Questions on Leases

Question A

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The IFRS 16 gives extensive guidelines on how the IFRS reporters can effectively recognize, present, measure, and disclose all forms of leases. The standard enables professionals to use an approved accounting model for the lessee. As a result, lessees should recognize liabilities and assets. However, the only exception is a case where lease agreement is less than 12 months, or the assets value is negligible to b included in the contract. The leases can effectively be classified as finance or operating, and there are no substantial changes between the IAS17 and IFRS 16 (M Carlin, Finch, and Manh 2014). Because of changes in other areas such as technology, it is necessary for the leases to have some changes to comply with the ever-changing variables. The IFRS 16 will be effective as from 1 January 2019 and was issued in the January of 2016.

The publication of the IFRS 16 by the International Accounting Standards Board (ISAB) will bring some significant lease changes once it takes effect. In contrast to the current IAS 17, the IFRS 16 will allow most leases to be included on the balance sheet so long as they are under a single model (Daske, Hail, Leuz, and Verdi, 2013). As a result, there will be a distinction between finance leases and operating leases. It was necessary for the IASB to revise the lease accounting standards because it was the best way of developing internationally recognized standards for leases. The ability to accept the leases and liabilities enables professionals and even businesspersons to solve efficiently the problems that may arise. Therefore, the accepted and upcoming accounting model for the leases will use a dual strategy. The separate lease accounting is appropriate because the two principal components, liabilities, and assets, will be inclusive. Therefore, even if the two require that the assets and liabilities should be recognized, there are some differences in the way they are handled or managed.

The primary objective of IFRS 16 is to establish a mechanism for providing up to date information that discloses all transactions for efficient administration and decision-making. Therefore, the IFRS 16 applies to all types of leases, and this includes sub-leases with an exception of IFRS 16:3. The components of the exception include leases that involve biological assets, and those of exploration of oil, minerals, and natural gas. Leases enable companies and individuals (the lessee) to acquire the rights to the use of some assets instead of buying them. The IFRS 16 is meant to eliminate the categorization of leases as finance or to operate as provided for by the IAS 17 (Glaum et al., 2013). As a result, a single accounting model is introduced and will be adopted later in 2019. Through the application of the model, every lease should recognize all liabilities and assets, and the interest on lease and depreciation separately. The IAS 17 only focused on whether the contract is similar to acquiring an asset for it to be included in the balance sheet. However, if not, it could not be included in the balance sheet.

Question B

Classifying a lease as operating or financing as provided for by the IAS 17 could not enable the accountants to classify it as liabilities or assets in the balance sheet. However, some of these leases could not be canceled, acting as potential sources of obligations. The IAS 17 provisions did hide some valuable information from the financial statements. As a result, it misleads the public. It is mandatory to include all the disclosures in the balance sheet and if not, the readers cannot get a real picture of the financial statements (Barth et al., 2014). This is what the IASB wanted to eliminate by coming up with the IFRS 16. Before making a contract, the IAS 17 does not require a distinction between a service contract and a lease contract. This is because both were accounted in the same category, as an expense that should only be included in the profit and loss account. On the other hand, the IFRS 16 has extensive guidelines on how to determine if a contract is under a lease or service (Bhat, Callen, and Segal, 2014). The distinction is of importance because of the new accounting standards that are yet to take place (as from the start of 2019).

A lease should grant the right to have control over an asset for a predefined period. Additionally, there should be a consideration in exchange for the assets for the given time that should be paid at once or periodically (Christensen, Hail, and Leuz, 2013). Also, the lease agreement gives the user a chance to make maximum use of the asset for his/her economic benefits. One of the main changes in the lease agreements due to the introduction of the IFRS 16 is an increase in the value of financial liabilities and lease assets (Nobes, 2015). Moreover, there is a possible change of financial metrics in the companys liabilities and assets. For instance, the companys leverage and other ratios will be affected.

In relation to the IAS 17, the IFRS 16 grants the lessee to consider the assets as a liability and as a tool that can be used effectively for economic gains. Therefore, it becomes necessary for the leased assets to be depreciated as per the policy and standards of the company while the accrued interest is considered as a liability (Choubey, 2016). There should be appropriate strategies for maximizing on the economic benefits of the leased assets to cover the potential liabilities. As a result, the IFRS 16 produces front-loaded costs to the lessee while the operating costs for the case of the IAS 17 posses straight-line costs. If it is assumed that there will be a linear depreciation of the leased property, there will be a decrease in the rate of interest for the liability, lowering the expenses over time (Bebbington, Unerman, and O'Dwyer, 2014). Therefore, the IFRS 16 gives the lessee an opportunity of maximizing on the economic benefits of the leased assets, encouraging companies to adopt the strategy instead of focusing at buying one.

It was necessary to make these changes because of the advantages associated with them. Any accounting change should be focused on making the profession better and easy to comprehend the concepts used (Uno and Bartelmus, 2013). In conclusion, the discussion above has demonstrated the necessity of having accounting changes to incorporate important issues in that can make the profession better. Various professions have made significant changes, and it is necessary for the accountants to include the idea of IFRS 16 in their operations, understand how it works before it takes effect so as to facilitate its execution when the right time comes.

References

Barth, M.E., Landsman, W.R., Young, D. and Zhuang, Z., 2014. Relevance of differences between net income based on IFRS and domestic standards for European firms. Journal of Business Finance & Accounting, 41(3-4), pp.297-327.

Bebbington, J., Unerman, J. and O'Dwyer, B., 2014. Sustainability accounting and accountability. Routledge.

Bhat, G., Callen, J.L. and Segal, D., 2014. Credit risk and IFRS: the case of credit default swaps. Journal of Accounting, Auditing & Finance, p.0148558X14521205.

Choubey, S., 2016. IFRS 16 Leases. The MA Journal, 51(2), pp.91-94.Christensen, H.B., Hail, L. and Leuz, C., 2013. Mandatory IFRS reporting and changes in enforcement. Journal of Accounting and Economics, 56(2), pp.147-177.

Daske, H., Hail, L., Leuz, C. and Verdi, R., 2013. Adopting a label: Heterogeneity in the economic consequences around IAS/IFRS adoptions. Journal of Accounting Research, 51(3), pp.495-547.

Glaum, M., Schmidt, P., Street, D.L. and Vogel, S., 2013. Compliance with IFRS 3-and IAS 36-required disclosures across 17 European countries: company-and country-level determinants. Accounting and business research, 43(3), pp.163-204.

M Carlin, T., Finch, N. and Manh Tran, D., 2014. IFRS compliance in the year of the pig: Hong Kong impairment testing. Journal of Economics and Development, 16(1), p.23.

Nobes, C., 2015. IFRS Ten Years on: Has the IASB Imposed Extensive Use of Fair Value? Has the EU Learnt to Love IFRS? And Does the Use of Fair Value make IFRS Illegal in the EU? Accounting in Europe, 12(2), pp.153-170.

Uno, K. and Bartelmus, P. eds., 2013. Environmental accounting in theory and practice (Vol. 11). Springer Science & Business Media.