Accounting for Leases - The Impact of AASB (IFRS 16)

This paper discusses the impact of the new accounting standard for leases (AASB/IFRS 16) on companies, with a focus on JB Hi-Fi. It examines the changes in financial liabilities, key financial metrics, and the implications for the retail industry.

Running head: ACCOUNTING FOR LEASES- THE IMPACT OF AASB (IFRS 16)
Accounting for leases- The impact of AASB (IFRS 16)
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ACCOUNTING FOR LEASES- THE IMPACT OF AASB (IFRS 16)
Introduction:
The current paper elucidates the understanding of the new accounting standard for
lease and examines the impact of the new lease standard on the company and its financial
performance. The new lease standard is introduced to essentially eliminate the accounting
distinction between financing and operating lease. With this, there will be increased financial
liabilities sans leased assets on the balance sheet of lessee. Accordingly, there will be
significant impacts on the key financial metrics for the companies having material off balance
sheet lease commitments. Although, there will not be any increase in the value of equity,
there will be increase in the enterprise value of the companies. For the analysis purpose, one
of the companies has been chosen from the ASX named JB Hi-Fi which is the largest home
entertainment retailer based in Australia. The company is engaged in selling wide variety of
entertainment products such as mobile phones, wireless speakers, headphones, and laptop and
game consoles.
Discussion:
The new accounting standard on lease has come in effect for the period beginning
after 1st January or on the given date. JB Hi-Fi has pointed out their annual report published
for the year ending 30th June, 2018 that the AASB 16 will be effective in the financial
statement of the group for the year ending June 30, 2020 (jbhifi.com.au 2019). A
comprehensive model has been introduced by AASB 16 for the identifying the lease
arrangements and accounting treatment for both lessees and lessors. The current guidance on
lease will be superseded by AASB 16 along with all the related interpretations. The
distinction between the service and lease contracts is created by AASB 16 on the basis of
whether the customer controls the identified assets. In addition to this, the lease accounting
does not identify differences between the operating and financing lease. A model under the
new lease standard has replaced the existing model and the new model where the recognition
for the corresponding liability and right for used assets for all the leases have to be
recognized by lessees on their balance sheet. However, such recognition will not include
leases for low value and short term leases. For the remeasuremnt of lease liability, the
measurement of the right of use assets is done at cost and subsequently, the measurement is
done at the cost less impairment losses and accumulated depreciation. At the initial level, the
leased liabilities are measured at the value of lease payments that are not being paid at the

ACCOUNTING FOR LEASES- THE IMPACT OF AASB (IFRS 16)
date of lease agreement. The leased liability is adjusted for lease payments and interest
subsequently along with the impact of modification of lease (Guermazi & Khamoussi, 2018).
It is expected that the requirements of the new lease standard to recognize the related
lease liability and right of asset use is expected to create considerable impact on the amounts
that is recognized on the consolidated financial statements of the group. There will be impact
on the classification of cash flows because under AASB 117, the payments concerning
operating lease are presented as operating cash flow. On other hand, under the AASB 16, the
payment of lease will be split into an interest payment and principal that will be represented
as operating and financial cash flow respectively (Hladika & Valenta, 2018). Moreover, the
new lease accounting standard requires the reporting entity to make extensive disclosures.
From the analysis of the financial report of JB Hi-Fi, it has been ascertained that the
company has made progress in preparing the implementation of the new standard in number
of areas during the financial year 2018. Such areas include identifying necessary changes to
the processes and system that required accounting treatment and reporting the facts in
accordance with the new standard. Efforts were put in collation of data for the calculation to
assess the impact of new standard and identifying areas of judgment and complexities that are
relevant to the group (Chu et al., 2019). In addition to this, the initial estimates for identifying
the discount rates were also developed. There are a number of unresolved areas on which the
reliable estimate of the financial impact on the on the consolidated results of the group is
dependent. Such areas involve conclusion of data collection, refining the approach of
discount rate, transition method choice and approach refinement to discount rate.
In relation to the some minor operating lease and lease concerning with stores, the
group has entered into some operating lease agreement. Stores have been taken on lease for a
term of between 5 to 15 years with an option to extent the period in some case. In the event of
the group exercising the option to renew, there are few clauses that are contained in the
market review clauses. Regarding the lease term and arrangement, the company opt for the
short term leased where appropriate which is considered as one of the strategies opted by
organization to drive growth. The leasehold improvement is stated at the cost that is less of
impairment and accumulated depreciation (Agyei, 2017). In addition to this, the provision of
lease by the group is their best estimate of the amount that is required to return the lease
premises to the original condition. Such estimation is done by considering the best estimate
of onerous lease obligations and past history of vacating stores. Costs comprised of

ACCOUNTING FOR LEASES- THE IMPACT OF AASB (IFRS 16)
expenditure that are attributable directly to the item of acquisition. It can be seen that JB Hi-
Fi does not have any onerous provision for lease and under the new standard; it is not
required by the company to obtain the information about original lease payments and lease
term for such leases.
Non cancellable operating lease commitment:
(Source: jbhifi.com.au 2019)
The group has commitment of non cancellable operating lease of amount $ 684.4
million for the year ending 30th June, 2018 compared to $ 683.6 million in year 2017
(jbhifi.com.au 2019). Under the AASB 117, it was not required to recognize the right of use
liability and assets for the future payments of the lease. The rental expense relating to
operating lease has increased from 152.4 in year 2017 to 193.1 in year 2018 (jbhifi.com.au
2019). It is indicated by preliminary assessment that the arrangement made by organization in
respect of the new lease standard will meet the lease definition under AASB 16. Therefore,
unless the lease are qualified for short term leases or low value after the application of AASB
16, the corresponding liability and the right of use assets will not be recognized by the group
(Ifrs.org, 2019).
Since, the new accounting standard for lease does not identify any differences
between operating and finance leases, and all the leases will be treated as financing lease
would have considerable impact on the solvency position of the business. The liabilities and
assets for the lease will be recognized will be recognized by lessee in the statement of profit
and loss while the depreciation and interest cost of assets will be recognized in the statement
of profit and loss. In respect to the introduction of new lease standard, there will be material
effect on the financial statements and the related financial ratios. There would be increase in
the percentage of owner’s equity of JB Hi-Fi due to capitalization of operating lease and this

ACCOUNTING FOR LEASES- THE IMPACT OF AASB (IFRS 16)
would have an impact on debt to equity ratio and debt to assets ratio (Hilliard &
Neidermeyer, 2018). Since the rent expense would disappear and will be replaced by interest
expense for lease liability the depreciation expense for the right of use under the new
standard. This would have an impact on decreasing the operating expense and thereby
increasing the income before tax and interest. At the same time, due to the recognition of
interest expense on lease liability, there will be an increased expense for the company.
There will be increased amount of debt and it is indicated by many research that the
combined net debt of the company has grown by some Euro 45 billion. Therefore, it is
expected that the financial metric indicating the total debt of JB Hi-Fi would increase after
the new lease standard becomes effective. Since the majority of the rental expenses will be
reflected in the depreciation, an increase in earnings before profit tax and depreciation will
also increase, however the increase will not be substantial (Joubert et al., 2017). There would
be lower return on capital invested for JB Hi-Fi because of higher investment in capital for
lessee.
Since the lease will be in balance sheet, the transparency of the financial statements
would be enhanced. However, the company would be negative impact because of adverse
affect on some key ratios such as return on assets, debt to equity and debt to assets.
Therefore, from the analysis, it can be inferred that the leverage and gearing ratios will
increase along with the additional liabilities brought into the element of debt into the
calculations. The computations for return on capital employed will reduce because an
increase in the operating profit is not proportionate to the increment in capital employed
(Oppong & Aga, 2019). In addition to this, the cash flow statement of the company will not
be fundamentally impacted by the new lease standard. However, there would be an impact on
the valuation of the items in the cash flow statement.
JB Hi-Fi is an organization operating in the retail industry and this particular industry
and the likelihood of the impact of this particular standard is considerably high given the
significant usage of rented premises for the stores hired by them. It is indicated by the Pwc
global lease capitalization that there would be an increase in the median debt of 98% for the
retailers (Ward & Lowe, 2017). Much of the leases for the retailers are in the form of medium
term leases, whether in shopping centers and premium location and with such leases offering
renewal options in the form of variable rentals. The variation in the rentals is because of
existence of contingent rentals in some locations where the property owner has vested interest

ACCOUNTING FOR LEASES- THE IMPACT OF AASB (IFRS 16)
in business performance and adjustment in inflation. The right to control assets in the retail
industry will be impacted by number of factors such as control over physical access over the
goods sold, physical access to space and tenant controlling the shop design along with
unrestricted use of defined retail space (Warren, 2016). Renting of the retail space under the
new standard would provide economic benefits those results from selling the products with
the objective of earning profit. Nonetheless, the retailers are required to consider the
potentially critical element of renewal option that are market priced but can be exercised only
when there is a significant economic incentive for the tenant to renew the lease (pwc.com.au,
2019). In such event when it is required to calculate the lease liability, it is required to include
the payment during the extended period of lease. Furthermore, the wider potential business
impact due to the interdiction of the AASB 16 on the retail industry could be identified in a
number of areas. Such areas include share based payment, debt covenants, lease negotiations
and dividend payment policy.
The operating lease by many lessees are currently managed though the accounts
payable system or on the spreadsheets. It is therefore required by them to conduct a
reassessment of index based payments and lease terms at each reporting date that now
requires capturing of extensive data (Stancheva & Velinova, 2019). Moreover, it might be
required by lessees to modify their process, information system and internal control for
complying with the standard.
Conclusion:
The analysis of the impact of the new lease standard that is AASB 16 have been
ascertained which views that the financial statement of the retail industry will be considerably
impacted due to the abolishment of differences between operating and financing lease. From
the analysis of the annual report of JB Hi-Fi, it has been found that the company is making
progress in a number of areas for the effective implementation of the AASB 16. Furthermore,
the financial metrics such as return on assets, debt ratio, debt covenants and earning before
inters, tax and depreciation would increased due to inclusion of operating lease on the
balance sheet. The accounting treatment for the leases would change considerably with
deterioration in the calculations of gearing ratios. Moreover, it has been evaluated that the
most sizeable impact of the new lease standard will be on the retail industry.

ACCOUNTING FOR LEASES- THE IMPACT OF AASB (IFRS 16)
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