Executive Summary This report has been undertaken mainly for the purpose of illustrating the significance of accounting concepts and standards in the financial reporting process of business entities. In this context, it has been depicted from analysis of the annual report of selected ASX listed entity that is Woolworths Group, that it has effectively applied all the relevant accounting concepts in development of its financial report. Also, the annual report evaluation of Woolworths as depicted that through it is still adopting the sue of AASB 177 for reporting of its leases but it would apply the new lease standard of AASB 16 in the future period. It has also provided adequate disclosures regarding the impact of this transition on its financial performance. 2
Contents Introduction......................................................................................................................................4 Part 1: Identification and Description of the Accounting Concepts used in Woolworths Limited.4 Going Concern Concept...............................................................................................................4 Accrual Accounting Concept.......................................................................................................5 Money Measurement Accounting Concept..................................................................................5 Cost Concept................................................................................................................................6 Part 2: New Accounting Standard Leases of AASB 16 and it’s Impact On Selected Company....7 Part 3: Summarizing the Key Disclosures that Company makes in context for Lease accounting as per new standard and the impact of its transitional provision from AASB 117 TO AASB 16. .9 Conclusion.....................................................................................................................................10 References......................................................................................................................................12 3
Introduction The report has been undertaken to analyze and examine the annual report disclosures of a selected ASX listed entity. The examination of the annual report disclosures is undertaken to identifying the accounting concepts used for presenting and disclosing the financial information. The next section of the report discusses the changes that have been incorporated within the new accounting standard for leases AASB 16. This is done in reference to the selected ASX listed company. Lastly, it examines the key disclosures that the company has made in relation to the leases and analyzes the impact of the transition from AASB 16 to AASB 117. The ASX Company selected for the evaluation purpose in the present report is Woolworths Limited, a leading supermarket giant of Australia. Brief Description of the Company Woolworths Limited is a recognized and leading retail chain of Australia having the presence of about 300 stores across the country. The major products provided by its retail stores include items of grocery, liquor, home improvements and is also involved in carrying out diverse businesses of hotels and pubs. It is recognized to be one of the largest companies within Australia in terms of revenue. The company strategic priority is to create better experiences for its customers and delivering them higher value (Woolworths Group, 2018). Part 1: Identification and Description of the Accounting Concepts used in Woolworths Limited The accounting concepts largely assist the development and implementation of various accounting principles within business entities. The different accounting concepts as provided by the IASB (International Accounting Standards Board) guides the overall, process of developing and presenting the financial statements. They can be regarded as wide conventions that have been developed for the purpose of providing a basic framework to financial reporting. The differentaccountingconceptsthathavebeen adoptedby Woolworthsin developingand presenting its financial statements are described as below: 4
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Going Concern Concept The business entities tend to develop their various financial statements on the basis of the assumption that they will continue to operate for an indefinite future period of time. As per this concept, business entity need to value its assets on a non-liquidation basis and fixed assets should be amortized over their useful lives in comparison to that for a shorter period. For example, Woolworths Limited adopts the use of historical cost measurement approach for value of its fixed assets and they are amortized over their useful lives (Kiabel and Nwanyanwu, 2014). The extract from its annual report illustrating same has been depicted as follows: (Source: Woolworth’s Annual report 2018) Accrual Accounting Concept The concept stated that a business entity need to record the expenses and income relating to particular accounting period in which they have been incurred or earned irrespective of the cash basis. As such, in accordance with this concept the income earned need to be recognized in the accounting period in which it arises rather than reporting it in future period in which it is expected to be realized. Similarly, expenses also need to be recognized within same accounting period in which they are incurred irrespective of the fact when they need to be paid. For example,WoolworthsLimitedhasrecognizedrevenueonfairvalueinrespectofthe consideration received or likely to be received in the future period of time (Unegbu, 2014). 5
Money Measurement Accounting Concept The money measurement concept of accounting has identified the need for businesses to develop and present their financial information in monetary terms. Woolworths Limited has adequately applied this accounting concept for preparation of its different financial statements as it all the financial transactions within the statements have been recorded in monetary terms as illustrated below: (Source: Woolworth’s Annual report 2018) Cost Concept The concept can be regarded as developed on the basis of going concern concept that has required the business entities to record the assets at historical cost. The market value is regarded to be irrelevant for accounting purposes as the business is estimated to continue for long period of time. For example, the fixed assets of the company are measured at cost less any depreciation or amortization losses (Kiabel and Nwanyanwu, 2014). The extract form the annual report in this context can be depicted as follows: 6
(Source: Woolworth’s Annual report 2018) Part 2: New Accounting Standard Leases of AASB 16 and it’s Impact On Selected Company AASB (Australian Accounting Standards Board) has directed all the ASX listed entities tocomplywiththeIFRSaccountingstandardsprovidedbytheIASBforincreasing comparability and homogeneity in the financial reporting process. The IASB has developed and implemented new standard for leases that is IFRS 16 leases that has identified the need for introducing a new model that require lessees to recognize all leases on the balance sheet with only exception of short-term leases and leases related to assets having underlying lower value. The changes have also been adopted by the AASB and are expected to become effective within the financial reporting system of business entities within Australia from the period of 1 Januarys 2019 (Mitchell, 2017). The changes to be introduced in the lease accounting model is expected top cause significant changes within Australian entities especially those dealing in high amount of operating leases. The business entities are required to gain a proper understanding of the new lease standard to effectively comply with the new accounting standard and disclose information as per the standard needs and requirements. The major objective behind the introduction of the standardistoeliminatetheclassificationbetweenoperatingandfinanceleasesandhas recognized the need for capitalizing all leases by recognition of lease liability and right of use of an asset on the balance sheet(Grossman and Grossman, 2010). 7
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The new accounting standard for leases that is AASB 16 has replaced the previous existing accounting standard for leases of AASB 117. There is no need for depicting the future obligations on a company on its operating leases and thus it is associated with the drawbacks of not accurately depicting the financial position of a company. It has been estimated as per the previous accounting standard for leases that there are about $3 trillion worth of future payments for leases that are not adequately recognized on the balance sheet. This has caused the need for IASB to introduce changes within its accounting standard for leases and thus AASB 16 has been introduced for promoting transparency within lease commitments of businesses and adequately reflecting the economic reality. The new standard would largely be beneficial for facilitating investment decision of users by providing a better disclosure of the financial performance of an entity (New leasing standard (AASB 16) brings significant impacts, 2016). However, the major challenge that is present before business entities in regards to implementing the new accounting standard for leases is the increasing level of complexity and risk in the financial reporting due to its significant impact of the standard on profitability position of companies. AASB 16 requires providing complete disclosure in regards to lease commitment that can be provided as a complex and time-consuming process. Also, the businesses are required to provide significant training to its accounting professionals to make significant changes in its balance sheet as per the new standards (Green, 2018). The training is required to enhance the understanding of the accounting professionals in regards to reporting of leases in accordance with the new standard. This is essential because new standard of recognition and measurement of leases requires completely reviewing the lease contracts for determination of lease term, right of use of an asset and its associated liability. In addition to this, there is increasing concern among the business entities regarding the impact of the new lease standard on the expenses recognition as instead of using straight line rental expense it is required to expense it more in early years as compared to the later years and this would have a large impact on earning position of entities. Thus, it can be said that major changes that are likely to be adopted within the balance sheet of companies need to be adequately explained to its investors and shareholders (Vengadasalam, 2019). As analyzed from the annual report of Woolworths Limited, it has applied the accounting standard of AASB 117 for reporting of its lease commitments. The leases are classified on the 8
basis of operating and financial leases and it has not yet adopted the new accounting standard of leases that is AASB 16. The current requirements has resulted in classifying the leases on the basis of their nature and finance leases are recognized in the balance sheet while operating leases are not recognized within its statement of financial position (Woolworth’s Annual report, 2018). The extract form the annual report disclosing the reporting of operating leases has been depicted as follows: (Source: Woolworth’s Annual report 2018) However, the company has declared the adoption of the new accounting standard for leases of AASB 16 after it becomes effective, i.e., from 1stJanuary 2019. The changes introduced are however impacted on the financial position statement of the company due to large volume of operating leases used by the entities of the retail sector. The company is required to recognize the lease liability and right of use of an asset as per the new accounting standard of AASB 16. It would be highly complex for the accountants of Woolworths Group Limited to comply with all new accounting treatments provided under the AASB 16. This is because capturing all the information required for calculation of lease liability and the associated disclosures is a very complicated process. This is because lease agreements have complex and inter-related elements that need to be analyzed adequately across large volume of operating leases that the retailers possess. Therefore, the company to face larger issues in relation to developing and presenting enhanced disclosures about its lease contracts within its financial reports which can be a challenging task for the accounting managers(IFRS Spotlight, 2016). 9
Part 3: Summarizing the Key Disclosures that Company makes in context for Lease accounting as per new standard and the impact of its transitional provision from AASB 117 TO AASB 16 As stated within the annual report of Woolworths Limited, it has been adequately disclosed that the company will replace existing accounting treatment for leases as per AASB 117 standard with the new standard for leases, that is, AASB 16 from 1STof July 2019. The AASB 16 adoption of accounting standard for leases would require the company to recognize the right of use (ROU) of an asset and its associated liability in a lease contract that need to be stated on its balance sheet (Dhaliwal, Lee and Neamtiu, 2011). The lease liability would represent the present value of future lease payments and interest expenses would be recognized on the lease liabilities and depreciation would be charged and recognized on the right of use value of an asset. The accounting for leases as a lesser is likely to remain unchanged as per the new accounting standard for AASB 16 (Jose and Constancio, 2018). In this context, Woolworths is likely to undertake an implementation project that determines the significant changes required within the accounting policy, states the budgetary requirements, costing involved in the transition process, identifies the systems requirements and processes identified for execution of the implementation plan. The transition process that is replacement of AASB 117 with the new accounting standard for AASB 16 would be done as per the use of modified retrospective approach as stated within theannualreport of thecompany.The overalleffecton implementationof new accounting standard for leases would be illustrated as adjustment to the opening balance of retained earnings on the date, 1st July 2019. Woolworth Group has also decided to implement different practical expedient in its transition process on the basis of lease by lease basis at the time of applying the modified retrospective approach. The potential impact of these expedients would be assessed under the implementation project undertaken by Woolworths(Woolworth’s Annual report, 2018). Woolworths has also provided adequate disclosures regarded the estimated impact of the transition process within its annual report on its statement of financial position. The new lease liabilities are estimated to amount $14 to $15 billion and the right of use asset will amount to $12 to $13 billion and would be recognized in context of its retained earnings. The major impact of 10
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the standard would be on the accounting treatment for property leases that includes it’s retain spaces, warehousing facilities, centre of distribution and support offices. Also, the impact of adopting AASB 16 on the financial statements in the preliminary periods would also depend on the economic conditions and its borrowing rates in the future context. It would also be dependent on the lease portfolio of the company, extent of application of practical expedients and adoption of new accounting policies that would have an impact on the application of AASB 16 accounting standard by Woolworths Group (Woolworth’s Annual report, 2018). The extract from the annual report of the company depicting the impact of adopting the AASB 16 lease standard is depicted as below: (Source: Woolworth’s Annual report 2018) Thus, it can be said that the adoption of the new standard would result in improving transparency and reducing the assumptions that are associated in determining the lease liabilities. However, it would also have a major impact on the key financial indicators of the company such as gearing ratios and the earning potential. The likely change would be depicted within profit and loss statement of the company such as changes in its EBITDA due to charging of depreciation and interest expense on lease liabilities as compared to rental expenses. Therefore, it is essential for the company to understand properly the likely benefits and challenges in adoption of AASB 16 before it become effective within its financial reporting processes (IFRS 16 – The new leases standard, 2016). 11
Conclusion The discussion held above has illustrated that it is very essential for business entities to develop their financial reports in accordance with key accounting concepts and standards. They provide a framework for developing and present the relevant financial information to the end- users and thus assisting the decision-making process for its primary users.In this context, as illustrated within the report that new accounting standard for leases, that is AASB 16, has been developed for improving transparency and reliability within financial reporting process of lease commitments of business entities. However, its adoption is associated with large number of challenges before business entities that they to address adequately for ensuring its effective compliance. As examined from the annual report of Woolworth group that it has not yet adopted the new standard for leases but has provided adequate disclosures regarding the date, transition process and the impact of the transition on its financial performance within the report. 12
References Deloitte. 2016. IFRS 16 Leases: impact, challenges and solutions. [Online]. Available at: https://www2.deloitte.com/ce/en/pages/finevare/article/irrs-16-leases-impact-challenges-and- solutions.html[Accessed on: 5 October 2019]. Dhaliwal, D., Lee, H.S. and Neamtiu, M. 2011. The Impact of Operating Leases on Firm Financial and OperatingRisk.Journal of Accounting, Auditing &Finance26(2), pp. 151-19. Green, J. 2018. What challenges might you face in applying IFRS 16 leases? [Online]. Available at:https://www.accountancyage.com/2018/08/01/what-challenges-might-you-face-in-applying- ifrs-16-leases/[Accessed on: 5 October 2019]. Grossman, A.M. and Grossman, S.D. 2010. Capitalizing Lease Payments.CPA Journal,80(5), pp. 6-11. IFRS16–Thenewleasesstandard.2016.[Online].Availableat: https://www.pwc.com/gx/en/services/audit-assurance/assets/ifrs-16-new-leases.pdf[Accessed on: 25 September 2019]. IFRS Spotlight. 2016.How will the new leases standard affect retailers? [Online]. Available at: https://www.pwc.com.au/assurance/ifrs/assets/new-leasing-standard-and-retailers.pdf[Accessed on: 5 October 2019]. Jose, M. and Constancio, Z. 2018. IFRS 16 (leases) implementation:Impact of entities’ decisions on financial statements.The Ieb International Journal of Finance17, pp.60-97. Kiabel, B. and Nwanyanwu, L. 2014. Some Basic Concepts of Accounting: A Critical Appraisal. Research Journal of Finance and Accounting5(7), pp. 197-201. Mitchell, S. 2017. Wesfarmers, Woolworths liabilities to double under lease accounting change. [Online].Availableat:https://www.afr.com/companies/retail/wesfarmers-woolworths-among- retailers-bracing-for-new-lease-accounting-rules-20170706-gx69ij[Accessedon:5October 2019]. 13
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New leasing standard (AASB 16) brings significant impacts. 2016. [Online]. Available at: https://www.hlb.com.au/new-leasing-standard-aasb-16-brings-significant-impacts/[Accessed on: 5 October 2019]. Unegbu, A. 2014. Theories of Accounting: Evolution & Developments, Income Determination and Diversities in Use.Research Journal of Finance and Accounting5(19),pp. 1-16. Vengadasalam, V. 2019. AASB 16 New Lease Standard: 1st January 2019. [Online]. Available at:https://www.accru.com/2018/10/aasb-16-new-lease-standard/[Accessed on: 5 October 2019]. WoolworthsGroup.2018.AboutUs.[Online].Availableat: https://www.woolworthsgroup.com.au/page/about-us/our-approach/strategy-and-objectives/ [Accessed on: 5 October 2019]. WoolworthsLimited.2018.Annualreport.[Online].Availableat: https://www.woolworthsgroup.com.au/icms_docs/195396_annual-report-2018.pdf[Accessed on: 5 October 2019]. 14