ACF3100 - Woolworths and the Impact of IFRS 16 Lease Accounting

This report examines the impact of IFRS 16 Leases on Woolworths' financial reporting. It discusses how the new lease standard, effective from January 1, 2019, necessitates recognizing all leases on the balance sheet, affecting various financial aspects. The report details the changes in expense recognition, the treatment of lease liabilities as principal and interest loans, and the impact on key financial metrics such as net debt, gearing, EBITDA, EBIT, and PBT. It also addresses the potential impact on debt covenants, share-based payments, and thin capitalization calculations. Furthermore, the report recommends that Woolworths abolish the distinction between operating and finance leases, recognize ROU assets and associated liabilities, measure them at present value, and treat lease liabilities as financial liabilities. It emphasizes the need to record existing lease commitments on the balance sheet and apply depreciation to ROU assets. This analysis provides insights into the administrative burden and complex elements of lease agreements that Woolworths must manage under IFRS 16.

Running head: ADVANCED FINANCIAL ACCOUNTING
Advanced Financial Accounting
Name of the Student
Name of the University
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).

3ADVANCED FINANCIAL ACCOUNTING
Thus, from the above discussion, it can be seen that there will be a huge administrative
burden on Woolworths in order to capture all the required information for the correct calculation
of lease liability. Apart from this, Woolworths will have analyze and evaluate different complex
and inter-related elements of lease agreements.
Requirement (iv)
Due to the introduction of the new lease standard of IFRS, Woolworths will have to make
some major changes in their accounting treatments of leases. It implies that the company has to
follow the new standard for the treatment of existing leases and new leases. For this reason, it is
recommended to Woolworths that they should abolish the distinction between operating leases
and finance leases in the financial statements. Thus, at the time of the inception of any lease, the
company is recommended to recognize a ROU and the liabilities associated with it. Due to the
introduction of this lease standard, Woolworths is recommended to measure the ROU and the
lease liabilities at the present value of the minimum lease payment. In addition, the
recommendation to Woolworths is to use interest rate of leases for the determination of present
value (ey.com, 2018).
It is recommended to Woolworths that to include some specific aspects for the
calculation of ROU in new lease standard. Woolworths needs to include any payment made to
the lessor at or before he beginning date of the lease. Apart from this, the company is
recommended to include the direct costs incurred at the time of the lease (kpmg.com, 2018).
It needs to be mentioned that the company is required treat the lease liability of their
business as the financial liability and they are required to be measured at amortized costs. Most
importantly, it is recommended to Woolworths that they should show the financial liability of

4ADVANCED FINANCIAL ACCOUNTING
lease in the company balance sheet. From the 2017 Annual Report of Woolworths, it can be seen
that the company has an operating lease commitments worth $24,438.8 million in 2017 and
$24,729.6 million in 2016 (woolworthsgroup.com.au, 2018). Due to the introduction of this new
lease standard of IFRS 16 Leases, Woolworths is recommended to record these lease
commitments in the liability side of balance sheet. Woolworth is also recommended to apply
depreciation on the ROU based on the provided depreciation rate (pwc.com.au, 2018).

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References
http://www.accaglobal.com, A. (2018). IFRS 16, Leases | F7 Financial Reporting | ACCA
Qualification | Students | ACCA Global. Accaglobal.com. Retrieved 20 April 2018, from
http://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-
study-resources/f7/technical-articles/ifrs16.html
2017 ANNUAL REPORT. (2018). Woolworthsgroup.com.au. Retrieved 20 April 2018, from
https://www.woolworthsgroup.com.au/icms_docs/188795_annual-report-2017.pdf
How will the new leases standard affect retailers?. (2018). Pwc.com.au. Retrieved 20 April
2018, from https://www.pwc.com.au/assurance/ifrs/assets/new-leasing-standard-and-
retailers.pdf
IFRS 16: The leases standard is changing Are you ready?. (2018). Pwc.com.au. Retrieved 20
April 2018, from https://www.pwc.com.au/assurance/ifrs/assets/ifrs-16-lease-
brochure.pdf
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https://www2.deloitte.com/content/dam/Deloitte/au/Documents/audit/deloitte-au-audit-
aasb-16-guide-220916.pdf
Leases A summary of IFRS 16 and its effects. (2018). Ey.com. Retrieved 20 April 2018, from
http://www.ey.com/Publication/vwLUAssets/ey-leases-a-summary-of-ifrs-16/$FILE/ey-
leases-a-summary-of-ifrs-16.pdf

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O'Donovan, B. (2018). New leases standard – Introducing IFRS 16. KPMG. Retrieved 20
April 2018, from https://home.kpmg.com/xx/en/home/insights/2016/01/leases-new-
standard-balance-sheet-transparency-slideshare-first-impressions-ifrs16-130116.html
IFRS 16 — Leases. (2018). Iasplus.com. Retrieved 20 April 2018, from
https://www.iasplus.com/en/standards/ifrs/ifrs-16