The main aspects of IFRS 16 "lease" and analysis of their consequences for companies

The ongoing transformation of accounting and preparation of financial statements based on the Accounting Reform Program in accordance with International Financial Reporting Standards is designed to ensure harmonization of domestic and international accounting and reporting rules. International Financial Reporting Standards (IAS), developed by the International Accounting Standards Committee (IASC), are adopted as the basis for the development of accounting standards in accordance with the main directions of development of accounting at the international level [1].

Lease (rent) is an agreement whereby the lessor transfers the right over a certain period of time to use the asset that is his property to the lessee in exchange for a payment or a series of payments. Rent is divided into financial (or leasing) and operating.

A lease is considered financial if substantially all the risks and rewards which connected to ownership of the asset, regardless of the transfer of ownership, are transferred to the lessee. That is, he gets the same rights and responsibilities, as if he has not rented the object, but buys it in installments. In this case, the leased property is reflected on the lessee's balance sheet both as an asset and as a liability. Otherwise, users of reporting can be misled about the true state of affairs in the company [2].

Operating rent, according to IFRS, are any other form of rent that does not meet the definition of leasing. It is reflected in the lessor's balance sheet, not appearing in the lessee's balance sheet. Expenses / incomes on rent of the lessee / lessor are visible in the income statement.

Most real estate organizations will act as lessors in rental transactions. The appearance of the new standard has practically not changed the accounting procedure for landlords, but it will have a significant impact on the customer base of the industry, that is, tenants. For example, one of the sectors for which the new standard will have the most noticeable influence is likely to be the retail sector, as it has a high volume of leased premises used to place stores.

The PwC Global Rental Lease Stu-dy, published in February 2016, notes that retail stores will increase the median debt ratio by 98% (due to recognition of lease obligations), and the median EBITDA will increase by 41% (in connection with the exclusion of all rental costs) [3].

In a broader context, real estate rental for retail and commercial property rentals may have a number of common characteristics, such as the possibility of extending the lease and variable rental payments. Historically, tenants accounted such a lease as an operating lease, reflecting lease payments as operating expenses by a straight-line method, without any significant impact on the balance sheet [4].

The new lease accounting standard will have an impact not only on the balance sheet of the tenants, but also on operating expenses, which should be divided into operating and financial costs now. From the perspective of the lessor, it is important to understand the impact of all these changes on tenants, since they can affect the behavior of market participants who will prefer short-term leases or leases with more flexible conditions for different types of contingent payments in order to reduce the amount recognized as a liability on rent.

The new accounting procedure for the lessor is similar to the current requirements, although some aspects have chan-ged.

The landlord decides whether to classify the lease as a finance lease or an operating lease as follows:

- leases for which virtually all risks and rewards of ownership of the underlying asset are transferred are financial leases;

- all other leases are operating leases. This criterion for classifying the lease has not substantially changed compared to IAS 17 [5].

The lessor initially assesses the finance lease receivables in the amount of the present value of future lease payments and the non-guaranteed residual value which is due to the lessor. The lessor discounts these amounts using the rate established in the relevant lease agreement [6].

The objective stated by the IFRS board was to minimize the change in the accounting procedure for the lessor. Most of the requirements of IFRS 16 regarding accounting from the lessor are direct "copying" of the text from IAS 17. This approach was adopted taking into account feedback and comments received from users and other stakeholders that the tenant's accounting procedure "must not be violated".

The main objective of the new standard is to ensure that tenants recognize assets and liabilities under large leases. The tenant applies a single model of rent accounting, in accordance with which he recognizes all large leases in the balance sheet (Figure 1).

Figure 1. Accounting model for tenant

The lease term is a rental period that is not subject to early termination, together with:

- periods for which an option to extend the lease is provided, if there is sufficient confidence that the tenant will use this option and extend the lease term;

- periods after the date of the possible execution of the option to terminate the lease, if there is sufficient confidence that the lessee will not use it and will not terminate the lease ahead of schedule. The options to terminate the lease, available only from the lessor, are not taken into account when determining the lease term [7].

The lease term begins from the moment when the lessor transfers the underlying asset to the lessee.

Tenants calculate the present value of lease payments using the interest rate laid down in the lease agreement. This is the rate at which the present value of lease payments and non-guaranteed residual value will be equal to the sum of the fair value of the underlying asset and all initial direct costs of the lessor. If the tenant cannot easily determine the interest rate laid down in the lease agreement, he uses the rate of borrowing additional borrowed funds.

Lease liability - after initial recognition - is measured at amortized cost using the effective interest method.

In general, the new disclosure requirements are more detailed than those required by IAS 17 - especially with regard to the presentation of information in the cash flow statement. This may mean a change in accounting practices for many companies.

Items of expenditure will be presented as depreciation and interest expense for most leases agreement – with the exception of variable payments that are to be charged to expenses at the time of origination. As a result, the EBITDA in the financial statements of the lessee will be higher [8].

Let's give an example to illustrate the accounting of a company-tenant.

Accounting lease agreement with the service component.

Lease agreement with the service component.

LLP "Ormis" leased 100 square meters of the warehouse at LLP "Central Market" on January 1, 2017 (the date of application of IFRS 16). The lease term is 3 years, the annual payment is 3,000,000. LLP "Central Market" provides its tenant with a weekly cleaning service free of charge. Exactly the same service for cleaning storage facilities in a neighboring building of a competing firm Bereke LLP costs 480 000 tenge annually, and a similar lease without cleaning is 2700000. The discount rate is 10%.

1) First, it is necessary to distribute the amount of payment under the contract into two components: service and lease. The reflection of the lease contract in the reporting of LLP "Ormis" is presented in Table 1.

Thus, the service element of the contract takes 452830 tenge, for the lease - 2547169 tenge per year.

2) The company LLP "Ormis" should make the posting as of January 1, 2017:

Asset (right of use)

Lease liability

In order to calculate the amount of this posting, the lease payments should be discounted at a rate that is given in the condition - 10%. It is not easy to determine a bet in real life. The standard says that you need to use the interest rate implicated in the lease agreement, if it is easy to calculate.

In fact, this is the internal rate of return of the contract, i.e. a rate that relates the fair value of an asset to leases based on direct costs and a set of lease payments, including the non-guaranteed residual value of the asset. If this rate is difficult to determine, then the tenant can use the rates in the calculations that the creditors will require of him when borrowing money in the same amount for the same period.

We have annuity cash flow - three payments at the end of the year, each payment is 2547169 tenge. The discount rate of the annuity is 2.4869 at a rate of 10% for three years.

So, 2,4869 x 2547169 = 6334554.

The current value of the flow of three payments at the end of the year in the amount of 2547169 tenge at the rate of 10% will be equal to 6334554. Therefore, the posting will be as follows:

Asset (right of use)

Lease liability – 6334554

3) Subsequently, depreciation in the amount of 2111518 tenge will be accrued on the asset.

4) The finance charge will be charged to the lease liability as shown in table 2.

5) The total costs associated with the lease will be distributed over the years as follows (Table 3).

From the table below it is clear that in the first year of rent the costs will be slightly higher in comparison with KZT330,000. But in the third year, the total costs under IAS 16 will be slightly lower.

Thus, the mechanism of tenants' reflection of leases in the financial statements of companies was developed in accordance with the requirements of international financial reporting standards. During this mechanism the initial assessment of lease obligations, variable lease payments and the discount rate were reviewed. Lease accounting was also reviewed in accordance with IFRS 16 “Lease”.

In order to ensure uniform approaches to the practical implementation of accounting principles in the reform of the accounting system, it was proposed to give detailed guidance on the implementation of the main principles of accounting in regulatory documents clarifying the nature of complex examples. Accounting of lease can have a significant impact on the business.

Almost all leases will be recognized in the balance sheet by reflecting the asset that is the right to use and the financial liability.

Thus, the IASB Board determined January 1, 2019 as the date of entry into force of the Standard, taking into account the time and resources required for its implementation.

This time allows organizations to analyze the impact of the application of IFRS 16, for example, in terms of the following aspects:

- need for changes in the system and processes; for example, keeping records for each separate lease agreement or portfolio level and performing appropriate calculations;

- judgments necessary for the determination of leases and evaluation of the lease terms;

- potential tax consequences if the accounting of leases for tax purposes is based on the method of accounting applied in the financial statements;

- the impact of the Standard on key indicators, restrictive conditions on loans and management compensation;

- additional data that may be required by organizations to meet the disclosure requirements.

RESOURCES

1. Leasing market of Kazakhstan // Bulletin of the rating agency "Expert RA Kazakhstan". -2017. October 18th

2. IFRS 16 “Leases” // https:// assets. kpmg.com/content/dam/kpmg/pdf/2016/07/ru-ru-first-impressions-ifrs16-2016-rus.pdf //

3. IFRS 16 A new standard for rental accounting // https: // www. pwc. Kz /en/ services/ accountingadvisory/ifrs-16/22-IFRS-16-Real-Estate.pdf

4. IFRS 16 Summary of the new standard // https:// www2. deloitte. com/ content/ dam/Deloitte/ru/Documents/audit/IFRS_news/25-january-2016-rus.pdf

5. Gazman V.D. Lease. – M., 2007.

6. International Financial Reporting Standard http:// online. zakon. kz/ Document/?doc_id=35621517

7. Rahimbekova A. IFRS "Application of International Financial Reporting Standards" // IFRS. - 2009. - ¹2. - p.4.

8. IFRS 16 //http://www. consultant. ru/ document/cons_doc_LAW_202611/

9. Zavidov B.D. Lease contract. General provisions and specific features. Moscow: IPC "League of Reason", 2007.

10. Borodin V.V. Accounting: Textbook for high schools. - Moscow, 2012.