment. Using of single accounting model for all leases by lessee comes with two exemptions in terms of short term leases and low value assets. Due to different capital structures of reporting entities, there will be further impact of the standard. However, for evaluating the impact of IFRS 16, assessments are required to be done based on circumstances and facts that are relevant to each entities. For instance, the entities renting office space that are treated as on operating lease will b e greatly impacted compared to entities purchasing office space. Therefore, it can be concluded that certain industries will be more impacted compared to other. References list: Collis, J., Jarvis, R., Skerratt, L. (2017). The role and current status of IFRS in the completion of national accounting rulesEvidence from the UK.Accounting in Europe,14(1-2), 235-247. Czajor, P., Michalak, M. (2017). Operating Lease Capitalization-Reasons and its Impact on Financial Ratios of WIG30 and sWIG80 Companies.Przedsi?biorczo i Zarz?dzanie,18(1, cz. 1 Practical and Theoretical Issues in Contemporary Financial Management), 23-36. de Albuquerque, F. H. F., Marcelino, M. M., Rodrigues, N. M. B., de Almeida Cariano, A. J. R. (2017). Accounting for lease transactions: analysis of possible lobbying in the issuing of IFRS 16.Revista de Educao e Pesquisa em Contabilidade,11(4). Demir, Z., Bas, E. (2017). THE EFFECT OF TAS 17 LEASING STANDARD AND IMPLEMENTATION OF THE NEW IFRS 16 LEASES STANDARD ON THE AIRLINE COMPANIES.PressAcademia Procedia,3(1), 153-173. Joubert, M., Garvie, L., 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 and Trends,15(2), 1-11. Morales-Daz, J., Zamora-Ramrez, C. (2017). Effects of IFRS 16 on Key Financial Ratios: A New Methological Approach Osei, E. (2017). THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB), AND THE INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB) SINGS SIMILAR TUNE: COMPARING THE ACCOUNTING TREATMENT OF NEW IFRS 16 WITH THE IAS 17, AND THE NEW FASB MODEL ON LEASES.Journal of Theoretical Accounting Research,13(1). Sacarin, M. (2017). IFRS 16 Leasesconsequences on the financial statements and financial indicators.Audit Financiar,15(145), 114-122. Zeghal, D., Lahmar, Z. (2016). The Impact of IFRS Adoption on Accounting Conservatism in the European Union.International Journal of Accounting and Financial Reporting,6(1), 127-160.