The main aspects of IFRS 16 "lease" and analysis of their consequences for companies
Table of contents: The Kazakh-American Free University Academic Journal №10 - 2018
Author: Toleukhanova Aziza,
Kazakh-American Free University, Kazakhstan
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 .
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 .
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) .
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 .
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 .
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 .
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).
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 .
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
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 .
Let's give an example to illustrate the accounting of a
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
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)
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
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
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
- 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
- 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
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and specific features. Moscow: IPC "League of Reason", 2007.
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Table of contents: The Kazakh-American Free University Academic Journal №10 - 2018