International Financial Reporting Business Estate Industry

Question: Describe about the International Financial Reporting for Business Estate Industry. Answer: a. Impacts Of Ifrs 16 On Real Estate Industry- S P Setia Berhad Group The key impacts expected to be witnessed by S P Setia Company As A Result Of IFRS 16 includes the following. From a perspective of a lessor's P Setia being in real estate industry might experience an increase in its operational costs as a result of revised lease terms by lessees. This is because there is an anticipation of the existing lessees to negotiate their lease terms ,to be short term and include more variables costs , in an endeavour to mitigate the adverse effects of reporting on their balance sheet. Therefore, a shift in trend will see S P Setia profits margins being affected negatively as a result of transferring the variable cost burden to them by lessees(EarnestYoung, 2016) Another notable effect in S P Setia company will be a shift from its existing leasing business currently valued at $ 7,117,543.00 million to the business of real estate selling . The expected increase in operational cost may make S P Setia find leasing business unattractive and reconsider the business of selling which is not characterised by increased operational cost (Natalie Tatiana Churyk, 2015). Real estate industry which S P Setia operates in is also expected to experience a shift in demand by lessees from leasing premises to owning . Lessees might find leasing unattractive as a result of the identified distortions of fundamental ratios is their balance sheet as a result of the adoption of IFRS 16 (IFRSFoundation, 2016) As a result of a shift in business, S P Setia will also experience a drop in its non-current assets by -93% as a result of the classification of the existing underlying lease assets into Current assets . Current assets will increase by 81% (appendix 1). This will, in turn, make S P Setia company liquidity ratios to raise as a result of a change in business .For example, current ratio will rise by 157% (Appendix 2). However, the increase in a current ratio of S P Setia to 352% from the current 194% (appendix 2) may not be sustainable in the long-run since the expected high demand for real estate purchases might only be experienced at the inception of the standard (Karen Wong, 2015). Also, the shift in business patterns by both S P Sitia and its lessees could trigger an increase in lease costs. This is because S P Sitia will need to cushion itself against increased operating costs resulting from the changes. This will make the companies in real estate who are the lessor to adjust prices upwards for them to accommodate the new lease terms anticipated (EarnestYoung, 2016). S P Setia and other companies in real estate will not be affected by the IFRS 16 directly as most of them are lessors in lease agreements. However, their key customers will be affected by the standard hence triggering the effects identified above the industry . (Natalie Tatiana Churyk, 2015) b) Impacts Of Ifrs 16 On Financial Services-Hong Leong Bank Berhad The key fundamental ratios in HLBank like CET 1 and Tier 1 which are currently at 11.147% and 12.297% will reduce to 10.20% and 11.32% respectively when the operating leases are introduced to the balance sheet (Appendix 3). This indicates that IFRS 16 will have to reduce the two capital ratios of banks with considerable operating leases. This will in turn trigger the banking regulators to demand additional capital from the bank if the reduction in core capital goes below the minimum required rates. For Example, the minimum required CET 1 and Tier 1 capital in Malaysia for a bank like HLB is 4.5% and 6% respectively(EarnestYoung, 2016). HLBank will be necessitated to change their risk appraisal processes currently in place in order to accommodate their customers who are adversely affected by the IFRS 16. This is because some class of HLBank customers who have operating leases in their books will experience distortion of their fundamental risk ratio like , gearing ratios ,which will make them not to qualify for loan facilities as per the current credit appraisal processes(Lindstedt, 2012). This will make the affected customers negotiate their existing debt covenants with the banks in order to mitigate the balance sheet effects of IFRS 16(Karen Wong, 2015) Due to this negotiation by lessees , HLBank can end up losing some considerable part of their returns attributable to the leases. This is because affected customers might demand low rates in an attempt to minimise the balance sheet effects . In addition, HLBank can end up loosing interest income from its current lease portfolio valued at RM 678,579 million if those customers consider the finance lease unattractive. Therefore, adoption of IFRS 16 will lead to HLBank and its industry peers to lose an important portfolio in their current finance lease or end up accepting low rates on the loans in order to maintain the portfolio(EarnestYoung, 2016) The banking industry is known for operating in leased premises in an attempt to free up working capital. This has been the practice and HLBank is not an exception for it holds RM 16,084,000 in operating leases in its balance sheet. This norm is anticipated to change with the adoption of IFRS 16 as HLBank will opt an alternative to existing operating leases which will minimise the adverse effects of the standard in their books. This alternative will involve owning the banking halls, negotiating with the service providers for separation of none-lease components from the main lease which will lead to fewer assets and liabilities as compared to long fixed term leases. Finally, they may negotiate with service providers for a variable payment which will reduce the adverse effects on their balance sheets(EarnestYoung, 2016). The banking industry has been using Sale and leaseback operations as a soft means of financing without recognising them in their books of accounts. This aspect has been facilitating banks to play around with its core capital ratios in order to comply with regulatory minimum requirements. This will no longer be attractive to banks/ lessees as IFRS 16 now mandates both parties is sale and leaseback arrangements to recognise the transactions in balance sheets. Therefore , IFRS 16 will be anticipated to reduce the number of sale and leaseback transactions significantly in the banking industry (EarnestYoung, 2016). c) Impacts Of Ifrs 16 On Airline Airasia Berhad An earlier research which was done had indicated that Airline industry will be the second highly affected industry by IFRS 16 (PWC, 2016). AirAsia will experience an abnormal increase in its leverage ratios as a result of the adoption of IFRS 16 (appendix 4). This is because AirAsia will be required to adjust its balance sheet assets and liabilities by RM 94,534,585 currently reported as off-balance sheet item. This shift will lead abnormal growth in assets value and liabilities by 443.49% and 560.52% (appendix 5) respectively in the AirAsia books (PWC, 2016) .This will lead to an abnormal increase in risk measure of AirAsia (appendix 4) making it look less attractive to various stakeholders like potential investors, lenders, creditors among others(Patricia Sandblom, 2015) Another significant effect is on EBITDA of AirAsia Company which will be expected to increase as a result of increased finance cost, amortisation and depreciation as preparers of financial statements will be required to report lease rentals as separate components of interest on lease liability and depreciation / amortisation of right of use assets (Appendix 6). Finally , AirAsia ROCE which is a key performance ratio in the airline industry will improve significantly as EBITDA will increase as a result of the adoption of the standard (appendix 4).It is used to measure efficiency on invested capital in the firm(Deloitte, 2016) AirAsia will also be necessitated to review its current business process and strategies to avert the negative effects in its books as a result of adopting IFRS 16 as follows. The company will consider reducing the current lease terms of Aircraft in order to reduce the liabilities therein(appendix 5). This is because shorter lease terms will see fewer liabilities recognised in their balance sheet hence controlling the leverage levels associated with increased liabilities. Also, AirAsia will start to negotiate their existing leases terms to have their big portions of their lease to be based on flying hours . In such cases, the contract will not amount to lease (where payment of lease rentals are based on flying hours) hence will end up mitigating the effects of increased liabilities and assets considering how significant AirAsia engage in lease of expensive aircraft(Deloitte, 2016) It can be observed that AirAsia lease contracts are dollar denominated . This will significantly be affected by foreign currency volatilities which would lead the company to forex losses in AirAsia income statements when making the interest payments and when translating the liabilities and assets into a functional currency(RM).To minimise this, AirAsia will need to negotiate with its suppliers of aircraft to keep the lease agreement on RM currencies(Natalie Tatiana Churyk, 2015).However, although AirAsia suppliers will not be affected by the IFRS16 ,they will also need to reconsider changing their business processes to accommodate the change in leasing trends expected in the airline industry .They will re-evaluate the business implications as a result of revised lease terms as for example AirAsia may opt for lease contracts based on flying hours , this will lead to an increase in their operational cost hence reducing their profits margins(PWC, 2016) References AirAsia, 2016. Annual Report 2015, s.l.: AirAsia Berhad. Deloitte, 2016. IFRS industry insights-Aviation sector - the implication of the new standard. IFRS 16-implication of the new standard, pp. 1-2. EarnestYoung, 2016. Applying IFRS 16 in Financial services. Applying IFRS 16 in Financial services, 1(1), pp. 1-13. EarnestYoung, 2016. Applying IFRS 16 In Financial services. Applying IFRS 16 In Financial services-IASB issues a new leases standard, pp. 1-18. HLBank, 2016. 2015 annual Report, Kaula Lumpur: Hong Leong Bank Berhad. IFRSFoundation, 2016. IFRS 16 leases. IFRS, pp. 1-20. Karen Wong, M. J., 2015. The Impact of lease capitalization on financial statements and key ratios :Evidence from Australia. Australasian accounting,Business and Finance Journal, 9(3), pp. 24-44. Kumbirai, M., 2010. A Financial Ratio Analysis of commercial Bank Performance in south Africa. Africa Centre for economics and Finance, pp. 30-53. Lindstedt, L., 2012. Consequences of the new lease standard, s.l.: Goteborgs University. Natalie Tatiana Churyk, A. R. H. L., 2015. Leasing: reducing the game of hiding risk. Journal of accounting and organisational change, pp. 162-174. Patricia Sandblom, A. S., 2015. The value Relevance of the proposed New leasing standard, s.l.: University of Gothenburg. PWC, 2016. In the spotlight-Impacts of IFRS 16 to Airlines. IFRS 16 -Leases, pp. 1-10.