AASB 16 is a new lease accounting standard published by the Australian Accounting Standards Board (AASB) in February 2016. AASB 16 changes the way that companies account for leases in their financial disclosures, especially their balance sheets and income statements. It replaces an earlier lease accounting standard – AASB 117. The purpose of AASB 16 is to close a major accounting loophole from AASB 117: off-balance sheet operating leases. The new Australian leases standard is heavily based off of IFRS 16, the international leases standard, and only varies on a few negligible details.
What is AASB 16?
Understanding the New Lease Accounting Standard for Australia
AASB 16 overview.
What is lease accounting?
The lease accounting standards define how companies must account for their leases – a specific type of contract that allows one party to use an asset of another party in exchange for consideration.
Leases may be for equipment or real estate and are classified as either operating or capital leases. However, a new lease accounting standard has been introduced that will change how companies account for leases.
Changes from AASB 117
AASB 16 removes the operating classification for leases, eliminating the ability of corporations to report operating leases in the footnotes of financial statements. The reasoning for the change was that when operating leases were reported in footnotes, corporate financial statements could be misleading about the true nature of a company’s liabilities. In response, after a decade of work writing and reviewing exposure drafts, the IASB released IFRS 16, and the AASB soon followed with AASB 16. AASB 16 closes the AASB 117 loophole by requiring that all operating leases now be accounted for as finance leases.
AASB 16 LEASE DEFINITION
Three criteria for a contract to qualify as a lease.
The definition of a lease has changed slightly. Under AASB 16, “A contract, or part of a contract, that conveys a right to use the asset (the underlying asset) for a period of time in exchange for consideration.” To qualify as right-of-use, the contract must meet 3 criteria:
1. Identified asset
There must be an identified asset. An asset can only be identified if it is physically distinct or if the lessee receives substantially all of the capacity of the asset. In addition, the lessor cannot have substantive rights to substitute the asset.
2. Economic benefit
The lessee must receive substantially all of the economic benefit. To determine what qualifies as “substantially all,” the parties must define the economic benefits of the asset and then determine the allocation of economic benefits.
3. Direct use of asset
The lessee must have the right to direct the use of the asset. If how the asset will be used was predetermined, the lessee must have the right to operate the asset or they must have designed the asset in a way that predetermines how it will be used.
Leases that are considered short-term (having a term less than or equal to 12 months in length) or low-value (the underlying asset’s value is less than or equal to $5000) do not need to be reported on the balance sheet.
Impacts to financial statements.
Impact to the balance sheet
Under AASB 16, a new right-of-use (ROU) asset will be presented separately on the balance sheet, as will a separate lease liability for almost every lease. All leases will now be considered finance leases unless they meet the low-value (less than or equal to $5000) or short-term (less than or equal to 12 months) exceptions. Key financial metrics such as Return on Assets will be influenced by the addition of these new assets and liabilities to the balance sheet.
Impact to the income statement
Companies must report a depreciation charge for leased assets within the operating costs section of the profit and loss statement. An interest expense must be reported for lease liabilities within the finance costs section of the profit and loss statement. Under the old standard, AASB 117, companies reported a straight-line lease expense that was typically the same in each period of the lease. With AASB 16, the expenses for leases will be front-loaded as the amount of interest is reduced over the term of the contract.