Lease Accounting and Financial Reporting

This assignment requires an in-depth analysis of the impact of lease accounting standards on financial reporting, focusing on Wesfarmers as a case study. Students must demonstrate their understanding of relevant IFRS and AASB pronouncements, particularly AASB 136 (Impairment of Assets) and AASB 139 (Financial Instruments: Recognition and Measurement). The analysis should include an evaluation of how lease accounting affects key financial ratios, such as leverage and profitability. Additionally, students are expected to discuss the implications of the new lease accounting standards for investors and creditors.

PART A
Part (i)
Wesfarmers Limited is the company that has been available for the analysis purpose and
throughout the study the annual report of the Wesfarmers Limited will be discussed with regard
to the impairment testing. The company is Australia based and is listed in the Australian Stock
Exchange having second largest place in the retail chains business and is big competitor to the
Woolworths Limited. For making the deep analysis and current analysis, the annual report for the
financial year ending 30th of June 2017 has been considered.
The financial statements have to be read with the notes to the accounts of the company and
therefore, the following assets of the company have been tested for the purpose of the
impairment if any during the year:
 Note number 5 has laid down the impairment test for the trade receivables. The trade
receivables are those from whom any amount is receivable and that too in the ordinary
course of business not any special transactions.
 Note number 7 has laid down the second major head comprises of the property plant and
equipment. It includes freehold lands, buildings, leasehold land improvements, plant
vehicles and equipment and Mineral lease and development.
 Note number 8 has laid down the third major head for impairment testing is the Goodwill
and other intangibles. The other intangibles include brand, contractual and non
contractual relationships, software and gaming and liquor licenses.
 Note number 17 has laid down the other major head namely Non financial assets and note
number 18 on Associates and joint Ventures and accordingly impairment is tested for the
loss in investment
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Part (ii)
Yes, the company has conducted the testing for impairment and that too in accordance with
Australian accounting standard and has provided the details explanation of each and every
testing done by them.
As per the seventeen note of the financial report of the company for the financial year ending 30th
of June 2017, following test has been done for the impairment:
 The group of the whole company tests the property plant and equipment, goodwill and
other intangibles on an annual basis. The testing becomes more frequently in case of the
intangibles having indefinite lives and accordingly the testing on at least annually or
frequent basis have been mentioned. The testing is also required when an indication is
there that the impairment that has been charged in the earlier period might have been
changed in the current financial year.
 The group will identify and prescribe the cash generating units. The need of identifying
the cash generating units will arise only when the individual assets will not be able to
generate the cash flows on its own on independent basis rather uses the other assets to
generate the profits. Also when the assets value in use so calculated cannot be simulated
with the figures as obtained with the fair value.
 Thereafter, the recoverable amount of each of the asset or the cash generating units as the
case may be is identified. Recoverable amount of an asset or the cash generating unit is
the higher of the fair value of asset less cost of the disposing off the same which is
defined as FVLCOD and the value in use. Value in use is nothing but the present value of
all the cash inflows that the company estimates for future for at least five years. The
present value is calculated by using the discounted rate or the cost of capital of the
company. In case the cash flows are required for more than five years then the same is
estimated using the growth rate of the company. For the calculation of the FVLCOD, the
discounted cash flow way has been used instead of other methods. Now the recoverable
amount so calculated is contrasted with the carrying amount of the asset and in case the
carrying amount exceeds the recoverable amount of the assets or the cash generating
units as the case may be then the impairment is booked otherwise the asset in
consideration is not impaired and is recorded at the carrying value only.
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 The other item of the asset which is tested for the impairment is the trade receivables.
These include the balances of the sundry debtors and other loans and advances made in
the normal routine of business. The trade receivables are check with different kinds of
risk like liquidity risk, credit risk and financial risk. The test for the impairment is
ongoing. It does not require being waiting for the balance sheet date of the year end. The
test includes the checking and verification of the creditworthiness of the debtors as to
whether they are in a position to generate the income and disburse the outstanding and
accordingly impairment is booked. In the given case recoverable amount is identified
using the discounted cash flow technique and this will exclude the short term debtors as
the discounting effect in this case will not be so significant or material.
This, in this mode, the company does the impairment testing.
Part (iii)
The accounting treatment of the impairment is similar to the depreciation and accordingly on the
one hand it is charged to the consolidated statement of profit and loss account and on the other
hand the impairment is deducted from the value of the assets so impaired as on balance sheet
date. On looking of the annual report of the company, the note number two of the annual report
of the company, following amount have been charged as the impairment and clubbed under the
head of the expenses in the consolidated statement of profit and loss:
S. No. Particulars Amount ($Million)
1 Plant, equipment and other assets 27
2 Freehold Property 22
3 Goodwill NIL
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Part (iv)
Every company lists out the key estimates and the assumptions for following each and every
calculation of expenditure or revenue like depreciation and impairment, etc and these are
mentioned in the annual report of the company. In the given case, the company has lists out the
key estimates and the assumption that the company has used in estimating the key assumptions
and the estimates for impairment:
 The note number seventeen is related to impairment of non financial assets and in that the
company has mentioned that the major key assumption has been taken in the fair value
less cost of disposal calculations. The company has identified the two cash generating
units namely Coles and Target. For both of the cash generating units, the method of fair
value less cost of disposal (FVLCOD) has been used for the estimation of the recoverable
amount. The assumptions have been made regarding the discounting rate and the growth
rate. For Coles and Target the discounting rate assumed is 8.9% and 11.0% respectively.
Both discounting rates are post tax and have incorporated a risk for the net post tax flows
which the company has estimated to achieve in the future years. For Coles and Target the
discounting rate assumed is 3.0% and 2.5% respectively. The growth rate has taken into
consideration the growth rate of long term in average terms.
 For the purpose of Curragh cash generating unit, recoverable amount has been
determined and different assumptions have been used for the impairment. These includes
the following:
- Life so remained shall be off approximately 17 years
- Estimates of the long term coal price
- Foreign currency rates based on 27th of June 2017
- Escalations may be around 2.5% per annum and
- Discount rate which shall be post tax will be 9.9%.
Thus, these are the assumptions and estimates that are listed in the annual report of the company.
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Part (v)
Yes, the impairment testing process of the assets of the company is very subjective. The first
instance where the subjectivity is highlighted is the use of the method of fair value less cost of
disposal instead of using the value in use method for calculation of the impairment loss of the
assets. Three cash generating units namely Coles, Target and Curragh have undergone the
impairment testing on the basis of this method only. It depicts that the company is not confident
itself in the estimation of the future cash flows or the budgeted plans because of which the value
in use method has not been employed by the company.
The result of this subjectivity is that the company will lose his faith as zero impairment has been
booked for the current year. However, if company would have been gone by the value in use
method, then the situation will be different.
Part (vi)
I have found the whole process of impairment testing as interest also and sometimes confusing
also. Interesting because new method of calculation of the recoverable amount has been
disclosed is fair value less cost of disposal (FVLCOD). On the other hand the same process is
confusing also because some calculations and the detailed facts were missing due to which some
explanations are in dark room like. For instance how the discounting rate has been calculated and
so on.
Part (vii)
The new insight is the adoption of the different method of calculating the impairment which is
fair value less cost of disposal (FVLCOD). Second insight is the different assumption for
different cash generating units can be taken by the company. For instance, for Coles and Target
different assumption have been placed and for Curragh different assumption has been placed.
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Part (viii)
In the significant accounting policies as adopted by the company as mentioned in the annual
report, it is mentioned that for the purpose of all fair value measurements the group has
categorized the assets into three levels. These are:
Level One - where fair value will be determined in accordance with the listed price in the market
Level Two – where fair value will be determined in accordance with other than listed prices
Level Three - where fair value will be determined in accordance with unlisted prices.
ANSWER TO PART B
i. The following reasons helps IASB board in believing that earlier account standard does
not reflect the economic reality:-
 The accounting treatment of the operating leases contracts which depicts that the
financial transactions does not involved actual obligation of the company and the
company is not liable to record them in their accounts while estimating the
liabilities or obligations (Ely, 2015).
 The nature of transaction was generally hided in the form operating lease contract
in place of the rentals or purchase contracts which shows that real transactions has
been hide by the management of the company.
 Net assets position of the company has been wrongly calculated as the contingent
liabilities will not taken into consideration irrespective of their amount involved
(Day and Stuart, 2013).
From the above, the statement made by the speaker in the meeting seems validated as the
financial data has been manipulated by the owners of the company by using the
ambiguity in standard or regulations governing lease contract.
ii. The following are the reasons which depicts that off the balance sheet liabilities are 66
times higher than the obligations reported in the balance sheet:-
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 As the earlier standard motivates of recording of the operating lease obligations as
continent liabilities as they are considered to be future obligations if the lease
rentals not paid on time, the liabilities will increase day by day as the lease period
expires.
 Only the actual obligations were reported in the former standard as liability on the
face of the balance sheet which are generally very less in case of lease agreement
as only financial lease was considered in this which were very less.
From the above two pints it can be analyzed that actual liabilities were less and having
only 1/3rd of the total obligations which are inclusive of contingent liabilities. So, at some
point of time the off the balance sheet (contingent liability) will become 66 times larger
than obligations reported on the face of the balance sheet for the entities for which lease
standard was applicable.
iii. The following are the points on the basis of which the chairperson thinks that under
former accounting standard the playing fields for some airlines companies were not made
available:-
- The major players in the airline industry have been into the operating lease contracts
and have captured the market by ignoring the finance lease on the other hand. Due to
operating lease they are liable to mention the liabilities relating to the leases as
contingent liability and that too in notes to accounts of the company rather than
mentioning on the first page of the balance sheet or in the schedules forming part of
the balance sheet.
- By doing so they have curbed their actual liabilities (Gross, 2014).
- When new company enters into the market then he has no by other means forced to
adopt for the operating lease and hence the players of the field will be the major
players of this industry and the others will remain as it is (Singer, 2017).
- Second reason is that the new entrants will take time to bring their financial
statements to that level so that they can also give the competition to others and if this
former standard prevails then there will be no level playing field among the
companies in the similar industry.
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iv. The reasons that as to why the Chairperson of the International Accounting Standard
Board have mentioned that the new accounting standard on the leases will not be popular
with everyone are as follows:
 At first it is very much clear that the new accounting standard on leases is majorly
applicable on the listed companies.
 The new accounting standard will make the parties to the contract to make the full
disclosure of their financial assets and financial liabilities (Knubley, 2010; Moore
and Nagy, 2013). The lessee cannot escape by mentioning the contingent liability
only and that too in the notes to accounts rather it will be recorded with full
liability under the provisions of the new accounting standard (Lim, 2014).
 It will make the existing listed companies which covers half of the listed
companies dealing into leasing transactions out of the business and thus will make
the standard unpopular not among their business industry but also in some other
business industry.
With this, the accounting standard will not be so popular.
v. As the new accounting standard on lease will bring about the more transparency about the
financial position of the company as well as the financial performance of the company,
the faith of the stakeholders including the banks, financial institutions, government
authorities, employees and others will get increased. Through this faith and the more
reliance on the financial statements of the company will lead the management of the
company to make a more informative and corrective decision in an efficient and effective
manner. Earlier, the company has been making the lease versus buy decision very fast
and vague but now the decision will effective and efficient one as in the case of lease the
assets and the corresponding liabilities are required to be checked.
Similarly the investors of the company including the potential investors will have more
faith and trust in the workings of the company on the basis of which the investors will be
able to take an effective decision regarding whether to invest in the particular company or
not.
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REFERENCES
AASB, (2016), “Impairment of Assets” available at
http://www.aasb.gov.au/admin/file/content105/c9/AASB136_07-04_COMPjun09_01-10.pdf
accessed on {23-01-2018}.
AASB, (2016), “Financial Instruments: Recognition and Measurement” available at
http://www.aasb.gov.au/admin/file/content105/c9/AASB139_07-04_COMPoct10_01-11.pdf
accessed on {23-01-2018}.
Company Official Website, (2017), “Annual Report 2016”, available on
www.wesfarmers.com.au/ accessed on {23/01/2018}.
Day, R. and Stuart, R., (2013), “New lease accounting proposal: what it means and what
companies can do to prepare.” Financial Executive, 29(6), pp.11-13.
FASB, (2016), “New Guidance on Lease Accounting” available at
http://www.fasb.org/jsp/FASB/FASBContent_C/NewsPage&cid=1176167901466 accessed on
{23/01/2018}.
Ely, K.M., (2015), “Operating lease accounting and the market's assessment of equity
risk”. Journal of Accounting Research, pp.397-415
Gross, A.D, (2014). “The path of lease resistance: How changes to lease accounting treatment
may impact your business”. Business Horizons, 57(6), pp.759-765.
Knubley, R., (2010). “Proposed changes to lease accounting”. Journal of Property Investment &
Finance, 28(5), pp.322-327
Lim, S.C., (2014), “Market Recognition of the Accounting Disclosure and Economic Benefits of
Operating Leases: Evidence from Borrowing Costs and Credit Ratings”.
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Ma W, (2011), “Impact on Financial Statements of New Accounting model for leases” available
at http://digitalcommons.uconn.edu/cgi/viewcontent.cgi?article=1194&context=srhonors_theses
accessed on {23/01/2018}
Moore, S. and Nagy, A., (2013), “CONTRACT STRUCTURING UNDER THE NEW LEASE
ACCOUNTING RULES: THE CASE OF CUSTOM DESIGN RETAIL, INC.” Global Perspectives
on Accounting Education, 10, p.81
Singer, R, ( 2017), “Accountinq for Leases Under the New Standard, Part 1: Definition and
Classification of Leases and Lessee Accounting”. CPA Journal, 87(8).
Singh, A.,( 2011). “A restaurant case study of lease accounting impacts of proposed changes in
lease accounting rules”. International Journal of Contemporary Hospitality Management, 23(6),
pp.820-839.
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