With the introduction of AASB 16 Leases (effective from 1 January 2019) a new single accounting model now requires lessees to recognise almost all leases on the balance sheet.
This means lessees will no longer determine whether a lease is an operating lease or finance lease, and most leases will need to be capitalised in the balance sheet recognising a lease liability and a right-of-use (ROU) asset.
There is minimal change to how the lessor accounts for leases. The standard is applicable to charities preparing General Purpose Financial Statements and General Purpose Financial Statements with a Reduced Disclosure Framework.
Charities preparing Special Purpose Financial Statements should also consider whether application of this standard is appropriate to any leases, including leases of right-of-use assets, particularly where accounting for leases may be a material and significant accounting policy, to present a true and fair view.
Under AASB 16, charities will need to recognise their right to use an underlying asset as a ROU asset and represent their obligations to make lease payments as a lease liability.
As a lessee, charities need to measure the ROU asset similar to other non-financial assets and recognise depreciation of this asset. The lease liability needs to be measured similar to other financial liabilities and requires classification of both principal and interest portions of cash repayments.
Identifying a lease
A fundamental difference between the previous accounting standards and how AASB 16 applies is in identifying a lease.
Under AASB 16, a lease is how defined as:
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.
The contract must:Relate to an identified asset – where the asset is physically distinct or where the lessee receives substantially all of the capacity of the asset;Provide rights to obtain economic benefit from use – the lessee must have the right to receive substantially all of the economic benefit from the use of the asset; andProvide rights to direct use of the asset – the lessee must have the right to direct the use of the asset, or where use is predetermined, have the right to operate the asset.
Charities should note that short-term leases (12 months or less) or leases for low-value assets (such as office furniture and low value equipment) do not need to be recorded on the statement of financial position.
Management will need to exercise judgement in relation to how leases are identified. All types of contracts could be affected (including property and equipment leases which were previously ‘off-balance sheet’), and charities will need to apply judgement and develop accounting policies on how a lease is identified to ensure consistent application.
Initial recognition and measurement
When capitalising a lease on the balance sheet (as lessee), the lease will be represented by a lease liability and a new ROU asset. The lease liability is initially measured at the present value of the remaining lease payments, discounted using either the rate implicit in the lease agreement, or where that rate is not easily determined, using the charity’s incremental borrowing rate (for example, the interest rate that a charity would be given by a bank).
Over the lease term, the lease liability will need to be increased to reflect interest on the lease and reduced by the repayments, while the right-of-use asset will be depreciated.
Impacts to charity reporting
As all leases will now be considered finance leases (except for short-term and low-value leases), and will be added to the statement of financial position, there will be an impact to a charity’s key financial metrics such as Return on Assets (ROA).
The depreciation charges and interest expenses related to leases will also have an impact to the statement of profit or loss and other comprehensive income, where expenses for leases are front-loaded rather than being expensed on a straight-line basis.
For the purpose of the Annual Information Statement, interest expenses should be allocated under the financial line item ‘interest expenses’ (for large charities only) and depreciation allocated to ‘other expenses’.
Charities may also need to consider impacts to debt covenants, credit ratings and impairment testing. Management should not underestimate the effort, time and costs required to implement changes and should discuss these with their accountant.