The Impact of a New Accounting Standard to an Entity

Recently, as sudden business headlines occur upon the news, New accounting standard
tweaks hit PAL, forcing their profits to ram down. Just an overview, November 16, 2019, the
flag carrier Philippine Airlines Holdings, Inc. (PAL) catch sight of downfall of its operation on
its financial reports. One fundamental knowledge that I have learned in my business finance
subject is that not all transcending and increasing net profits signifies a profitable operation there
is, but thorough analysis must be made in order to put together what really those financial
statements tries to encapsulate because ratios don’t lie. As a result, despite the revenue inflow of
PAL on its nine-month operation resulted to increase and considering their expenses are stable,
with the application and adoption of the new Philippine Financial Reporting Standard 16, tables
have turned.

So, how did these happened? Lease or rent contracts are common arrangements for
companies to access and control assets without the need for significant cash outflows at the time
of acquisition. Accordingly, most, if not all, companies would be affected by the new accounting
standard on leases. A company can thus lease in one of two ways (capital leasing or operating
leasing). Capital leases can be simply related on taking out a loan to purchase a car, payments are
made periodically and at the end of the term, the asset is owned therewith. On the other hand,
operating lease do not transfer ownership and payments are made only for the usage of the asset.

Prior to the adoption of PFRS 16, it is required that the assets and liabilities associated
with the capital leases must be on the company’s balance sheet. So, technically these leases are
recorded under the PP&E while the lease liabilities were recorded in debt or other liabilities. On
the other hand, operating leases, both an asset and a liability, are not reported on the entity’s
balance sheet. Hence, currently, rental fees are recognized in the financial statements as expense
over the term of the entity’s lease agreement and only requires a disclosure on their notes to the
financial statements. Furthermore, one of the prominent changes introduced by PFRS 16 is the
recognition of the lease contract on an entity’s balance sheet. It requires the recognition of an
asset (representing the usufruct of an entity to the asset) with the corresponding liability
representing the liability to the owner of the asset (representing the debt for the use on the asset).
 Going back to my concern, how does this change in accounting standard affects an
entity? In conclusion, (PAL) Philippine Airline Holdings Inc., currently undergoes 52 planes that
are under an operating lease (just as half of its count of fleet amounting to 98 aircraft). As the
reporting entities are three-quarters away from the new standards date of effectivity, drastic
changes required by PFRS 16 should have had them understand and assess its impact on to what
their financial reports could be. For companies like PAL that clenches on large volume of lease
of operating contracts, repercussions are deemed expected as the possibility could be, such as
having the option to extend the lease term or determining the implicit interest rate on the lease
arrangement.

Consequently, based on my findings, prior to January 1, 2019, PAL Holdings Inc., value
of share was stable as it can be (Figure 1), but after the few weeks of the new accounting
standard’s adoption, present and prospective investors jumbled their analysis and assessment,
thus selling their respective shares and performed profit taking as they have evaluated that with
the adoption of PFRS 16, PAL Holdings Inc., will tend to incur doubling losses and be bearish
on a certain moment of time. Eventually, as the time passes by, the value of PAL tends to be
declining amidst the rule on how leases should be reported affected them.

Therefore, it is clearly evident that a change in an accounting standard will surely mess
up everything that an entity has from top to bottom. Financial statements won’t show us the true
colors of an entity, thus there are still other variables to consider in evaluating their worth. As
show in Figure 2, the value of share of PAL Holdings Inc., continuously declines from the date
of adopting PFRS 16. But, the gist here is should we, as the user of these financial statements, let
the leases be the least of our concern? As modernization and government intervention rises up,
the need for these kind of update is not a piece of cake. It will always require human judgment
and logical thinking. And according to Manila Times, it may also be the time to reimagine the
possibilities of changing business models (from a traditional arrangement where companies take
control of the asset to a service model that effectively achieves the same objective).
Figure 1
 Figure 2

References:

Philippine Daily Inquirer.(2019). New accounting tweaks hit PAL, forcing profits to plunge.
Retrieved from: https://business.inquirer.net/283526/new-accounting-tweaks-hit-pal-forcing-
profits-to-plunge

Trainer, David.(2018 May 1). Impact of Operating Leases Moving to Balance Sheet. Retrieved
from: https://www.forbes.com/sites/greatspeculations/2018/05/01/impact-of-operating-leases-
moving-to-balance-sheet/#3afab02c5577

Arboleda, Aira Regina.(2018). New accounting standard on leases. Retrieved from:

https://www.manilatimes.net/2018/10/12/business/columnists-business/new-accounting-standards-
on-leases/451014/451014/

Investagrams.(2019). PAL Holdings Inc. (PSE:PAL). Retrieved from:

https://www.investagrams.com/Stock/PSE:PAL