Impact of IFRS 16 Leases on Woolworths

Running head: ADVANCED FINANCIAL ACCOUNTING
Advanced Financial Accounting
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Author’s Note

1ADVANCED FINANCIAL ACCOUNTING
Requirement (iii)
Woolworths is one of the major Australian companies operating in the Australian retail
market. It is considered as the second largest retail companies in Australia by revenue. In
Australia, the Australian Accounting Standard Board (AASB) has adopted the new lease
standard of International Financial Reporting Standard (IFRS) 16 Leases that will be effective
from 1 January 2019 (accaglobal.com, 2018). It needs to be mentioned that this new lease
standard will have major impact on different financial aspects of Woolworths. Due to the
implementation of the new lease standard, the retail companies of Australia will have to record
all of their leases in the balance sheet and will have to change the lease profile every year. In
Woolworths, some specific areas will be impacted with the introduction of this new lease
standard and they are discussed below:
Under the new standard of IFRS 16, all the leases of Woolworths will be recognized in
the balance sheet as lease liability and a corresponding ‘right-to-use’ (ROU) asset. There will be
a change in the recognition of expenses in the income statement of Woolworths. More
specifically, there will be change in the way of presenting expenses in the income statement
along with timing of cost recognition for lease in each year. Under this new lease standard,
Woolworths will consider the lease liability as equivalent to a principal and interest loan. Thus,
in the later years, the company will have to pay principal amount (iasplus.com, 2018).
Apart from the above, the adoption of new lease standard will affect some of the key
financial metrics monitored by the stakeholders of Woolworths. First, there will be an increase in
net debt and gearing of the company due to the new lease standard. However, it will exclude the
ROU assets of the leases. Due to the introduction of this new lease standard, there will not be any

2ADVANCED FINANCIAL ACCOUNTING
inclusion of the lease expense in the income statement of Woolworths. For this reason, there will
be an increase in Earnings before Interest Tax Depreciation and Amortization (EBITDA)
(pwc.com.au, 2018). The new standard of IFRS 16 Leases will convert part of the lease cost of
Woolworths into interest expenses that includes Earnings before Interest and Tax (EBIT). For
this reason, there will be an increase in the EBIT of Woolworths. Under the new lease standard,
Woolworths will have to pay more interest in the initial lease period. For this reason, there will
be decrease in Profit before Tax (PBT) of Woolworths. In addition, there will be uncertainty
regarding the impact of these financial metrics in future as there will be change in the portfolio
of leases and renewals. Hence, it will be required for Woolworths to carefully manage their lease
portfolio (pwc.com.au, 2018).
Moreover, this new lease standard will have potential impact on some other financial
areas of Woolworths. There will be changes in the debt covenants of Woolworths due to the
introduction of IFRS 16 Leases as re-negotiation needs to be done in the lease agreements. For
the metrics of share-based payment, re-negotiation needs to be done for performance hurdle. The
new standard will bring change in net debt of the company that will affect the thin capitalization
calculation and tax deductibility of interest of Woolworths (www2.deloitte.com, 2018).
Most importantly, while calculating the lease liabilities, Woolworths will need to
consider some specific areas. First, the company is required to determine the aspect of contingent
rent and whether contingent rent is in-substance fixed. Woolworths is required to consider the
renewal/purchase option. It implies that the company needs to include some market-price
renewal option in the lease liability. Apart from this, Woolworths is required to separate and
exclude bundled services at the time of the calculation of lease liability (www2.deloitte.com,
2018).