ACCA Strategic Professional · Strategic Business Reporting (International) · Leases
Orbis plc has a lease liability of $600,000 and loan covenants requiring gearing (debt/equity) not above 50%. Equity is $1,300,000 and existing borrowings are $100,000. The finance director proposes to treat a new 8-year property lease as an operating expense with no recognition, to stay within the covenant, although the lease is not short-term or low-value and has fixed payments. What is the most appropriate response under IFRS and professional ethics?
The lease must be recognised under IFRS 16 because no exemption applies, and the accountant should challenge the proposal as misleading reporting that breaches integrity and professional behaviour. Including the lease takes gearing to about 54%, above the covenant, but that pressure does not justify off-balance-sheet treatment.
- AAccept, because covenant compliance justifies keeping the lease off balance sheet
- BRecognise the lease under IFRS 16, and raise the concern as the proposal is intended to mislead; accountants must not be associated with misleading informationCorrect
- CRecognise only the interest as an expense and disclose the capital in the notes
- DAccept if the auditor is informed verbally
Explanation
No IFRS 16 exemption applies: the lease is long-term, not low-value. Omitting it would misstate liabilities, and the professional accountant's fundamental principles (integrity, professional behaviour) prohibit association with misleading information. Gearing including the lease would be 700/1,300 = 54%, above 50%, which is the motive. Covenant pressure does not justify non-compliance.
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