THE IMPACT OF IFRS 16 IMPLEMENTATION ON KEY FINANCIAL RATIOS: AN EVIDENCE FROM PAKISTAN COMPANY: PAKISTAN INTERNATIONAL AIRLINES

Abstract

The controversial history of lease accounting stems from its use as a method offinancing that is "off-balance-sheet." Public demand for increased transparency in financial reporting has led to heightened interest in lease accounting within the accounting profession. Despite longstanding concerns, lease accounting remained unchanged for over 30 years until the introduction of IFRS number 16. Prior to this, lease accounting provisions were governed by International Accounting Standard (IAS) number 17, which allowed for 2 types of lease accounting method: operating and finance leases. However, disagreements still exist regarding how operational leases should be handled in the lessees' financial accounts. (Ali, S. (2021). Lease accounting can be split into two categories: operating lease accounting and finance lease accounting. The former only records lease expenses on the income statement, whereas the latter reports depreciation and finance charges on the income statement in lease commitments and assets added to the statement offinancial position. Operating lease accounting is known as "off balance-sheet", while finance lease accounting is called "on-balance-sheet". The lack ofleased asset and liability information on the financial position statement can make it difficult for stakeholders to compare lessees and have a full view ofthe lessee's financial situation. (AL Hussain, R. F.2019) The IFRS (International Financial Reporting Standards) 16 was instituted to address criticisms ofthe IAS 17 and rectify the omission ofmany lease transactions from balance sheets, which previously made it challenging to estimate off-balance-sheet amounts. Prepare for a fundamental change in lease recording and financial reporting with the introduction of IFRS 16. Operating leases lasting over one year will now be capitalized, eliminating the previously used "off-balance-sheet" accounting treatment. For businesses with significant operating leases, this change will lead to a noticeable increase in assets and liabilities and a decline in equity, which could have an effect on financial ratios. A company's financial situation and performance over time can be determined using financial ratios, which are an effective tool. (Cumming, C. J. (2019). Numerous global studies have focused on analyzing the effect of IFRS 16 on the financial sector. In Turkey, a specific study investigated how the implementation ofIFRS 16 influenced financial ratios such as debt, asset and equity, ROA, and ROE. The study specifically examined retail companies listed on the Istanbul Stock Exchange and found significant statistical effects on their ratios due to the new accounting standard. Another Finnish study evaluated the 2015 fiscal years financial statements and numerous financial standards, such as the capitalization ratio, current ratio, and Earnings before interest, taxes, depreciation and amortization. The analysis showed that the top three Finnish construction companies, YIT Corporation, Lemminkainen Corporation, and SRV Group Pic, all experienced worsening gearing and current ratios as a result ofthe adoption ofIFRS 16. (Fuad, F., et al, 2022) Pakistan has recently implemented IFRS 16. This change has been in effect since January 1st, 2019. This study analyzes how this new adoption ofimpacts the key financial ratios as well as financial statement of public companies in Pakistan, particularly those who rely heavily operating leases. The research specifically focuses on airline operators, who often use lease finance for their aircraft fleets. This study is particularly relevant since 2019 marks the beginning ofIFRS 16 implementation for all public companies in Pakistan. In short, IFRS 16 was created to address the issue ofoff-balance-sheet leasing transactions that IAS 17's statement offinancial condition did not include. This made it challenging for users to assess the liabilities and assets ofleasing companies and estimate the amount off-balance sheet. Following its implementation, companies with significant operating leases can expect its financial ratios would be significantly impacted by a rise in liabilities, assets, and a decline in equity. The goal ofthis study was to determine how IFRS 16 might affect Pakistan International Airlines' (PIA), an airline firm that financed its aircraft through leases, financial statements, and key ratios. The implementation ofIFRS 16 will affect all public firms in Pakistan starting in 2019, hence this research is quite pertinent.