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1000 x 485_2

Business Transformations: Importance

Business Transformation continues to present challenges and disappointments more often than not.  There have been many books and publications those attempted to provide insight for business leaders (including management accountants) but we still struggle to improve business performance through transformation programs driven by ERP.  It typically isn’t a failure of one functional group rather paths to success have changed quite dramatically over the last decade or so.  There is no single approach to resolving these problems; success requires a coordinated program that involves multiple elements. This means evolving from a world that’s understood and organised by functions to where ERP applications have exposed the logical relationship b/w functions.  Most companies haven’t recognised this revelation, so they continue to attempt to resolve cross functional design issues from a functional mind set.

The Challenge:

Let’s take an example of receiving raw materials. Say, 20 years ago the material would arrive at the loading dock, and clerk would complete a paper form on which receipt will be recorded, showing material, PO number, vendor etc. The supervisor would take the material and take to purchasing department. Next morning clerk would clip the original PO to the pertinent receiver and place them on purchasing manager’s desk. Purchasing manager would check the documents and proceed to accounts department where accounting clerk would look up the standard cost for the material, multiply with the quantity, place the entry in the GL and pass the file to A/P, and so on.  Each department analysed and modified the information so then everyone who needed information received it eventually. Each department adapted the detailed information to its particular processes and procedures. As early IT applications were developed, overnight updates would translate the information from one form to another and update files.  Today when material arrives, operator takes a hand held device, looks up the PO, creates receiver on the device, enters the transaction and everything, which used to take a day or so during manual operating days, happens as a result of one action. What’s the procedure for moving from a manual process (with many opportunities to tailor the information) to one where the company has aligned all functional processes and then designed, implemented and accepted consistent cross functional business processes?

Anything as dramatic as a business transformation must be built into company’s vision, which can take the form of merger/ acquisition strategy, an organic growth approach, or many others.  To ensure an effective business transformation:

  • Vision must define, understand and address the current or potential customer’s needs(i.e., Focus on Customer).
  • Vision must include the concept of business optimization(i.e., addressing internal issues of process competence and performance).

Focus on Customer: The dynamics of moving from one style to the other require redesigning many business processes that have always been part of a logically integrated organism that we managed functionally.  Change requires the ability to see the logic and design for efficiency.  Widespread introduction of ERP applications initiated about 20 years ago. Today we have entire suites of functionality available that provide opportunities to understand cross- functional integration to meet customer’s ever changing needs.  To use the new capabilities we need a different approach to business reengineering, so its necessary to capitalise on new, logical insight into how integrated business process operate.

Business Optimisation: Business optimisation requires companies to:

  • Analyse business fundamentals that affect both cost and revenue
  • Identify areas ripe for improvement;
  • Create a ROI stream;
  • Select IT applications that support process designs and implementations;
  • Create continuous improvement governance programs; and
  • Create and implement optimal business process designs.

The Transformational Organisation

It’s the organisation rather an individual that must be truly transformational for a business to make the most effective use of the capability of IT applications. On the other hand, one key leader who doesn’t see himself or herself as transformational can easily derail the entire process.  There are many examples from both ends of the spectrum that rendered all efforts fruitless.

Example1 :One CEO declared that the business team was too busy with “more important things” to become involved in defining business processes, so the CIO was,  by edict, IT leadership, business leadership and owner of all the solutions. The CFO supported the decision and CIO accepted it.  The result? The technical team and software vendor consultants designed business process and functionality that the functional business executives never accepted. The program failed!

Example 2 :Inanotherbusiness, the CIO, a business leader, drove the transformational program at the direction and with the support of the CEO, only to be derailed by a revolt of functional business leaders who hadn’t bought into the program. Here CEO thought that by assigning a business leader to lead the ERP implementation, he could gain acceptance from the other senior executives. But, now work was done to alter the functional thought process of the other executives, and the CIO was simply written off as a traitor.

Example 3 :Inanotherbusiness,  leaders talked the talk very well, but at the end of the program, they distrusted the ROI, managed costs to the lowest level possible, compressed timelines, marginalised project teams and eliminated critical program elements because they didn’t understand their importance. Here, while individual leaders may have accepted opportunities to transform their parts of the organisation, the organisation remained rooted in past behaviours and resisted changing the business process both within and between their areas of responsibility.

Finally, we need to remember are:

  1. Transformation isn’t for the faint of hearts. It’s difficult and complex business that requires cross functional understanding and focus throughout the executive suites.
  2. Key leaders’ roles are crucial to any organisation trying to become transformational, and not one of the key leaders individually has the ability to perform all the necessary roles.
  3. Selecting key leaders who understand and embrace the transformational process is critical to success.
  4. It’s necessary to train the cross functional leadership team on the role of business process supported by integrated business applications to deliver improved business results.
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1000 x 485_3

New Lease Accounting Model – The Beginning of New Way

On 13 January 2016 the International Accounting Standard Board issued IFRS 16 Leases, the new accounting standard on leasing. The new standard eliminates the distinction between finance and operating leases for lessees and requires recognition of lease liabilities for leasing arrangements.

This contrasts with the existing accounting models for leases require lessees and lessors to classify their leases as either finance leases or operating leases and account for those leases differently and a result lessee in an operating lease is not required to present important information about significant assets and liabilities arising from leases.

The project was few years back the International Accounting Standards Board (‘IASB’) and the Financial Accounting Standards Board (‘FASB’) initiated a joint project to develop a new approach to lease accounting that would require almost all assets and liabilities arising from leases to be recognised in the statement of financial position. While IASB has issued its leasing standard the FASB is expected to issue the new leasing standard under US GAAP in first quarter of 2016.  The new requirements would supersede the present requirements with respect to lease accounting under IFRS and US GAAP respectively.

After the initial Exposure Draft (‘ED’) issued in the year 2010, both FASB and IASB issued a revised ED of the standard in May 2013. They received significant feedback on their proposals and consequently the Boards redeliberated almost all aspects of the revised ED.

IFRS 16 is effective for annual period beginning on or after 1 January 2019.. A company can choose to apply IFRS 16 before that date but only if it also applies IFRS 15 Revenue from Contracts with Customers. It is expected that the new standard will be adopted in India from Financial Year 2019-20

Lessee accounting model

Under the new model the underlying principle reflects that, at the start of a lease, the lessee obtains the right to use an asset for a period of time and has an obligation to pay for that right. Consequently the new standard requires lessees to recognise assets and liabilities arising from all leases on the balance sheet, subject to certain exemptions for short term (leases with a lease term of 12 months or less) and small asset leases (where the underlying asset has a low value when acquired).

As the new standard considers all leases as financing arrangements, a lessee would always recognize and present in the income statement amortisation of lease assets separately from interest on lease liabilities.

Impact on the balance sheet

For companies that currently have significant operating leases, the new lease standard is likely to result in increase in lease assets and corresponding lease liabilities and may have significant impact on key financial ratios derived from recognition of lease assets and liabilities (for example, leverage and performance ratios).

While the proposed guidance is expected to affect lessees across all sector, impact is likely to be higher on “asset-light” business models, particularly in the aviation, retail and logistics sectors.

Impact on the income statement

The impact on income statement of the new model will depend on the significance of leasing to the lessee and the length of its leases. EBITD A is likely to increase compared to the amounts reported today because, a lessee will present the implicit interest component operating lease payments as part of finance costs whereas, today, the entire lease expense is included within operating costs.

The net profit, however, is likely to decrease because interest expense is typically front loaded as the combined effect of amortization of lease asset and interest on lease liability is higher in the earlier years of a lease than in the later years and vice-versa. Over the lease term, the total amount of expense recognised is the same.

Impact on the cash flow statement

Consistent with the balance sheet, the new model reduces operating cash outflows, with a corresponding increase in financing cash outflows for principal repayments, compared to the amounts reported today to reflect the economics of a financing arrangement 

Lessor accounting model

The lessor’s accounting will not change as the difference between finance and an operating lease has been retained. However, it requires a lessor to provide some additional disclosures to enable users of financial statements to better evaluate the uncertainty of cash flows associated with the lessor’s leasing activities. The enhanced lessor disclosure requirements are as listed below:

  • Table of lease income- requires a lessor to disclose the components of lease income recognised in the reporting period.
  • Information about exposure to residual asset risk- requires a lessor to disclose information about how it manages its risk associated with any rights that it retains in leased assets.
  • Information about assets subject to operating leases- IFRS 16 requires a lessor to provide the disclosures required by IAS 16 Property, Plant and Equipment separately for assets subject to operating leases-further distinguished by significant classes of underlying assets from owned assets that are held and used by the lessor for other purposes.

Key differences between IASB and FASB model


While both IASB and FASB requires a lessee to recognise lease assets and liabilities on the balance sheet giving an exemption related to short term leases, the IASB model provides an additional exemption for small asset leases (i.e. asset whose underlying value is low at inception) from recognition as assets and liabilities. 


Although both Boards require recognition of lease liabilities for all leasing arrangements on the balance sheet, the Boards have diverged on the recognition of leases in the lessee’s income statement. While the IASB’s model requires all leases to be presented in a manner similar to today’s finance leases  (referred to as Type A leases), the FASB has proposed a dual model that, in addition to Type A leases, would permit a straight-line expense recognition pattern similar to today’s operating leases (referred to as “Type B”). This is achieved by measuring the amortisation of the lease asset each period as a balancing amount (i.e., accounting plug), calculated as the periodic straight-line lease expense (calculated in a manner similar to current Type Aoperating leases) minus interest on the leType Base liability for the period. Therefore for the Type B leases the amortisation of leases asset will be inverse of interest on lease liability i.e. it will lower in earlier years and will increase in later years so that the charge on income statements reflect straight-line pattern.  Under the FASB’s dual model approach, determining whether a lease is Type A or Type B would be based on guidance similar to the classification model under current U.S. GAAP but without the bright lines.

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