AASB 16 Leases: Assess the financial impact now

Is the new Leasing Accounting Standard AASB 16 just changing accounting numbers or will disclosure of the financial impact which is imminent, change the way business operates?

While AASB 16 Leases which requires Operating Leases to be put on the balance sheet, does not apply to financial statements for reporting entities until 31 December 2019 and 30 June 2020 balances dates, the market has for some time been estimating what the impact of AASB 16 will have on various companies and industries.

Additionally, whilst there has to date been little disclosure by companies of the likely impact of AASB 16, December balancers are on notice that if they have not made disclosures to date, they will need to disclose the impact in their 31 December 2018 financial statements and June balancers in their June 2019 financial statements according to the Australian Securities & Investments Commission (ASIC). The only exception is for those companies that prepare reduced disclosure requirements financial statements.

https://asic.gov.au/about-asic/media-centre/find-a-media-release/2018-releases/18-159mr-major-changes-affecting-reported-net-assets-and-profit-and-other-focuses-for-30-june-2018-reporting/

The initial market analysis suggests that the way Leases are currently structured, may drastically change, given the impact on key metrics such as increasing Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), but reducing pre-tax profit, and a significant blow out in net debt and gearing ratios that it is argued will lead to additional complexity when discussing borrowings and debt covenants with bankers and other funding providers, including shareholders.

The Australian Financial Review 5 September 2018 quotes Macquarie Equities as estimating that Myer’s net debt would rise from $66 million to $2 billion with net debt /EBITDA leverage rising from 0.4 to 5.3. Similar changes are estimated for Woolworths with net debt rising from $3.8 billion to $5.8 billion with net debt /EBITDA leverage rising from 0.4 to 2.8.

Back in April 2015, Morgan Stanley stated that adoption of the new leasing accounting standard would “will boost earnings before interest, tax, depreciation and amortisation but will reduce pre-tax and net profits, as the amortisation and financing costs will exceed rental payments, especially for faster growing retailers with relatively new leases.” In particular, Morgan Stanley argued that “the impact on retailers will be considerable", blowing out gearing levels and reducing return on capital employed, but will vary from retailer to retailer.”

Clarity’s Autumn 2017 edition, in particular, an article authored by Shaun Lindemann, Partner of PKF Hacketts (Brisbane), drew attention to the need to carefully consider the impact of AASB 16, including EBITDA, Net Debt/Gearing and remuneration and dividend policies.

As we get closer to the operative date of AASB 16, and only three months before disclosures of the impact of AASB 16 for December balancers, action becomes more imminent. It may be time to talk to your trusted PKF audit team.