IFRS 16: Accounting and automation by EBS-IT Services in the Oracle solution

The Accounting Pronouncements Committee (CPC) issued Technical Pronouncement CPC 06 (R2), which discusses leasing transactions, whose origin is correlated with International Financial Reporting Standards (IFRS) 16. As a result, CVM Resolution 787 made this pronouncement mandatory for publicly traded companies as of January 1, 2019.

According to CPC 06 (R1), which precedes CPC 06 (R2), “a finance lease is an agreement whereby the lessor transfers to the lessee, in exchange for a payment or series of payments, the right to use an asset for an agreed period of time.” According to the same Committee, "a finance lease is one in which there is a substantial transfer of the risks and rewards incidental to ownership of an asset. Title to the asset may or may not be transferred." An operating lease, on the other hand, "is a lease other than a finance lease."

In practical terms, until the end of 2018, for publicly traded companies, operating leases continue to be accounted for by recording the expense directly in the income statement for the year, without any accounting entry in assets and liabilities. The accounting for finance leases, on the other hand, records the asset in fixed assets, recognizes the lease liability, and records the financial expense and depreciation in the income statement.

With the adoption of IFRS 16, the accounting of operating leases will disappear and assets characterized as arising from leases will be accounted for as right-of-use assets, with their disclosure in a separate line in the balance sheet or by opening the balances in an explanatory note. The disclosure of liabilities follows the same logic. Thus, there will no longer be accounting differences between operating and finance leases, as the event will be treated solely and exclusively as a commercial lease.

Furthermore, it is worth noting that even if there is no formal lease agreement, a rental agreement, for example, can be characterized as a right of use, since the essence of the transaction prevails over the form of the agreement (accounting principle of substance over form).

The table below summarizes what was explained in the paragraph above:

Accounting fora lessee's lease

A small retail business starts operating with R$ 70,000 and purchases R$ 30,000 in merchandise, leaving the remainder in the company's cash account. It then signs a three-year lease agreement with annual payments of R$ 12,000, with an implied interest rate of 10% per year. It is assumed that, over the next three years, this company will earn R$ 25,000 per year with a cost of R$ 10,000. For simplicity, taxes and annual contract adjustment rates were not considered.

The first step in accounting for the lease is to bring the contract amount of R$ 36,000 to present value, considering an annual rate of 10%. Therefore, the right of use and respective lease liability is R$ 29,842.22. Interest expenses total R$ 6,157.78, as shown below.

After recording all entries (the spreadsheet detailing the entries can be downloaded here), the following statement is evident**:

Analysis of accounting entries and resulting impacts

When analyzing the retail company's statement, it is worth noting that the counterpart of the right of use of R$ 29,842.22 (Ref: L4) is composed of the sum of commercial leases of current and non-current liabilities totaling R$ 36,000.00 (Ref: L8 and L11), plus interest to be appropriated from current and non-current liabilities totaling R$ – 6,157.78 (Ref: L9 and L12). This accounting reflects a financial liability (debt) that did not previously exist with operating leases that were only recorded in the income statement. Therefore, debt ratios such as interest-bearing liabilities/EBITDA and net debt/equity will be directly impacted.

With regard to the impact on the result of lease entries, it is worth noting that financial expenses are decreasing (Ref: L19), while the effect of depreciation is calculated linearly (Ref: L20) based on the value of the right of use and the term of the contract. When adding the financial expenses of the lease agreement plus the depreciation for the three years (Ref: L19 and L20), the same amount of operating expense is reached according to the IAS 17 criterion, which is R$ 36,000.00 (Ref: L 28). That said, it is understood that there are temporal differences between IAS 17 and IFRS 16, but at the end of the lease term, i.e., in three years, under both criteria, the total net profit was R$ 9,000.00 (Ref: L21 and L29).

Another important point concerns cash disbursements. Under both standards (IFRS 16 and IAS 17), the amount was the same, i.e., R$ 36,000.00, which refers to the sum of the lease contract installments. In other words, the change in accounting resulting from IFRS 16 does not impact the company's cash flow.

Conclusion

Many companies still use spreadsheets to control and prepare IFRS 16 calculations. We have noticed that Brazilian companies preferred to use Excel until they became familiar with the new process and are now seeking the solution that EBS-IT Services has developed in the Oracle cloud solution.

Want to learn more about our solution? Click here and request a presentation.

*Marcos Batista holds a master's degree in Business Controllership and is a course coordinator at Fipecafi College. Author of the book: The contribution of the controller as a business partner – systematization of activities from the perspective of the performance management system. He works as a consultant in the area of Management Consulting and is one of the people responsible for the IFRS 16 solution at EBS-IT Services.

**The column "Ref" stands for References and is intended to facilitate the reader's analysis. For example, Ref L1 and L6 refer to Lines 1 and 6, and mention the accounts TOTAL ASSETS and TOTAL LIABILITIES + PL.

The "ACCOUNTS" column shows, in a simple manner, balance sheet accounts for assets, liabilities, equity, and income, in addition to three indicators: net income, EBITDA, and EBITDA margin, in accordance with IFRS 16 accounting (Lines 1 to 23). Next, lines 25 to 31 show income statement accounts and the three indicators mentioned above, in accordance with IAS 17 accounting standards, which is the criterion prior to IFRS 16.

Columns A0 to A3 refer to the "years" of the accounting entries. A0 indicates the year the company was established and the initial measurement of the lease. Years A1 to A3 show, together with the accounts, the amounts resulting from the accounting entries.