The purpose of accounting standards issued by the national accounting standards boards of different countries as well as that of Internal Financial Reporting Standards Board are very much similar. The objective behind formulation of accounting standards is mainly to improve the quality of financial reporting by the organizations. In case of Australia it is the Australian Accounting Standards Board (AASB) that has since its inception has formulated accounting standards (AASBs) for the entities and organizations to be followed in preparation and presentation of financial statements.
Earlier AASB 117 was in force to guide the entities to account for leases in the books of accounts. However, subsequent to lot of criticism from different corners for the inability to reflect the financial reality of leases the International Financial Reporting Standards Board under the Chairmanship of Hans Hoogervorst has developed a new standard IFRS 16 to improve the reporting of leases in the books of accounts of an organization with the objective of reflecting the financial reality of leases in the books of accounts and financial statements (Jarva & Lantto 2012). Australian Accounting Standards Board has also followed on the footsteps of IFRS and has developed a new accounting standard AASB 16 in alignment with IFRS 16 to ensure that the Australian corporations as well as entities that are required to adhere to the Australian Accounting standards must improve the reporting of leases in the books of accounts (Pellens, Fülbier, Gassen, Sellhorn, Barekzai, Bonse & Hillert 2017).
The Chairperson has a very valid reason behind his observation that IAS 17, i.e. the IFRS that was in force prior to the issue of IFRS 16, was not capable of reflecting the economic reality of leases. As he made it clear in his comment while speaking on the issue that entities in all across the globe have more than 3 trillion euros worth of assets in leases. However, more than 85% of these leases are off the Balance sheets because the old IFRS allowed these entities to classify these leases as operating lease. IAS 17 does not require the operating leases to be shown in the Balance sheets as a result more the 85% of the leased assets were off the Balance sheets. Thus, there is valid reason for the Chairperson of IFRS to say that the economic reality of leases is not reflected by IAS 17 earlier (Joubert, Garvie & Parle 2017).
The reason that prior to the issue of IFRS 16 the off Balance sheet lease liabilities were 66 times greater than the actual debt reported in the Balance sheet is mainly due to the non-recognition of operating leases in the Balance sheet. As already mentioned that 85% of total leases were classified as operating leases and earlier as per IAS 17 the operating leases were not required to provide for any liability in the balance sheet (Fitó, Moya & Orgaz 2013). Rather IAS allowed the operating leases as expenditures in the year of payment and only in case of non-payment as and when operating lease payments were due that such amount used to be shown as accrued operating leases under current liabilities. Thus, the economic reality and financial position of an entity using significant amount of operating leases were not correctly reflected in the financial statements due to the accounting treatments and financial disclosure requirements under IAS for operating leases (Xu, Davidson & Cheong 2017).
The chairperson of IFRS correctly argued that there was no level playing field between some airline companies due to the ineffective accounting treatment and financial disclosure requirements under IAS 17. As per the former standard on leases an entity was not required to show the expected amount of liabilities for large number of aeroplanes and other equipment taken on lease if these were classified as operating leases. As soon as an airline company classified the leases as operating leases it was not required to include the equipment and flights in the Balance sheet and the liabilities in respect of these equipment and flights were also off the Balance sheet. Thus, for airline companies that have classified most of its leases as financial leases will have completely different looking Balance sheet as compared to those that have classified most of its leases as operating leases. Thus, there would be no level playing field between the airline companies with significant financial leases and airline companies with not so significant amount of financial leases (Abbott & Tan?Kantor 2018).
The new accounting standards, i.e. IFRS 16 for international entities and AASB 16 for Australian entities, will not be popular with everyone as IFRS 16 and corresponding Australian accounting standard AASB 16 require the entities to show both financial and operating leases in the Balance sheet to reflect the economic and financial reality of leased assets and liabilities in respect of these leases. As a result of the accounting treatment and disclosure requirements for operating and financial leases in the financial statements the large entities with significant amount of operating leases would have to report all of its operating leases in Balance sheet. As a result of this the debt and liability position of such entities would reflect the actual economic reality of these entities thus, the rosy pictures that were being painted under IAS 17 would not be possible. Thus, the new accounting standard IFRS 16 would not be popular with such entities that have significant amount of operating leases in its books of accounts (Firth & Gounopoulos 2017).
The annual report 2018 of Qantas contains the complete set of financial statements. An evaluation shall be conducted on the annual report of the company and specifically that of its financial statements to assess how leases have been classified and reported in the financial statements. The appraisal of leasing arrangements made by the company shall be made taking into consideration the detailed discussion that has been made on IFRS 16 and AASB 16 earlier in this document.
Qantas operating in Airline industry however, is not an exception to the practice of not reporting huge amount of operating leases in the Balance sheet as the practice is very much widespread in the industry. However, with the introduction of IFRS 16 it is expected that the economic reality of operating leases would not be concealed from the users of financial statements as the standard makes it compulsory for the entities to report such operating leases also along with financial leases (Edeigba & Amenkhienan 2017).
For the financial year ending on June 30, 2018 the company has reported its leases as per the requirements of IFRS 16 as it did even for the previous year ending on 30th June, 2017 (Backof, Bamber & Carpenter 2016).
Non-cancellable operating lease rentals as per the income statement of the company for the financial year ending on June 30, 2018 has reduced significantly to $272 million whereas the same in the corresponding period of previous financial year, i.e. financial year ending on 30th June, 2017 was as high as $356 million (Tan?Kantor, Abbott & Jubb 2017).
The amount of lease hold improvements for the current financial year ending in June, 2018 is $402 million compared to the amount of lease hold improvements for the previous year of $447 million. At the beginning of the financial year, i.e. on July 01, 2017 opening net book value of lease hold improvements were $447 million. During the year the company made an addition of $39 million and transferred $18 million along with other adjustments to end up with a balance of $402 million as net book value of lease hold properties as on June 30, 2018 (Müller, Riedl & Sellhorn 2015).
The capital management strategy of Qantas as provided in the annual report 2018 the company clearly states that maintaining optimal capital structure for the company is one of the prime objectives of the management. Thus, the management in order to maintain an optimal capital structure to minimise the cost of capital will hold an appropriate level of net debt by ensuring there is off Balance sheet debt for operating assets used by the company in its business operations. This has been done to reflect the net debt of the company at an appropriate level as per the size of Qantas measured by invested capital in the company (Olesen & Cheng 2017).
The company as per the capital invested belongs to a net debt category of $5.1 to $6.3 Billion metric however, in both 2018 and 2017, i.e. financial year ending on June 30 in each of these years, the company had a net debt of $4.9 billion and $5.2 billion respectively. It is important to note that the company has kept operating leases off Balance sheet to manage the capital of the company as per the appropriate net debt metrics of the company (Dimitras, Gaganis & Pasiouras 2018).
Thus, the company is reporting the leases as per IAS 17 and it is helping the company to keep operating leases off the Balance sheet. However, with the introduction of IFRS 16 and correspondent Australian Accounting Standard AASB 16 Qantas would be bound to show the liabilities in respect of operating assets. Thus, huge amount of operating liabilities that have been kept off the Balance sheet to reflect the financial position especially the debt position differently would have to be included in the Balance sheet to reflect the actual economic reality of lease transactions in the financial statements of the company. It is clear that the change in accounting rules as formulated in the new IFRS 16 and AASB 16 for reporting the leases would impact Qantas and companies that use significant amount of operating assets (Cascino & Gassen 2015).
Inclusion of operating lease related debt in the Balance sheet would reflect the economic and actual reality of leases and debt position of the company. Obviously with significant amount of debt off the Balance sheet prior to introduction of IFRS 16 would negatively influence the financial picture portrayed by the financial statement earlier (Czajor & Michalak 2017). However, the economic reality of the debt position of the company would be correctly reflected in the Balance sheet of the company. Thus, the investors and other stakeholders of the company would be able to assess the financial position and performance of the company better due to the fair and correct reporting of lease related items in the financial statements of the company (Kraft & Landsman 2017).
Short term impact:
In the short term the financial position of the companies will be drastically different from earlier periods due to the use of IFRS 16 for reporting leases. The companies will find difficult to arrange long term debt as the debt and liability positions of the company would be significantly different from previous years once IFRS 16 is mandatory for reporting leases. The capital gearing and debt to equity ratios will deteriorate significantly in the short run subsequent to the compliance with IFRS 16 for reporting leases.
Conclusion:
Lease arrangements are quite different based on their classification, i.e. financial leases are generally for the entire or almost entire period of the equipment or asset that is taken on lease. The present value of total expected lease payments under financial lease is shown as liability in the balance sheet under non-current liabilities and an equal amount of is shown as asset under non-current assets in the Balance sheet. However, in case of operating lease, i.e. generally for a significantly short period of time compared to the useful economic life of the asset taken on lease, only the annual lease rental is shown as expenditures in the income statement to show the net income from business. Thus, operating leases largely kept as off Balance sheet items to not reflect the economic reality of huge proportion of operating leases by the companies around the globe including Qantas.
References:
Abbott, M., & Tan?Kantor, A. (2018). Fair Value Measurement and Mandated Accounting Changes: The Case of the Victorian Rail Track Corporation. Australian Accounting Review, 28(2), 266-278.
Backof, A. G., Bamber, E. M., & Carpenter, T. D. (2016). Do auditor judgment frameworks help in constraining aggressive reporting? Evidence under more precise and less precise accounting standards. Accounting, Organizations and Society, 51, 1-11.
Cascino, S., & Gassen, J. (2015). What drives the comparability effect of mandatory IFRS adoption?. Review of Accounting Studies, 20(1), 242-282.
Czajor, P., & Michalak, M. (2017). Operating Lease Capitalization-Reasons and its Impact on Financial Ratios of WIG30 and sWIG80 Companies. Przedsi?biorczo?? i Zarz?dzanie, 18(1, cz. 1 Practical and Theoretical Issues in Contemporary Financial Management), 23-36.
Dimitras, A., Gaganis, C., & Pasiouras, F. (2018). Financial reporting standards’ change and the efficiency measures of EU banks. International Review of Financial Analysis.
Edeigba, J., & Amenkhienan, F. (2017). The Influence of IFRS Adoption on Corporate Transparency and Accountability: Evidence from New Zealand. Australasian Accounting, Business and Finance Journal, 11(3), 3-19.
Firth, M., & Gounopoulos, D. (2017). IFRS adoption and management earnings forecasts of Australian IPOs.
Fitó, M. À., Moya, S., & Orgaz, N. (2013). Considering the effects of operating lease capitalization on key financial ratios. Spanish Journal of Finance and Accounting/Revista Española de Financiación y Contabilidad, 42(159), 341-369.
Jarva, H., & Lantto, A. M. (2012). Information content of IFRS versus domestic accounting standards: evidence from Finland.
Joubert, M., Garvie, L., & Parle, G. (2017). Implications of the New Accounting Standard for Leases AASB 16 (IFRS 16) with the Inclusion of Operating Leases in the Balance Sheet. Journal of New Business Ideas & Trends, 15(2).
Kraft, P., & Landsman, W. R. (2017). Effect of mandatory IFRS adoption on accounting-based prediction models for CDS spreads.
Müller, M. A., Riedl, E. J., & Sellhorn, T. (2015). Recognition versus disclosure of fair values. The Accounting Review, 90(6), 2411-2447.
Olesen, K., & Cheng, F. (2017). Convergence of accounting standards does not always lead to convergence of accounting practices: The case of China. Asian Journal of Business and Accounting, 4(1).
Pellens, B., Fülbier, R. U., Gassen, J., Sellhorn, T., Barekzai, O., Bonse, A., … & Hillert, G. (2017). Internationale Rechnungslegung: IFRS 1 bis 16, IAS 1 bis 41, IFRIC-Interpretationen, Standardentwürfe. 10. Schäffer-Poeschel.
Tan?Kantor, A., Abbott, M., & Jubb, C. (2017). Accounting Choice and Theory in Crisis: The Case of the Victorian Desalination Plant. Australian Accounting Review, 27(3), 273-284.
Xu, W., Davidson, R. A., & Cheong, C. S. (2017). Converting financial statements: operating to capitalised leases. Pacific Accounting Review, 29(1), 34-54.
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