Accounting for Leases Under the New Standard Paper Example

Introduction

With the move from IAS 17 to the use of IFRS 16, one of the biggest implications will be the treatment and value of the right-of-use asset and the lease liability. IFRS 16 will no longer have operating and balance sheet leases but will have the lease liability and the corresponding right of use of asset in almost all contracts created (Albert).

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The effects of the right-of-use asset and the lease liability will particularly affect the lessee as follows:

Right-of-use asset and lease liability

As the IFRS scraps the need to classify the lease of an asset (as operating or finance) at its inception as was the case in IAS 17. IFRS 16 however requires the prescription of every other lease into the single model where the right-of-use asset is reported as an asset whereas the corresponding the liability under liability section (Iasplus.com).

The right of use of asset will be recognized which will be equal to the amount of lease plus the incidental cost such as direct cost less the lease liability in question. This will include a direct debit to the use of right to the asset and a consequent credit to the lease liability. This paints a different picture altogether as what was carried out in IAS 17 where nothing was done at the beginning.

Another important factor affecting the value of the right-of-use asset and lease liability in the case of IFRS 16 is the lease element will only be accounted for in the balance sheet whereas any other element not relating to the lease are accounted differently. In comparison to IAS 17, the value of the asset under question was not separated and therefore any value of material not related to the lease was accounted as part of the whole lease asset value. The resulting effect was the increase in the amortization cost in the case of the operating lease and a reduction of the EBITDA of the company in comparison to the new standard (Moore, and Shoemaker).

The lease liability in the case of IFRS 16 is accounted differently as the lease liability value is valued in the balance sheet at present value of lease payments over the lease term. In the case of Accounting in Exhibit 3 of the article, the lease liability under question for the asset is determined by the present value of the ordinary annuity for the affixed amount ($131,473) each year for the period of 15 years at its inception. For the case of IAS 17, the lease accounting would only include booking the rental expense at the end of the year in the profit and loss statement. In the case of IFRS 16, in the case the firm makes a payment as the end of the period for the use of the asset to the lessor, depreciation/amortization will be recognized based on depreciation policy of the firm. This is to mean that in the case of the payment, part of the amounts will relate to the amortization or depreciation expense. For the case of Accounting in Exhibit 3 of the article, this is seen by the amortization expense at the end of the year being $66,667 which is debited to amortization account and credited to the right of use of asset. The case of interest expense in IFRS 16 is also different altogether as the interest expense is charge on lease liability and allocated to the lease payments. This works to reduce the lease liability as well as reducing the lease payments each year as exhibited in the case of Accounting in Exhibit 3 of the article.

Because of the impact of IFRS 16 on the first year, many lessees have resorted to reducing the length of leases to less than a year to avoid the complications of lease accounting. This can be related to the fact that the impact on profit under IFRS 16 in year ensures that more benefits at the inception of the lease (year 1) and reduction of the benefits as the lease amortizes into the future (Robert Singer et al.). This can be seen in the case of:

• Interest of the lease
• Depreciation expense of the lease
• Other incidental costs at year 1

Using this fact, more of expenses are apportioned in year 1 which are all deductible expenses against profit that help to increase the EBIT of the asset as well as helping the company generate more taxable profit in the first year of lease (Silvia).

• Rental expense - xxxxInterest expense xxxx-
• Depreciation xxxx-
• Cleaning expenses xxxx-
• Total xxxx

Based on this fact, many companies will be looking to shorten their lease period to at least 12 months period or lesser which will enable them to accrue to the different deductible expenses as well as reducing the lease payment amounts over the short period. The companies will also look to adopt the lease period to 12 months as it is easier to implement and adopt as compared to the future period.

Works Cited

Albert, Amber. "New Lease Accounting Standard (ASC 842): Blowing Up The Balance Sheet | GAAP Dynamics". Gaapdynamics.Com, 2018, https://www.gaapdynamics.com/insights/blog/2016/11/15/new-lease-accounting-standard-(asc-842)-blowing-up-the-balance-sheet/. Accessed 9 Nov 2018.

Iasplus.com. "IFRS 16 - Leases". Iasplus.Com, 2018, https://www.iasplus.com/en/standards/ifrs/ifrs-16. Accessed 9 Nov 2018.Moore, Porter Keadle, and Matt Moore Shoemaker. "Get Ready For FASB'S Lease Accounting Rules - Banking Exchange".

M.Bankingexchange.Com, 2018, http://m.bankingexchange.com/news-feed/item/7161-get-ready-for-fasb-s-lease-accounting-rules?Itemid=584. Accessed 9 Nov 2018.

Robert Singer, CPA et al. "Accounting For Leases Under The New Standard, Part 1 - The CPA Journal". The CPA Journal, 2018, https://www.cpajournal.com/2017/08/23/accounting-leases-new-standard-part-1/. Accessed 9 Nov 2018.

Silvia. "IFRS 16 Leases Vs. IAS 17 Leases: How The Lease Accounting Changed - Ifrsbox - Making IFRS Easy". Ifrsbox - Making IFRS Easy, 2018, https://www.ifrsbox.com/ifrs-16-ias-17-leases/. Accessed 11 Nov 2018.