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As a new accounting graduate you have recently joined the accounting department of an ASX listed company. To complete this assignment, you will need to select a suitable company yourself that meets the following criteria:

  • The company must be a constituent of the S&P/ASX 300 index (asx300list.com);
  • The company cannot be in the ‘Financial’ sector;
  • The company must publish audited annual financial reports in English, fully complying

with IFRS or AASB standards;

  • The company must have a 30 June year end.

The Chief Financial Officer (CFO) approaches you with your first task. One of his responsibilities is to monitor the development of new and revised accounting standards in order to be aware of potential impacts on the company as early as possible. One of the major issues facing your company is the changes to AASB 117 Leases and the transition to AASB 16 Leases from 1 January 2019. The CFO has been researching on this and has studied the press releases issued by AASB in the past regarding this and has been comparing the changes between the two standards.

Since your company have many leases agreements, he is highly concerned about the impacts the new accounting standard for leases could have on the company's financial position and performance.

You have been asked to undertake some research and prepare a report for presentation at the next board meeting, to be held on 8 November 2018. Your report must address each of the following:

  1. a description of leases your company (as the lessee) currently has and how they are recognised, classified and presented in the latest annual report of your company according to AASB 117 or IAS 17 and a summary of the new rules according to AASB 16 Leases or IFRS 16 for the classification, recognition, initial and subsequent measurement, and the presentation of leases from the perspective of a lessee .
  2. an analysis of the potential impacts on the company’s financial position and performance from the application of the new rules (if the new rules were applied) to current lease contracts as per latest annual report.
  3. an evaluation of whether AASB 16/IFRS 16 improves financial reporting (you are required to refer to the Conceptual Framework for the objective of GPFR and qualitative characteristics of useful financial information).
  4. in the form of a conclusion, recommended actions to best prepare your company and the financial reporting unit for the new accounting treatment.
Background

It is needed for the business organizations to comply with the required accounting standards and regulations in the process of financial reporting. In this process, it is their responsibility to consider the revised accounting standards and regulations in different aspects of financial reporting (Nobes 2014). In Australia, the Australian Accounting Standard Board (AASB) has introduced the new and revised lease standard that is AASB 16 or IFRS 16. The main aim of this report is the lease accounting of Wesfarmers Limited.

It can be observed from the 2018 Annual Report of Wesfarmers that the company has recorded about the operating leases in the notes to the financial statements under Commitment and Contingencies. Wesfarmers has three types of operating leases; that are leases within one year, leases greater than one year but less than five years and leases more than five years (Wesfarmers.com.au 2018). The amount of leases less than one year in 2018 and 2017 is $2323 million and 2417 million respectively. The amount of lease commitments more than one year by less than five year is $ 7618 million in 2018 and $7989 million in 2017. The amount of leases more than five years is $8432 million and $9159 million in 2018 and 2017. The total operating lease commitments of Wesfarmers for 2018 and 2017 are $18373 million and 19565 million respectively (Wesfarmers.com.au 2018).

As per the annual report, Wesfarmers does the recognition of finance and operating leases based on the fact that whether they possess risks and rewards related to the ownership of leased assets. The company does not include rents under the classified leases. In 2018, Wesfarmers has recognized the operating lease payments as an expense in the income statement on straight-line basis over the term of lease. The company has recognized the incentives for operating leases as a liability (Wesfarmers.com.au 2018).

AASB 16 Leases or IFRS Leases: With the help of this revised standard, AASB has introduced a single model for lease accounting and it puts the obligation on the lessees to recognize all leases as assets and liabilities with a term of more than 12 months. Thus, the requirement for the lessees is to recognize a right-to-use asset and a lease liability that provides the lessees with the right to use the assets and liabilities for making the lease payments. The companies will be required to treat the right-to-use asset as other financial aspects that need to be depreciated (iasplus.com 2018).

Wesfarmers' Operating Leases

It needs to be mentioned that the new lease standers will have major impact on the financial performance and position of Wesfarmers. After the application of AASB 16 in the current lease contracts of Wesfarmers, the present value of these lease commitments would be shown as liability in the statements of financial position with assets that represent right-to-use (Wesfarmers.com.au 2018). Hence, the increase in the liability would degrade the financial position of the company. At the same time, Wesfarmers will be needed to split the occupancy-related expenses between amortization and interest expenses. Thus, the increase in the expenses will negatively affects the profitability of Wesfarmers (Wesfarmers.com.au 2018).

  Leasing the real estate is a major activity of the retailers like Wesfarmers. In the presence of new lease standard AASB 16, Wesfarmers may need substantial judgment at the time to determine and reassess economic incentives for renewing retail lease locations (Dimitropoulos et al. 2013). At the same time, Wesfarmers will be needed to implement systems for the estimation and re-measurement of variable payments that are linked with index at the spot rate for every reporting period. In addition, Wesfarmers will be needed to split service charges from the elements of lease. On the overall basis, AASB 16 will initially affect the financial position and performance of Wesfarmers due to increase in debts, expense and complexities in lease treatments (pwc.com 2018).     

As per the above discussion, the new lease standard will lead to the inclusion of a lease liability and right to use asset on the balance sheet. It implies that the companies will have to include the costs for using lease assets along with the benefits in the balance sheet. This will contribute towards more exact representation of financial position of the companies as it will reflect all the liabilities so that the investors can get the useful information about the companies. At the same time, it will lead to more integration between the business departments related to lease agreements (Verriest, Gaeremynck and Thornton 2013). The main objective of the general purpose financial reporting (GPFR) is to provide the investors with the required financial information for decision-making; and new lease standard will fulfill this objective of GPFR by providing them with the useful information about lease commitments. In addition, as per the qualitative characteristics of financial information, financial information must be relevant and must be represented faithfully. The new lease standard will improve financial reporting by including most relevant lease information for the investors. Additionally, adherence to this lease standard will ensure the faithful representation of the financial information related to leases (Müller 2014).

Conclusion and Recommendations

Based on the above discussion, some recommendations are provided below for Wesfarmers to prepare for the adoption of the new lease standard:

  1. There will be need of effective project governance for Wesfarmers for the adoption of AASB 16 and thus, Wesfarmers will be needed to include representatives from different departments in the adoption process like finance and accounting, operations, procurements, IT, taxation, treasury and investor relations (deloitte.com 2018).
  2. Wesfarmers should conduct a readiness assessment to measure the level of challenge in the AASB 16 adoption process.
  • Wesfarmers needs to gather the required data for the adoption of AASB 16.
  1. In this process, Wesfarmers should take into consideration the effects as well as communication impact in the adoption of AASB 16 (deloitte.com 2018).

References

Dimitropoulos, P.E., Asteriou, D., Kousenidis, D. and Leventis, S., 2013. The impact of IFRS on accounting quality: Evidence from Greece. Advances in Accounting, 29(1), pp.108-123.

Iasplus.com. (2018). IFRS 16, Leases [Completed]. [online] Available at: https://www.iasplus.com/en-ca/projects/ifrs/completed-projects-2/leases [Accessed 1 Oct. 2018].

Müller, V.O., 2014. The impact of IFRS adoption on the quality of consolidated financial reporting. Procedia-Social and Behavioral Sciences, 109, pp.976-982.

Nobes, C., 2014. International classification of financial reporting. Routledge.

Pwc.com. (2018). [online] Available at: https://www.pwc.com/gx/en/services/audit-assurance/assets/ifrs-16-new-leases.pdf [Accessed 1 Oct. 2018].

Verriest, A., Gaeremynck, A. and Thornton, D.B., 2013. The impact of corporate governance on IFRS adoption choices. European accounting review, 22(1), pp.39-77.  

Wesfarmers.com.au. (2018). Annual Report 2018. [online] Available at: https://www.wesfarmers.com.au/docs/default-source/reports/wes18-044-2018-annual-report.pdf?sfvrsn=6 [Accessed 1 Oct. 2018].

Www2.deloitte.com. (2018). Leases: A Guide to AASB 16 [online] Available at: https://www2.deloitte.com/content/dam/Deloitte/au/Documents/audit/deloitte-au-audit-aasb-16-guide-220916.pdf [Accessed 1 Oct. 2018].

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[Accessed 23 July 2024].

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