New leases accounting standard – how different will your balance sheet look?
This article introduces the new leasing 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.
Short-term leases
- Lease term is less than or equal to 12 months
- Excludes any leases with a purchase option
Low value assets
- Value of the underlying asset (when new) is low value
- Includes items such as laptops, most office furniture
- Excludes vehicles
If either of these options are able to be used and the entity choose to apply the exception then the lease payments associated with those leases are recognised as an expense on either a straight-line basis over the lease term or another systematic basis.
How to do lease accounting under AASB 16?
Example
Lessee Limited leases a vehicle under the following terms:
Length of lease
Commencement date
Lease payments
Initial direct costs to take out the lease – legal fees
Entities’ incremental borrowing rate
5 years
1 January 2019
$500 per month
$525
6%
Existing accounting under AASB 117
| 2019 ($) | 2020 ($) | 2021 ($) | 2022 ($) | 2023 ($) | Total ($) | |
| Income statement | ||||||
| Operating expense – rent | (6,000) | (6,000) | (6,000) | (6,000) | (6,000) | (30,000) |
| Legal fees | (525) | – | – | – | – | (525) |
| Profit or loss impact | (6,525) | (6,000) | (6,000) | (6,000) | (6,000) | (30,525) |
| Balance sheet | ||||||
| Right of use asset | – | – | – | – | – | – |
| Lease liability | – | – | – | – | – | – |
Accounting under AASB 16
On day 1 the lessee will record a lease liability of $25,274, a right of use asset of $25,799 and a cash payment for legal fees of $525.
The entries at each subsequent reporting date are shown below.
| 2019 ($) | 2020 ($) | 2021 ($) | 2022 ($) | 2023 ($) | Total ($) | |
| Income statement | ||||||
| Interest expense (1) | (1,516) | (1,246) | (962) | (660) | (340) | (4,725) |
| Depreciation (2) | (5,160) | (5,160) | (5,160) | (5,160) | (5,160) | (25,800) |
| Profit or loss impact | (6,676) | (6,406) | (6,122) | (5,820) | (5,500) | (30,525) |
| Balance sheet | ||||||
| Right of use asset | 20,639 | 15,479 | 10,319 | 5,160 | – | |
| Lease liability | 20,791 | 16,038 | 11,001 | 5,661 | – | |
Notes:
(1) Calculated using the incremental borrowing rate of 6%
(2) Straight line depreciation based on ROU asset of $25,274 + $525 = $25,799 over 5 year term.
The example above is a simple example to illustrate the principles in AASB 16. Entities should consider the terms and conditions in their leases that would affect the lease accounting, for example:
- CPI rental increases
- Market rent resets
- Make good clauses
- Variable rents linked to sale or usage of the assets
- Lease incentives
- Extension / termination options affecting the lease term
- Commencement date of the lease.
Some myths on AASB 16
| Myth | Truth |
|---|---|
| AASB 16 accounting is the same as current finance | The current finance lease accounting under AASB 117 is not the same as lease accounting under AASB 16, however on transition, entities can opt to transfer the existing balances as the transition. |
| Leases of corporate head offices are excluded from AASB 16 | There is no differentiation in AASB 16 as to the type of assets being leased – if an agreement meets the definition of a lease and is not specifically scoped out then it is included in the AASB 16 accounting treatment. |
| The right of use asset will always be equal to the lease liability | The right of use asset uses lease liability as the base for the calculation, however there are other components to the right of use asset such as lessee’s initial direct costs, prepaid lease payments, lease incentives and restoration provisions. |
| Hire purchase agreements are excluded from AASB 16 | If the agreement meets the definition of a lease and is not specifically scoped out then it is included in the AASB 16 accounting treatment. |
Why AASB 16 is not just an accounting issue?
Many of the accounting standards affect the numbers reported but have no impact on the rest of the organisation but AASB 16 is different. The transition team for AASB 16 in your organisation should include a range of employees to consider the following issues (not an exhaustive list):
Final comments
Lease accounting under AASB 16 can be complex and we have only provided a brief overview in this article. Please contact your Bentleys Advisor for further information.
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The Bentleys Team
Tony Sacre
Chief Executive Officer
Bentleys Network