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Understanding the changes to the Lease Accounting Standard

Accounting standards concept

The Australian Accounting Standards Board (AASB) published AASB 16 in February 2016.

The Standard must be applied to annual reporting periods beginning on or after 1 January 2019.

As we are now well into 2020, this Standard is applicable to all businesses and it changes the way that companies manage the financial accounting of their leases. It has a direct impact on the balance sheet and profit and loss statements.

AFG Account Managers Jane Chen and Carol Tran discuss the changes that have been implemented and what it means for our not for profit (NFP) clients.

Composite image of computer in front of window in office

What is the Lease Accounting Standard?

Australian accounting standards define the way that companies must carry out their accounting processes. The Lease Accounting Standard relates directly to any type of lease that the company holds. This can be a lease for a property, for example the business office or a warehouse, or any type of equipment such as computers, photocopiers, phone systems, machinery or vehicles.

Historically, these were classified as either operating or capital leases, but the changes we are reviewing today see the removal of the operating lease classification. Jane says,

“Previously, you only needed to record the lease payment as an operating expense and that was it. But now, depending on the kind of lease you have, the majority of payments will have to go on your balance sheet.”

Profit or Loss Sheet

What has changed?

With the removal of the operating classification, the treatment of leases has now become far more complicated. Jane explains,

“Under the new accounting standard, subject to limited exceptions, all leases are required to be capitalised on the balance sheet. Just like a hire purchase of a work vehicle, it is recognised as an asset and the loan payable will be assessed as a liability for the period owed. Under the changes to the Standard, you need to calculate the interest that you would have been charged if you borrowed enough money at the beginning of the term to purchase outright. So, this calculation will impact the balance sheet and the profit and loss.”

We understand that this might seem a bit crazy to the average not for profit organisation that typically wouldn’t use credit or loan facilities and therefore would not be used to seeing an “Interest Paid” expense account on their P&L, but that is the effect of the new rules.

Note that there are two exemptions – short-term leases (less than a year) and small assets (value less than $10,000).

Focused female professional preparing report doing paperwork

Complexity of the changes

There is a significant degree of complexity now involved with lease accounting, and for many this adds major calculation challenges. Jane continues,

“Under the old rules, at the end of the year when your auditor came to validate your lease payments, all they would look at is how much you’d paid and whether it matched what was stated in your lease agreement. They were simply checking the amount… because it was only the amount that mattered.

Now you need to closely examine all contracts to identify any terms and conditions that will impact your calculation under the new accounting standards.Things like content of the assets hired, break costs, make-good policy and particularly any non-lease components.

AASB 16 requires you to split out the non-lease components of a contract – an example might be the copy cost built into your photocopier contract. In this situation, you would need to calculate the lease of equipment cost and treat it under AASB 16, while treating the copy cost as a straight expense. In good news, there is a get-out-of-jail card in paragraph 15 of the Standard, which allows you to treat non-lease components under AASB 16 ‘as a practical expedient’ – so while you don’t get out of having to do the interest calculation, you may not have to spend time dividing up your contracts into lease and non-lease components.

In addition, if your lease is subject to CPI and it doesn’t have a defined percentage – so it is driven by the market rates – it is considered a variable payment. That means you have to adjust your calculations every year to make it align with what you’ve paid in the past years.

Businesswoman signing document

Carol also highlights how some Accounting For Good clients have already adopted the new policy and have discovered additional challenges.

“It can be even more difficult to navigate the new Standard, especially for not for profits where they might have a lease that is valued significantly below the market rate. The new Standard requires that you recognise it at the true market rate.

You could potentially have to do a full valuation of your lease… where you’ve never had to do it before. For example… where you’ve had a long-term lease that was offered by a donor or a supporter, it’s possible you’ve never had a proper lease agreement in place. This would need to be analysed and you may have to redo your lease to be able to comply with the new Standard.

It’s not just additional work for your accounts team… it could be additional work for your management as well.”

Business Team busy working

Accounting For Good’s team of experts

Our team understands the changes and knows how to navigate the processes involved in the calculations. We are already supporting our clients by attending board meetings and outlining the expected financial impacts. Jane says,

“This change will have an impact on your financial position.Our job is to assist management and its stakeholders to understand the impact of this new Standard.”

Carol concludes that there are still some elements open for interpretation. She explains,

“Different auditors will have different perspectives – it is a complex standard – so our approach is to work with the auditors as much as possible. That way we avoid any surprise changes at audit time.”

We understand that these changes are complex, but our team of accounting specialists have the expertise to navigate the new Standard confidently. Contact us if you have any questions.

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