AASB 16 Leases: Minimising the impact on profit and loss

25 June 2018

The way leases are accounted for is changing. AASB 16, effective from January 1 2019, makes it compulsory for all leases to appear on the balance sheet (with some exceptions).

Although this will represent a significant departure from current practices, there are good reasons for this change. AASB 16 will cause the lessee's financial leverage and capital employed to become much more transparent, as well as address concerns about off-balance sheet financing through the use of operating leases.

That said, businesses must be aware of the changes and start preparing now in order to minimise disruption.

What is a lease?

AASB 16 defines a lease 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."

Additional guidance on assessing whether a contract conveys the right to control the use of an identified asset states that the customer must:

  • Have the right to obtain substantially all of the economic benefits from the use of the identified asset
  • Have the right to direct the use of the identified asset.

What impact will AASB 16 have on the education sector?

For the education sector, all leases will all need to be brought to account. This includes leases of land and buildings, high value IT equipment, photocopiers and servers, as well as cars and buses.

Peppercorn leases, whereby an asset is provided at a very low, nominal or a token amount, will be caught under AASB 16  and will have the added impact of having to be recorded on the balance sheet what the fair value of that lease would have been.

When should you start preparing for AASB 16?

The short answer is as soon as possible. There are a number of things you may have to do to ensure you are compliant with AASB 16:

  • Valuers may need to be engaged
  • Lease contracts may need to be renegotiated
  • The expected impact of the changed will need to be reported the year before the standard is effective.

In order to calculate the expected impact on your profit and loss statement, you'll need to take into account the following key inputs:

  • Term of the lease
  • Calculation of the lease liability
  • Calculation of the right-of-use asset
  • Discount rate to be applied.

Methods for transition to AASB 16

There are two transition options available for AASB 16. The full retrospective method involves:

  • Comparatives are restated
  • Cumulative effect of the change is recognised as an adjustment to opening equity at the start of the earliest comparative period presented
  • Third statement of financial position presented at the start of comparative period \
  • Limited transitional relief.

The modified retrospective method involves:

  • Comparatives aren't restated
  • Cumulative effect of the change is recognised as adjustment to opening equity at the start of the current period (date of initial application)
  • Third statement of financial position isn't needed
  • More extensive transitional relief.

What about novated leases?

A novated lease is a three-way agreement between an employer, employee and finance company. The employer agrees to take on the employee's lease obligations with the finance company.

However, novated leases aren't captured by the new standard, because AASB 16 states that the entity must have the right to obtain substantially all the economic benefits from use of the asset, and the right to direct the use of the identified asset. Under a novated lease the employer does not have this right.

Minimising the impact of AASB 16

The key point for businesses wanting to minimise the impact of AASB 16 is to start thinking about it now. Other things they can do are:

  • Use an incremental borrowing rate, if applicable, to help with calculations
  • Use sufficiently specific performance obligations to try and match the future revenue with the amortisation of the lease liability
  • Consider the lease period and the impact this will have on the fair value of the lease liability
  • Look at transition options
  • Consider novated leases, if applicable.

BDO has years of experience helping the education sector navigate changing reporting standards. For more information on how we can help, contact the team today.