Impact of AASB 16 on Lease Financing

This report evaluates the impact of the new accounting standard AASB 16 on lease financing, including changes in financial statements and leasing habits. It also discusses the improved comparability between companies that lease assets and those that borrow to buy assets. The report includes key disclosures made by Woolworths Group in its annual report.

Leasing
Module Number-
[DATE]
Hewlett-Packard
[Company address]

Abstract
The current report has been presented to critically evaluate the new accounting
standard for lease financing being AASB 16, Leases. The reason for replacing of earlier
AASB 117 due to its drawbacks has been discussed. The provisions set by the newly
formulated standard AASB 16 are discussed in the report, with main discussion about the
effect casted on the financial statements of companies dealing significantly in lease financing.
The possible effect on the leasing habits because of change brought by the standard are also
discussed. The effect of the pronouncement of the accounting standard on the comparability
between the financial statements of companies using the lease assets and owned assets is also
conversed. In the final section the key disclosures highlighted by Woolworths Group in its
annual report in relation to the transitional provisions adopted by the company are shown.
The disclosures made by the company represent the effect of the application of the new
AASB 16 on the consolidated statement of financial position as at 24th June 2018.

Table of Contents
Abstract..........................................................................................................................1
Introduction....................................................................................................................2
Drawbacks of old accounting standard for lease, AASB 117...............................................2
Why was the change necessary.........................................................................................3
Changes incorporated by new accounting standard.............................................................3
Effect of change on companies having significant level of lease financing...........................4
In the former accounting standard for lease (AASB 117) both operating lease and finance
lease were allowed, why did companies have a tendency to classify most of the lease contract
as operating lease? How does positive accounting theory relate to this behaviour of
managers?.......................................................................................................................5
Improved comparability between the companies that lease assets and companies that borrow
to buy assets because of implementation of IFRS 16..........................................................5
Possible explanation as to why after the implementation of AASB 16, reporting entities might
be more likely to buy more assets and lease fewer assets....................................................6
The key disclosures made by Woolworths Group on its accounting for leases including on the
transitional provision and effect of the transition to AASB 16 from AASB 117....................7
Conclusion......................................................................................................................8
References......................................................................................................................9

Introduction
AASB 16, Leases has been formulated to replace the former accounting standard dealing with
leases, i.e. AASB 117. The provisions set by AASB 16 are equivalent to the provisions
marked by the IAS 17, Leases. The purpose of setting of AASB 16 is setting up of a broad
model dealing with the identification and financial statement treatment for the lease
arrangements entered by both the lessor and lessee. The provisions of the newly formed
AASB 16 are different from earlier AASB 17 and the listed entities are mandated to switch to
the new standard. Switching to the new standard requires implementation of transitional
provisions. These transitional provisions are discussed in the current report with the example
of information disclosed in the annual report of Woolworths Group.
Woolworths Group works in the retail industry and is headquartered in Bella Vista, in New
South Wales Australia. The company is named as second largest Australian corporation in
terms of revenue. The group is known in Australia mainly for the super market chain it
operates therein.
Drawbacks of old accounting standard for lease, AASB 117
The main drawbacks of the earlier applicable AASB 117, Leases dealing with accounting of
leases are listed in the following sections. These drawbacks framed a major criterion for the
authorities to replace the AASB 117 with AASB 16.
 The state of financial statements was misrepresented when AASB 117 was applicable. The
financial statements only represented the lease liabilities and right-to-use assets in case of
finance leases earlier. The reporting of operating leases was limited to note to accounts. The
liability in case of operating leases was only shown in notes and hence remained unread by
most readers. The financial statements hence lacked transparency then.
 The lessee companies shall be now required to fully disclose all the lease liabilities in the
balance sheet, which earlier were only informed about in the notes to financial statements. It
may result to issues in complying with the domestic and international reporting frameworks.
 Due to the application of AASB 117, most of the lessee companies having large lease
portfolios opted for classifying their most of the leases as operating leases to remain safe
from disclosing lease liabilities in balance sheet. The classification that was actually required
for the type of lease was erroneously modified to gain advantage. This gave them the

opportunity to play with financial statements and manipulate the real state of their financial
position. This policy could be taken as equal to earnings management, as the readers only
saw what was in financial statements and considered the liability of entities to be lesser than
it actually was. Their credit risk kept hidden under the name of operating leases (Xu,
Davidson, and Cheong, 2017).
 Even when the disclosures about the off-balance sheet operating liabilities was made in the
notes to financial statements, many readers used to find the information insufficient to reflect
completely the obligations attached with those leases. The presentation style too did not
reflect the actual state of affairs.
 There is need to align the domestic reporting framework of the organization with the
international reporting frameworks to avoid the possible issues in determining the capital and
revenue nature lease in the recorded framework.
Why was the change necessary
The earlier AASB 117 required classification for leases as finance lease or operating lease.
The identified operating leases were allowed to be transacted off balance sheet and no
reporting was required in the financial statements. The only effect on financial statements
was upon the profit & loss account because of charging of lease payment as expenses. There
was no charge of either asset or liability in the books relating to the operating leases. Because
of non-presentation of lease liability anywhere, the actual liability always kept hidden from
the stakeholders using the information presented in financial statements. Only place where
disclosures were made in financial statements were in notes to accounts, which again
remained unread by majority of readers. The financial information, due to non-representation
of liability relating to operating leases, was misled. There was no faithful representation in
relation to the lease related transactions (Brumm, Liu, 2019).
To eliminate the misrepresentation of financial statements due to differential treatment
followed for operating and finance leases, the old AASB 117 was decided to be eliminated by
the standard setting authorities. In place of AASB 117, AASB 16, Leases was introduced.
The introduction of this standard brought in effect a single system of accounting for both
operating and financing leases. Resultant, the earlier discrepancy got eliminated and now,
accounting is required for both kinds of leases. The issue in the lease recording framework
arise due to the procedural work used for the recording of the lease items.

Changes incorporated by new accounting standard
 The accounting model adopted by new AASB 16 is single. The model followed earlier just
for financing lease is now followed for both operating and finance leases and lessees are no
longer required to initially determine whether a lease is operating or financing. This is the
change which shall impact upon the accounting earlier followed by the lessees. Any off
balance sheet treatment has been done away with now. However, still exemption to treat off
balance sheet is yet available for low value asset lease and short term lease (i.e. less than 12
months) (Joubert, Garvie, and Parle, 2017).
 As far as the accounting model for lessors is concerned, the AASB 16 does not bring
significant change into that except the enhancement of the disclosure process. The additional
disclosure required from the end of lessor relates to risk management related activities. Also,
the AASB 16 has disallowed the non-resources debt netting as the leveraged lease model is
now removed. Further, the change is observed in the treatment followed for residual value
guarantees (Kabir, and Rahman, 2018).
Effect of change on companies having significant level of lease financing
The main effect of the change is undoubtedly to be observed significantly upon the
companies that have significant level of lease financing. However, the major impact yet shall
be upon those relying on operating leases as compared to those with reliance upon finance
lease.
For the entities that have significant level of operating leases shall face a transformation in
the statement of financial position. The indicators signifying the finances shall drastically
change because the balance sheet shall now be required to add some assets as well liabilities
which were earlier treated off balance sheet. Earlier only the profit & loss statement was
affected by operating leases, but now the balance sheet shall also show the effects (Giner,
Merello, and Pardo, 2018).
The lessee companies shall be now required to fully disclose all the lease liabilities in the
balance sheet, which earlier were only informed about in the notes to financial statements.
The impact is major, as the accounting is changed and so is the presentation. The major
corporations are even expected to be required to create new departments for just accounting
the new lease requirements. The effort and money expenditure to deal with the impact is
supposed to be high in the initial adoption at least (Dakis, 2016).

In the former accounting standard for lease (AASB 117) both operating lease and
finance lease were allowed, why did companies have a tendency to classify most of the
lease contract as operating lease? How does positive accounting theory relate to this
behaviour of managers?
As seen above, the earlier accounting standard followed a dual model for accounting of
operating and finance leases. While the finance leases were compulsorily required to be
reported in financial statements and ease was seen in case of operating leases. The liability
and asset against operating leases were exempted to be reported in the balance sheet and were
allowed to be carried off balance sheet. A mere disclosure regarding the asset and liabilities
in relation to operating leases was required in the notes to financial statements. The entity
was able to misrepresent the financial statements and true picture of liability was not shown
to the readers of financial statements. The ease in method and opportunity to present
financials in a better state was a main motive behind the tendencies of organisations earlier to
classify most of the lease contracts as operating leases (Brumm, & Liu, 2019).
Positive accounting theory presents an organisation as an accumulation of all the contracts
entered by it. The motive of this theory is to minimize the contracts’ cost to make them look
more valuable. The use of this theory in operation usually leads to the organisations hiding
their material aspects to depict contracts attached with lower costs and organisation looking
more valuable (Kothari, 2019).
There is a relation between the practice of managers classifying most of the leases as
operating lease and positive accounting theory because classification of leases as operating
lease allowed the managers to hide the material liability attached to leases. This led to
showing the financials in a better state with lower obligations than actually headed on entity,
i.e. the costs were tried to be minimised as approached by positive accounting theory (Raj, &
Roy, 2016).
Improved comparability between the companies that lease assets and companies that
borrow to buy assets because of implementation of IFRS 16
The companies who borrow money to buy asset follows an accounting model in which the
assets they own are shown in the balance sheet on the asset side, and the liabilities they have
to pay, i.e. the borrowings are shown on the liabilities side. A dual effect is seen on the
balance sheet and the entire financial statements (Ogilvy, et al. 2018).

After the implementation of IFRS 16, all the companies operating anywhere in the world, if
required to comply with the guidelines of international accounting standards are required to
follow a single and realistic accounting model for lease transactions. Any form of lease, be it
operating of finance lease, shall affect two sides of a balance sheet. An asset shall be created
in the books of lessee and at the same time a lease liability shall also be created. IFRS 16 is
an umbrella standard based upon which the lease accounting standards as followed by every
listed entity, irrespective of the location shall be based. No off-balance sheet treatment of
lease transaction is allowed after the implementation of IFRS 16, except lease of low value
asset (i.e. US$ 5000 or less) and short term leases (i.e. less than 12 months).
As seen from the treatment followed by companies borrowing to buy asset, and leasing asset,
the implementation of IFRS 16 has brought a common accounting treatment, i.e. creation of
an asset and at the same time creation of a liability (Morales-Díaz, and Zamora-Ramírez,
2018).
E.g.: ABC concern borrows $10,000 to buy a plant for water filtering. The effect shall be,
showing a plant of $10,000 on asset side, and borrowings of $10,000 on liability side. The
competitor of ABC concern, XYZ Company leases the same plant for $10,000 and pays no
down payment. A simple treatment would be recording plant on asset side at $10,000 and
recording lease liability of $10,000. The reader reading the financials of both companies can
easily compare the transactions entered by both the companies (Giner, Merello, & Pardo,
2018).
Hence, it can be said that the implementation of IFRS 16 has improved comparability.
Possible explanation as to why after the implementation of AASB 16, reporting entities
might be more likely to buy more assets and lease fewer assets.
Introduction of the new AASB 16 has leashed the opportunity from the hand of organisations
to misstate the financials by classifying most of their leases as operating leases. The liability
of lease is now must to be entered in the financials. There is no way present to hide it from
the stakeholders (Abbott, & Tan‐Kantor, 2018). Also the reporting requirements for lease
transactions are now extended. Implementation of IFRS 16 has raised the costs for companies
that had material leases off balance sheet and that would have such transactions lined for
future as well. For companies who shall lease now have to follow AASB 16 with some
ongoing costs in for obtaining information periodically for reporting lease assets and lease

liabilities on every reporting date. These could also be termed as re-measurement costs. Costs
are also to be incurred by organisations to determine discount rates now. Also, for the
companies whose lease portfolio is huge, the extended disclosure requirement shall also incur
costs. The financial information, due to non-representation of liability relating to operating
leases, was misled. There was no faithful representation in relation to the lease related
transactions. Mainly in every case the burden is largely upon the lessee side (Hladika, and
Valenta, 2018).
The impact of applying AASB 16 is huge as already seen. The lessee companies shall
certainly reconsider their lease strategies. It is likely from the part of the lessee companies
with large lease portfolio to now rather buy assets than to lease them because of the extended
regulations imparted upon them. Also the use of single accounting model has snatched the
opportunity to keep certain liabilities off balance sheet earlier. Hence, the implementation of
ASSB 16 is expected to have an impact upon the leasing market certainly (Baskerville,
George, & Makale, 2018).
The key disclosures made by Woolworths Group on its accounting for leases including
on the transitional provision and effect of the transition to AASB 16 from AASB 117.
KEY DISCLOSURES MADE IN ANNUAL REPORT
It is analysed that the lessee companies shall be now required to fully disclose all the lease
liabilities in the balance sheet, which earlier were only informed about in the notes to
financial statements. However, failure to meet these lease provisions of the company may
result to high penalties to company. Woolworths Group has clearly inserted a note in its
annual report in relation to the new AASB 16, Leases. The company mentions about
replacement of their earlier followed AASB 117 with the new AASB 16. The change in the
accounting of operating leases now by recognition of asset with name right-of-use (ROU)
asset and corresponding lease liability in the Consolidated Statement of Financial Position is
being correctly stated. The effect of the same upon the statement of financial performance is
also mentioned. The group shall now recognise depreciation upon the right-of-use (ROU)
asset and interest expense upon the lease liability. Disclosures have been made about the
impact upon the accounts of financial year 2018 to make them comparative with the
financials of upcoming year 2019, as the company has prepared to adopt the AASB 16 from 1
July 2019 (Han, Chand, & Mala, 2019).

The group expects the property leases for warehousing facilities, support offices, distribution
centres and retail premises to be mainly effected by the impact of the new AASB16 (Chen, et
al. 2018).However, disclosure related to the changes in the lease recording needs to be made
in the notes to accounts attached with the annual report of company. The main effect of the
change is undoubtedly to be observed significantly upon the companies that have significant
level of lease financing. However, the major impact yet shall be upon those relying on
operating leases as compared to those with reliance upon finance lease which would be
disclosed in the recorded items off the
TRANSITIONAL PROVISIONS
The AASB 16 is to be applied to the organisation using a “modified retrospective approach”
from 1st July 2019. The entire effect that AASB 16 shall have on the financials of year 2018
shall be only adjusted in the retained earnings balance carried forward on 1st July 2019. The
entire comparative information is not restated by the company. The effect of change shall
apply on company’s position as a lessee and not as a lessor. The estimated on the lease
liabilities and Right-to-use assets for financial year 2018 due to the transition are mentioned
as follows:
The net effect casted by these lease liabilities and right-to-use assets shall be recognised
against the retained earnings at the end of financial year 2018, after adjusting the net effect by
reversal of existing incentive liability and straight line lease of $260 million and deferred tax.
This balance of retained earnings shall be then used to start the financials for year 2019
(Ogilvy, et al. 2018).

Another important transitional disclosure made by the group relate to the non-lease
component of the property lease. AASB 6 exempts payment for non-lease component from
the lease liability except when the lessee company specifically chooses to combine the non-
lease and lease component. The group on account of having material non-lease component in
the leased portfolio elects to not combine both of them. Resultant, the price of the non-lease
component taken on a stand-alone basis shall be excluded from the lease liability of the
property leases. Hence, the entity has estimated the price of non-lease component
individually from the accumulated undiscounted operating lease commitment of worth $22.9
billion for financial year 2018. The estimation of standalone non-lease component is worth
$3,807 million for year 2018. The standalone non-lease component for financial year 2017 is
measured at $4,014 million (Giner, Merello, & Pardo, 2018).

Conclusion
It is analysed that financial information, due to non-representation of liability relating
to operating leases, was misled in the report. There was no faithful representation in relation
to the lease related transactions. However, various provisions of the lease and undertaken
work have been given in this report. The lease determination for the capital nature and
revenue nature is determined on the basis of the lease provisions. The New AASB 16 is
implemented to remove the erroneous and fraudulent practices for which AASB 117 was
started to be used by many corporations. The initial phase when AASB 16 has been
introduced however is facing much resentment from public. The main resentments are from
lessee corporations. Their efforts as well as cost are certain to raise atleast in the preliminary
phase because of the transition to the new standard. Also a drastic change shall be felt in their
financial statements as the transition is certain to impact upon the capital structure as well as
the profitability. However, the AASB 16 is very certain to leash out the unethical practices
followed in the shade of operating leases in AASB 117. The major benefit is for the
stakeholders of financial statements. Earlier the major liability by lessee corporations was just
reported in notes to accounts and never shown in the balance sheet. This kept the stakeholders
in a state of unawareness. Now the readers shall get a complete glance about the corporate
condition of an organisation by just simply looking at the financial statements. Also the
disclosure in notes shall be improved to impart to the understanding and comparability. The
users shall be more equipped to compare the financials of companies leasing assets and the
companies who borrow to buy assets. At the same time, the difference in the approach of two
companies shall also be known to the users.

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