3 recent changes to accounting standards that every CFO should be across
Do you prepare financial reports on the General Purpose Financial Reporting basis? Then you need to be across three recent changes to accounting standards announced by the AASB.
The following key changes will impact how you prepare your reports and are described in more detail below:
- AASB 9 – Financial instruments
- AASB 16 – Leases
- AASB 15 – Revenue from contracts with customers
AASB 9 – Financial instruments
The first recent change to accounting standards concerns financial instruments.
Many professionals think that that when they work in a non-financial company (such as a manufacturer, retailer, service company, etc.), they don’t have to worry about “financial instruments”, as they have none.
The reality is that every single company has some financial instruments in its accounts. For example, trade receivables.
Among the various changes to accounting standards in AASB 9, the major one that will affect most organisations is the new impairment model that is prescribed by the standard: specifically, the new credit loss model is based on EXPECTED losses instead of incurred losses.
AASB 9 prescribes the following three impairment models:
Under the general approach, a financial instrument moves through three stages as its credit risk deteriorates. Each stage determines how the loss allowance for credit losses is measured.
In terms of the simplified approach you don’t have to determine which stage the financial instrument is in.
The loss allowance will be based on the lifetime expected credit losses on every reporting date.
This change allows entities to use practical expedients to measure expected credit losses, provided such methods are consistent with AASB 9. For instance, a provision matrix based on historical observed default rates over the expected life of the trade receivables to determine lifetime expected credit losses on trade receivables.
AASB 16 – Leases
Off-balance sheet financing is when assets or debt are NOT SHOWN in the company’s balance sheet.
Operating leases were a perfect example of this because, although the contract may say that a company leases an asset from another company, the contract’s conditions may, in fact, be very similar to purchase.
AASB 16 seeks to eliminate the risk that organisations will end up in off-balance sheet financing.
What are the implications of this change to accounting standards?
Initial measurement:
I. An entity obtaining a right to use and asset (right-of-use asset) at the commencement of the lease;
II. A corresponding lease liability (similar to how finance leases of lessees were treated under AASB 117).
The right-of-use asset and the lease liability will initially be measured on a present value basis. The lease payments shall be discounted over the lease term using the interest rate implicit in the lease, if that rate can readily be determined. If this rate cannot be readily determined, the lessee shall determine its own incremental borrowing rate.
Peppercorn leases – Initial recognition and measurement (AASB 1058)
AASB 1058 Income of Not-For-Profits has been recently released. A key feature of this is that an asset should be recognised at fair value where the consideration paid is less than fair value. This concept means that right-of-use assets under peppercorn leases must now be recognised at their fair value.
Where not-for-profit agencies enter into leases at below-market lease terms and conditions:
- Recognise a right-of-use asset and measure it at fair value in accordance with AASB 13 Fair Value Measurement (para Aus25.1); and
- Recognise a lease liability measured in accordance with AASB 16; and
- Recognise any difference between the carrying amount of the right-of-use asset and the lease liability as income in profit or loss statement (AASB 1058 para 10).
Subsequent measurement:
- The right-of-use asset will be treated similarly to other non-financial assets; for example, depreciate the right-of-use asset and test for impairment; and
- Measure the lease liability similarly to other financial liabilities; for example, reflect interest on the lease liability and deduct lease payments to reflect the capital redemption portion when the payment is made.
Therefore, no rental expense will be recognised in the statement of profit and loss. The rental expense will be replaced by the depreciation and interest expenses.
AASB 15 Revenue from contracts with customers
The third recent change to accounting standards concerns accounting for revenues: one of the hottest issues in the finance world.
Why? Because companies like to manipulate profits by either overstating or understating revenues!
This is partially due to intentional manipulation but also because of insufficient guidelines and rules relating to revenue recognition.
That’s the reason why AASB 15 is here. It’s good news. It identifies a five-stage process to follow in recognising revenue:
Although it’s one of the most important accounting standards to master, it’s NOT easy. In fact, it’s very complex and very challenging to implement in practice.
It would be wise to seek assistance from an accounting professional to assist you with the implementation.
Contact us if you need assistance with adapting to any of the recent changes to accounting standards.
