This article introduces the new leases accounting standard AASB 16 and what the new standard means for businesses.
Most organisations in Australia undertake some form of leasing activity whether it is renting a corporate office, photocopiers, laptops or vehicles.
In the past, many of these lease arrangements have been classified as operating leases which required expenses to be recorded on a systematic basis over the life of the lease through the income statement with no impact to the balance sheet (statement of financial position).
AASB 16 Leases which is effective for annual periods beginning on or after 1 January 2019 (i.e. 31 December 2019 or 30 June 2020 year ends) will change this accounting and require the majority of leases held by lessees to be recorded on the balance sheet.
Lessor accounting is substantially unchanged and lessors continue to classify their leases as operating or finance.
Why are these changes occurring?
The classification of leases as operating leases meant that many entities had significant assets which were critical to their business which were not being recorded in their financial statements, the associated liabilities were also understated. In addition, users of the financial statements, such as analysts and banks, adjust the financial statements for the operating lease commitments note in making their decisions and these adjustments are often not correct.
What does the new standard mean for entities?
Fundamentally, all leases in place at any entity (i.e. any agreements meeting the definition of a lease below) will be recorded in the balance sheet as a non-current Right of Use asset with an associated lease liability (separated into current and non-current components). The income statement (statement of profit or loss and other comprehensive income) will show the lease expense as depreciation (relating to the Right of Use asset) and interest relating to the lease liability rather than rent expense being shown as an operating expense.
What agreements will meet the definition of a lease?
A lease is defined in AASB 16 as a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
As part of identifying the population of leases, an entity is required to consider all agreements which involve the use of an asset to determine whether it meets this definition regardless of the name of the agreement – this might include agreements such as supply agreements, usage agreements, management agreements, outsourcing agreements.
Exceptions from lease accounting
Once the population of leases has been identified then there are two exceptions to lease accounting which lessees can choose to apply – short term leases and low value assets.