Preparing for AASB 16 Leases
Australian Government departments and agencies will be required to apply the new accounting standard for leases for the 2019-20 financial year. The new standard AASB 16 Leases requires much more data to be captured as well as having significant implications for a broad range of agency systems and accounting policies.
Context
Accounting standards issued by the Australian Accounting Standards Board (AASB) apply to annual financial statements for Commonwealth entities and the Australian Government Consolidated Financial Statements (CFS) under paragraphs 42(2)(a) and 48(2)(a) respectively of the Public Governance, Performance and Accountability Act 2013 (PGPA Act).
The AASB has introduced AASB 16 Leases, removing the distinction between operating and finance leases for lessees and requiring the recognition of a right-of-use (ROU) asset and lease liability on the balance sheet for most leasing arrangements. (1) The new standard is effective for periods on or after 1 January 2019. For most Commonwealth entities, the initial application of AASB 16 will be for the 2019-20 financial year.
Impacts
The elimination of nearly all ‘off balance sheet’ accounting for leases by lessees will require the capture of more data than under the previous standard (AASB 117) with impacts for different systems operated within various areas of an entity.
This will include former operating leases from buildings to potentially smaller leases such as motor vehicles through to multi-function printers.
The application of the new standard will result in leases being recognised as ‘right of use assets’ through the statement of financial position, with depreciation and interest expenses being recorded in the statement of comprehensive income.
Entities need to assess the impact of the standard on their systems and controls as a matter of priority. The changes are expected to be far reaching and will need to be assessed at an early stage to ensure data is available for entry into the 2019-20 portfolio budget statements (2) and full compliance by the initial application date of 1 July 2019.
Prior to preparing transition plans, entities should first update their accounting policies. Due to the number of significant management decisions that are required to be documented prior to commencing transition planning, this should involve senior management. Areas to be considered include the selection of a transition approach, identification of the incremental rate of borrowing, the setting of a low value lease threshold and choosing whether to exempt short term leases. (3)
The Department of Finance issued “Finance Position Paper: Implementation Options for AASB 16 Leases” in June 2018. This paper sets out the nine transition options available for the initial application of AASB 16 and seven non-transition elections related to general requirements.
What does this change mean?
To explain the change, here is a worked example of an office lease to illustrate the impact of the new standard.
- Lease for office accommodation
- Lease commencement: 1 July 2016
- $950,000 per annum
- Lease term: 10 years + two 5-year option periods (we assume for this example that the lessee is reasonably certain to exercise the first option period)
- Lease incentive: First 3 months’ rent free
- Rental increases: Fixed rate increases of 3.75% per annum
- Incremental borrowing rate: 2.7% (using the Commonwealth Government 10-year bond rate as at 30 June 2018 for illustrative purposes)
- Estimated makegood provision at the end of the first option period: $650,000
Under the existing leasing standard, AASB 117, the above example would have been straight-lined with an operating lease expense being recorded each year of $1,229,018.
Under the new leasing standard AASB 16 and using the modified model required to be applied by the Department of Finance, a right of use asset and lease liability is required to be recognised with a right of use depreciation charge and a lease liability expense being recorded as expenses.
The table below provides an illustration of this impact for the 30 June 2020 year:
| Under AASB 117 | Option 2 AASB16.C8(b)(i) |
Option 3 AASB16.C8(b)(ii) |
||
|---|---|---|---|---|
| Income Statement | ||||
| Operating lease expense | 1,229,018 | |||
| Right of Use Asset depreciation | 1,019,322 | 1,032,339 | ||
| Makegood depreciation | 28,915 | |||
| Lease liability interest expense | 349,053 | 349,053 | ||
| Makegood interest expense | 12,856 | 12,856 | 12,856 | |
| Total expense | 1,270,790 | 1,381,231 | 1,394,248 | |
| Balance Sheet | ||||
| Right of Use Asset – Cost | 15,289,827 | 12,302,036 | ||
| Right of Use Asset – Accum Deprec | (4,077,287) | (1,032,339) | ||
| Makegood Asset | 318,070 | |||
| Lease Liability | (12,540,703) | (12,540,703) | ||
| Makegood Provision | (483,140) | (483,140) | (483,140) | |
| Straight-Lined Lease Accrual | (1,134,443) |
What does this mean for government agencies?
- Government agencies need to assess the impact of the new standard on their systems and controls as a matter of priority.
- Senior management needs to be actively engaged as significant management decisions need to be made prior to transition planning.
- Accounting policies will require review and updating.
- Transitional plans need to be prepared to manage the change process.
For more information, contact Adrian Kelly, Partner, Charterpoint, email adrian.kelly@charterpoint.com.au
- Finance Position Paper, Implementation Options for AASB 16 Leases 2017-18 No.01, Version 1.0 June 2018..If required by the Department of Finance.
- If required by the Department of Finance.
- The Auditor-General ANAO Report No.47 2017-18 Financial Statements Audit: Interim Report on Key Financial Controls of Major Entities.