AASB 16 leases: What is the impact?

Under the new leasing standard, entities will be required to recognise on the balance sheet the liability relating to all leases (including those formerly classified as operating leases) along with associated right of use assets (ROUs) for each of these leases.

What options do we have for implementing the new standard?

There are three transition approaches open to entities:

1. Fully retrospective whereby adjustments are made as if AASB 16 had always been in force
2. Modified retrospective whereby the new standard is recognised only from the beginning of the current period and cumulative effects are recognised in brought forward reserves
3. Modified retrospective (as above) with practical expedients.

What are the practical expedients?

The main practical expedient which is expected to appeal to preparers is the option to recognise ROUs at the value of lease liabilities at the start of the current period. Many preparers will find this useful as it removes any requirement to revisit assumptions from before the date of transition.

Another key expedient is that which allows entities to ‘grandfather’ previous assessments around leases. Under this provision, entities can elect not to reassess contracts at the transition date that were previously assessed as not being (or containing) leases.

Practical example

While the modified retrospective approach with practical expedients is the easiest of the three approaches to implement, it is undoubtedly the one that most reduces comparability of information in both current and future periods. As such, Boards should consider all of the options available as part of their impact assessment process before deciding on which route to take.

This can be illustrated with a simple example. Take a 20-year building lease, with annual payments of $1.2m, an implied interest rate of 7% which commenced on 1 January 2005. Assuming that the ROU is depreciated evenly over the term of the lease, the transitional impact on the balance sheet at 30 June 2019 could be any one of the following:

It becomes evident from this example that the transition options can give vastly different results. Note firstly that where practical expedients are applied, the value of the ROU is $1.9m greater and so there will be an additional charge of $1.9m to depreciation over the remaining term of the lease. The above example assumes that depreciation is charged evenly over the term of the lease, but this may be on a reducing balance basis for some leases.

Secondly, it is worth considering that while depreciation and interest charges will be shown in the comparative profit or loss under the fully retrospective approach, this will not be true for the modified approach and so current and comparative periods will not be comparable.

It is also worth considering that the example assumes that the discount rate used in all cases is the same. However, under the fully retrospective model, the incremental borrowing rate would be used at transition versus the rate implicit in the lease for modified retrospective. Where lease terms are long or company circumstances have changed drastically, this might result in considerable differences.

What can PKF do?

PKF has developed a tool to help entities not just in identifying the initial financial impact of the new standard at the transition date, but also to assist with the ongoing reporting requirements of entities.