Discuss About The Speed Cast International Ltd Annual Report?
AASB 16 shall be effective from 1st January 2019 onwards, the main objective of which is the recognition of all kinds of leases that are above 12 months in the financial statements. Under this standard, the lessee shall recognize the right to use an asset on the assets side and the liability to pay the lease payments on the liability side of the balance sheet. Further, the lessee shall also record the depreciation of such leased asset and the interest on lease liability in its income statement (AASB, 2016). Also, the cash flows shall show the cash repaid portion of lease payments and bifurcate it into interest and principal. This shall be common for all types of leases whether operating lease or finance lease. Hence, the application will cater to both types of leases.
We shall elaborate the above points with regard to a company in GICS Sector – Speed Cast International Limited, a leader in the field of network service from the perspective of a stakeholder, say the Shareholders of the company.
The leasing standard has been changed due to the reason that the earlier model required to classify the lease into operating lease and finance lease but did not require the lessee to show the leased asset and its liability in its financial statements in case of the operating lease (AASB, 2016). Due to this the users and stakeholders of the financial statements of the lessee were not finding a satisfactory presentation of the lease transactions in the financial statements of the lessee in case of an operating lease. Hence the concerned boards have decided to make the requisite amendments to the leasing standards (Porter & Norton, 2014).
The change will be that the lessee will have to record the right of use of the asset in the balance sheet and consider it as a depreciable asset and also show the obligation to pay off the lease payments as liabilities in the balance sheet (Northington, 2011). Further, the depreciation of the said asset and interest on the lease payments shall be disclosed in the income statement.
The above said changes will have an impact on the net incomes shown in the income statement of the lessee as the interest on lease payments as well as depreciation will be added to the expenses in the income statement. Hence the net incomes will get reduced. Such as reduction in net distributable incomes shall affect the shareholders of the company as the distributable profits will reduce and thus the earning per share will reduce. Therefore, it will impact the wealth of the shareholders since there will be a reduction in the profits of the company.
The benefits to the shareholders will be that after the new lease standards are adopted, the shareholders will have a transparent picture of the lessee company’s financial leverage and capital employed and as such a better comparison can be made as to in which company they should invest further. The decision-making ability of the investors will undergo an immense change. The disadvantage shall be the reduced portion of their profits in the form of dividends and also a reduction in total equity.
First, we shall ascertain the effects of the new standard on the lessee company’s financial statements that is Speedcast International Limited. The changes in the recognition of lease effects will change the related ratios such as net profit ratio which was 2.70 % for the year ending December 2016, Net Leverage Ratio which was 8.67% and other such ratios (Melville, 2013). The N.P Ratio will decline due to increase in the interest and depreciation expense. The Net Leverage Ratio will show an increase due to rise in borrowings which are the lease payable (Speedcast International Ltd, 2016).
Other ratios such as interest coverage ratio, Earning per share will also show a downfall due to increase in expenses and decrease in net profits. When the expenses are on a surge and the
The effect on the stakeholder’s financial statements will be that as the earnings and dividends will reduce from the lessee company and such it will reduce the net profit of the stakeholders also. Further, due to a reduction in dividends and earnings per share, the market price per share may reduce and thus the total value of investments may reduce which is shown in the balance sheet.
When it comes to reporting regarding the environmental and social aspects such as energy use and efficiency, carbon emissions, etc of the leased assets, it should be the responsibility of that entity which has got the right to use that asset and is actually using it. The reason behind this is that as the asset is no longer in the hands of the lessor as the lessee has legally taken the right to use the asset and is using the asset for the business operations (Bodie et. al, 2014).
For our chosen stakeholder that is the shareholders, there are no regulatory requirements for such reporting as the lessee company is using the assets for its business use and the shareholders are not using the assets for their individual use.
Hence, the lessee should ensure that the society or the environments are not affected by the lease arrangement. For example- water or air pollution, soil erosion, cutting of the tree, emission of harmful gases, loss of jobs. This is required as this will adversely affect the society and environment which shall have long-term ill effects (Shah, 2013). On the other hand, if the lease arrangements give back advantages to the society, it will be advantageous in both short and long run for the owner or user as well. Hence, it will create a positive impact that will help the organization, as well as the society at large.
The overall reporting after the AASB 16 comes into effect shall be more beneficial and informative to the users of financial statements.
The changes in reporting and its use by the users of financial statements can be summarized in following points:
The new standard that will be effective from the year 2019 shall almost eliminate the reporting of the leases off balance sheet and the lease transactions will be shown on the balance sheet and income statement. Earlier and at present also the financial lease is shown in the income statement and balance sheet but the operating lease is being shown outside the financial statements in the notes to accounts (Libby et. al, 2011). The proposed change will help in redefining of the financial metrics such as the financial ratios like gearing ratio, and other such ratios (KMPG, 2016). It means that the effect of operating lease and their effect on the ratios will also be known to the users of financial statements. The benefit of this will be ease of comparison with other companies in the industry but the disadvantages are also there as the net profitability of the company will go down further affecting the creditability, the finance costs and also the perception of the stakeholders.
The users of the financial statement will better know the asset base of the company once this standard comes into effect as the assets that are being used by the company whether owned or leased will be reflecting in the balance sheet (Damodaran, 2012). At present the assets under operating lease are shown as off-balance sheet item (KMPG, 2016). The users are generally aware of the financial statements and do not go into in-depth study in the notes to accounts and other information.
The information regarding the net worth of the company, the existing borrowings, the profitability of the company and such matters are of utmost importance for the financial institutions from which the company seeks financial assistance (Parrino et. al, 2012). When the operating lease is not recognized in the financial statements although the right to use the asset is vested in the company, this does not give the correct picture of the financial position of the company to the financial institutions (KMPG, 2016). Hence with the implementation of the AASB 16, the financial institutions will have a clear image of the financial position before imparting any more loans and advances.
The users of the financial statements of the lessee will now determine whether they want to further invest in the company or not. This is due to the fact that the company shall show the interest and depreciation expenses in the income statement which will for sure bring down the profitability (BDO 2016). Further, this will impact the earnings per share/dividends to the shareholders and may be a reduction of the market price per share. This may result in a reduction in the number of investors of the company as they will start getting lower returns on their investments (Speedcast International Ltd, 2016).
The total concept of AASB 16 shall be summarized through following precise points:
As per the earlier and present standards on leasing, the leases are classified in the financial statements as operating lease and finance lease. With the coming of the new standard, all the leases will be recognized in the same manner and there will be no difference in the operating and finance lease with regard to their recognition in the financial statements (AASB, 2016).
The new standard will affect almost all the financial ratios such as gearing ratios or net leverage ratios, current ratio, asset turnover ratio, interest coverage, net profit/ margin ratio. Other financial metrics will also be affected such as EBITDA, Net Profits, earning per share, dividend per share, operating cash flows, etc (BDO 2016).
The changes in the standard will affect the perspective of the stakeholders of the company such as shareholders, investors, government, employees, financial institutions, etc. as there will be changes in the credit ratings, borrowing costs, net asset values, earnings per share of the company which directly or indirectly affect the stakeholders (Needles & Powers, 2013).
The implementation of the new standard will increase the total expenses of the lessee company as the lease rentals will be replaced by interest on the lease was taken as well as the depreciation on the right to use assets (Williams, 2012). The main effects will be that due to the large assets such as ships, aircraft, big machinery, etc. and not small assets such as computers, laptops, small equipment, etc
Conclusion
Going by the overall discussion it can be commented that the new standard will be highly beneficial to the organization and eliminate the lease reporting and will thereby appear on the balance sheet. Hence, a level of an enhanced transparency will be witnessed. From the amendment and updating point of view, it can be said that the new standard will altogether bring a vast change in the reporting mechanism in respect to the operating leases which was treated as an off-balance sheet item. Hence, the shareholders will be able to get a better grasp of the lease operations which was not possible earlier. Though there are certain problems but in totality the mechanism will be highly beneficial and bring widespread transparency.
References
AASB 2016, Leases, viewed 19 September 2017 https://www.aasb.gov.au/admin/file/content105/c9/AASB16_02-16.pdf
BDO 2016, New leases standard requires virtually all leases to be capitalised on the balance sheet, viewed 19 September 2017 https://www.bdo.com.au/en-au/accounting-news/accounting-news-february-2016/new-leases-standard
Bodie, Z., Kane, A. & Marcus, A. J 2014, Investments, McGraw Hill
Damodaran, A 2012, Investment Valuation, New York: John Wiley & Sons.
KMPG 2016, AASB 16: A fundamental overhaul of lessee accounting effective 2019, viewed 19 September 2017 https://home.kpmg.com/au/en/home/insights/2017/04/aasb-16-fundamental-overhaul-lessee-accounting.html
Libby, R., Libby, P & Short, D 2011, Financial accounting, New York: McGraw-Hill/Irwin.
Melville, A 2013, International Financial Reporting – A Practical Guide, 4th edition, Pearson, Education Limited, UK
Needles, B.E. & Powers, M 2013, Principles of Financial Accounting, Financial Accounting Series: Cengage Learning.
Northington, S 2011, Finance, New York, NY: Ferguson’s.
Parrino, R., Kidwell, D. & Bates, T 2012, Fundamentals of corporate finance, Hoboken, NJ: Wiley
Porter, G & Norton, C 2014, Financial Accounting: The Impact on Decision Maker, Texas: Cengage Learning
Shah, P 2013, Financial Accounting, London: Oxford University Press
Speedcast International Ltd 2016, Speedcast International Ltd Annual Report & Accounts 2016, viewed 19 September 2017 https://www.speedcast.com/speedcast-reports-full-year-2016-results/ ‘
Williams, J 2012, Financial accounting, New York: McGraw-Hil
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