By Jon Griffin, Director of APL Financial
The article in July’s 2019 CPA magazine In The Black, “Peppercorn leases: the lowdown on AASB 16 and AASB 1058” proved just how out of touch the Accounting Standards Board is.
Hopefully the Accounting Standards Board will come to their senses, stop dreaming and cancel AASB 16 Leases.
For those that missed the article or are unaware of AASB 16 Leases, in summary peppercorn leases are to be recorded at its market price value.
Peppercorn lease arrangements occur when the landlord reduces the rent payable to an amount much lower than the market price
· Lease on premises signed on 1 July
· The market price value rent for the premises is $100,001 pa
· 5 year lease
· The peppercorn annual rent is $1 pa
In year 1 $500,000 will be brought on to the balance as an intangible asset and $500,000 will be booked to the profit and loss statement as income.
$100,000 is recognized as a rental expense in year 1 and the intangible asset is reduced by $100,000.
The net effect of applying AASB 16 leases is in the first year to increase net operating profit by $400,000 ($500,000 - $100,000) and then for the next 4 years reduce the net operating profit by $100,000 pa.
The release of AASB 16 Leases suggests the Accounting Standards Board does not understand the purposes of financial statements and does not understand the basis on which accounting financial statements are prepared.
Maybe those learned people who sit on the Accounting standards board need to get out of their ivory towers, prepare a set of financial statements, present and explain those financial statements to management and shareholders.
The primary purpose of financial statements is to summarize the operations of an entity for a particular period so first of all management and shareholders can make informed decisions about the future.
The application of AAS 16 Leases distorts the annual financial result by increasing the operating net profit by $400,000 in year 1 and then reduces operating profit in the future years by $100,000. How is this distortion useful information?
For not for profit entities the application for AAS 16 is confusing and misleading. The organization will show an operating profit overstated by $400,000. The organization does not have an additional $400,000 to spend on its community and does the Accounting Standards board have any comprehension of the time involved in trying to explain the purpose of recognizing the $400,000 and how it improves periodic reporting.
For the for profit entities, if management does a great deal with the landlord and can bargain the rent down then so be it and by ignoring ASS 16 Leases that gain is reflected through the profit and loss statement as reduced rental expense. Once again how does the application of AAS 16 Leases improve the annual reports.
There is a much more important basic accounting concept which the Accounting Standards Board obviously does not understand and that is, all financial statements are prepared on the basis of price paid for goods and services and contracts entered into.
Many accounting standards refer to “value” however when they refer to value they actually mean price. For example, according the accounting standard, stock needs to be recorded “at cost or net realizable value whichever is the lowest” when in fact a better description is “at cost or net realizable price whichever is the lowest”.
Value and price are not the same and until the accounting standards board comes to grips with this issue it will continue to release Accounting standards which make financial statements more confusing and harder for the reader to understand.
There is a place for value reporting within the accounting framework however it is not in the current set of financial statements which we produce. Mixing value and price in the same set of financial statements will just confuse accountants and confuse stakeholders who rely on those financial statements.