Woolworths and Wesfarmers’ liabilities will double, and Myer’s liabilities will treble in 2019 – not because of a major acquisition but because of new accounting rules (AASB 16 Leases).
Putting this in very simplistic terms – companies that rent space to sell their goods, record that rental expense in their profit and loss account with other expenses such as wages, electricity etc.
However, they would very likely have entered into a lease agreement for a 5 or 6 or even 10-year lease, and it is this commitment that up to now has not been reflected in the accounts of the operator.
Companies are now being forced to bring operating leases onto their balance sheets for the first time, from January 2019.
Whilst the new accounting standard will improve transparency it will also have a major impact on key financial metrics such as gearing ratios and return on invested capital, as the present value of leases will be represented on the balance sheet as an asset and liability. It becomes a bit more complex as companies have to book depreciation and interest expense on leases liabilities rather than rental expense.
All companies with operating leases will be affected, including banks, telcos, airlines and miners, but the biggest impact will be on retailers, particularly large anchor tenants with 10 to 15 year leases.
It is reported that Myer’s total liabilities will blow out from $760 million to at least $2.6 billion. We will see significant changes in gearing and big changes in fundamental ratios that we watch. Investors may get a bit of a fright when all this happens.
Wesfarmers total liabilities will rise from $17.8 billion to $32.7 billion and net debt to EBITDA will increase from 1.4 to 3.1 after the change. Its gearing will rise from 39 percent to 58 percent. Wesfarmers has one of the largest off- balance sheet lease liabilities due to its 3500 Coles supermarkets, Bunnings, Officeworks, Target and Kmart stores. The finance director of Wesfarmers says they have 3500 leases to account for and have put in IT systems costing a couple of million dollars.
Australian Securities and Investments Commission states that it expects companies to disclose the impact of the new lease standard for financial years ending on or after December 2018.
The new lease standard may prompt retailers to opt for shorter lease terms to reduce the impact on balance sheets and earnings.
For further reading on this subject see an article that appeared in the Financial Review – Sept 5 2018