Australian financial reporting is poised to experience the biggest upheaval since Australia adopted International Financial Reporting Standards (IFRS) in 2005. Are you ready?

The introduction of three new Australian accounting standards will significantly change the financial reporting landscape for how entities recognise revenue, account for financial instruments and how lessees account for operating leases. These changes come into effect between now and 2019 and raise a plethora of issues for organisations in every industry sector.

New revenue standard, AASB 15 Revenue from Contracts with Customers

AASB 15 fundamentally changes the financial reporting landscape for how entities recognise revenue by introducing a five-step model to determine when to recognise revenue and at what amount. The core principle of AASB 15 is to recognise revenue to depict the transfer of promised goods or services to customers, in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. AASB 15 determines that an entity recognises revenue in accordance with the core principle by applying the following five steps:

The new AASB 15 raises many questions such as:

🔺How will the amount and/or timing of revenue recognised be impacted?

🔺How will current agreements be affected?

🔺Which processes and systems will need changing?

🔺Which wider business planning activities will be affected?

🔺What staff training will be required?

AASB 15 applies to annual reporting periods beginning on or after 1 January 2018. Earlier application is permitted. The date of initial application is the start of the reporting period in which a vendor first applies AASB 15. AASB 15 is applied retrospectively either to:

🔺Each prior period presented in the financial statements in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors with a choice of three practical, expedients, or

🔺The current period with a cumulative effect adjustment.

New leases standard, AASB 16 Leases

The current accounting treatment of operating leases in the records of lessees is well understood and quite simple. Currently operating lease payments are recognised as an expense on a straight-line basis over the lease term. However, the brand new AASB 16 is changing that. AASB 16 introduces a single lessee accounting model (all leases, finance and operating leases, will be accounted for in the same way) and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of ‘low value’. A lessee will now be required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments. Assets and liabilities arising from a lease are initially measured on a present value basis. As a consequence, a lessee recognises depreciation of the right-of-use asset and interest on the lease liability.

The new AASB 16 is expected to have a negative impact on lessees’ profit before tax in the initial years of an operating lease, because the current even operating expense over the period of the operating lease will be replaced by depreciation of the leased asset (capitalised right-of-use asset) and an interest expense on the lease liability, which will decrease over the period of the lease as the capital amount of the lease liability is repaid.

The new AASB 16 will lead to an increase in assets and liabilities in the lessees’ statement of financial position due to the initial recognition of a right-to-use asset (which will be depreciated over the useful life of the right-to-use asset) and a lease liability (which will be repaid over the period of the lease through lease instalments). It should also be noted that the right-of-use asset would be recognised in the statement of financial position of the lessee as a non-current asset, whereas the lease liability will be split into a current and non-current liability. This could potentially impact the bank covenants of an organisation, as well as other key financial ratios, which are based on net current assets.

In some cases, the recognition of both a lease asset and lease liability will have no economic implications for a lessee. Nevertheless, as with the potential impact on reported profits, lessees should be considering the potential impact of AASB 16 on, for instance, any loan covenants, profit or loss, earnings before interest, tax, depreciation and amortisation (EBITDA) and/or management compensation arrangements they might have in place in 2019 and beyond.

AASB 16 is effective for periods beginning on or after 1 January 2019. Entities may adopt the standard earlier, but if they elect to do so, they must also adopt AASB 15 as there can be significant interactions between the two standards. An entity is permitted to follow one of two approaches in adopting AASB 16, the retrospective approach or the modified retrospective approach. Given the broad impact of AASB 16, significant transitional exemptions and simplifications are available to entities.

New financial instruments standard, AASB 9 Financial Instruments

The objective of the new standard is to simplify the accounting for financial instruments.

This new standard applies to financial instruments including, cash, trade receivables, trade payables and investments in shares. The standard introduces significant changes to:

🔺the classification and measurement of financial instruments,

🔺how impairment losses are recognised; and

🔺the rules around qualifying to apply hedge accounting.

AASB 9 sets out a new ‘expected loss’ impairment model for those financial assets and will replace the existing ‘incurred loss’ model in AASB 139 Financial Instruments: Recognition and Measurement. Under AASB 9, the impairment model is more forward looking, in that a credit event (or impairment ‘trigger’) no longer has to occur before credit losses are recognised. For financial assets that are measured at amortised cost or fair value through other comprehensive income, an entity will now always recognise (at a minimum) 12 months’ expected losses in profit or loss. Lifetime expected losses will be recognised on assets for which there is a significant increase in credit risk after initial recognition.

At initial recognition of the financial asset, an entity recognises a loss allowance equal to 12 months’ expected credit losses, which consists of expected credit losses from default events possible within 12 months from the entity’s reporting date. An exception is purchased or originated credit impaired financial assets.

The recognition of impairment and interest revenue) is summarised in the table below:

The effect of adopting the new financial instruments standard raises many questions such as:

🔺How will reported results be impacted?

🔺Which financial assets need to be recorded at fair value?

🔺Which processes and systems will need changing?

🔺Should the standard be adopted early?

🔺Which wider business planning activities will be affected?

🔺Should this trigger an assessment of the entity’s risk management strategy (including hedging and hedge accounting)?

🔺What staff training will be required?

🔺How will current agreements be affected?

AASB 9 applies for annual reporting periods beginning on or after 1 January 2018. Early application is permitted. The new requirements apply retrospectively, which is consistent with the requirements in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. However, there are some special transition rules and concessions that are available.

Recommendation

Organisations should now begin to consider how to prepare their financial statements using these three new accounting standards. The changes can be complex and can have impacts beyond just the accounting. When adopting these ‘triple threat’ new accounting standards, including deciding which transition route to apply, organisations need to consider the commercial and practical impacts of the changes in their accounting. As the choices made by organisations will affect the way the performance of their business is measured and reported, it is vital to consider not only the commercial and practical issues, but also any tax impacts of these changes.

Aletta Boshoff is the IFRS Advisory Partner at BDO Australia