Understanding IFRS/ PSAK 73 regulations

New Accounting Standards in IFRS and US GAAP

Figure 1: Scenario

Figure 2: Motivation to Replace IAS 17

Most operating leases are comprised of financial obligations similar to finance leases and other financial commitments (such as loans). The flexibility to design leases as operating leases or finance leases gave companies an option to hide their financial obligations on the balance sheet. Therefore, boards had concerns about the lack of transparency of information about lease obligations for investors and analysts. Listed companies using IFRS Standards or US GAAP are estimated to have around US$ 3.3 trillion lease commitments. Over 85% of these lease commitments do not appear on balance sheets today.

Figure 3: The IFRS16 Leases Standard Quick Overview

The new lease accounting standard IFRS16 Leases was published by the International Accounting standards board (IASB) on January 13th, 2016. The effective date of the new IFRS16 is January 1st, 2019. However, there is the possibility of a limited early application. The changes in the lease accounting standards are focused on lessee accounting. Lessors will not face any significant changes compared to IAS17.

There are some small differences between IFRS16 and US-GAAP ASC842. Every company that has leased-in a building or other assets will be affected by the new standard IFRS16. Nearly all accounting possibilities not shown on balance sheets are eliminated as lessees are required to capitalize and recognize most leasing contracts directly on their balance sheet.

The new accounting standards IFRS 16 and US GAAP ASC842 determine that lessees will no longer distinguish between finance leases (recognized on the balance sheet) and operating lease contracts (recognized off the balance sheet). With the new accounting standards, companies are required to recognize a right-of-use asset and a lease liability for almost all types of lease contracts with few exceptions. This is based on the principle that a lease contract is the acquisition of a right to use an underlying asset in exchange of lease payments. Until the new accounting standards, finance lease contracts were recognized on balance sheets, whereas operating lease contracts were recognized off balance sheets. The effect of this approach is a substantial increase in the amount of recognized financial liabilities and assets for companies that have a significant amount of lease contracts currently classified as operating leases.

Figure 5: IFRS: Finance Lease and Operating Lease

Figure 6: IFRS 16 - The New Accounting Standard for Leases

The new accounting standards do not substantially impact lessor accounting. However, when compared to the old standards, there are some additional requirements regarding disclosure reporting. IFRS16 will have a big impact on lessee accounting, as companies are required to recognize almost all leasing contracts on their balance sheet. There is a single accounting model for all leases, with a few exceptions.

Effects of The New Accounting Standards

Figure 7: Effect analysis by IASB

The new accounting standards will have a big impact on the balance sheet and the performance metrics of lessees. An effect analysis conducted by the IASB provided the following results. The sum of lease assets will increase significantly which leads to an increase in the balance sheet total. This increase of lease assets is tied directly to the financial liabilities which therefore also increase significantly. Furthermore, the ratio of equity to liabilities will decrease due to the rise in financial liability. The leverage will increase due to the rise in lease assets recognized on the balance sheet. This also leads to a decrease in asset turnover. EBIT/ Operating Profit (earnings before interest and taxes ) and EBITDA (earnings before interest, taxes, depreciation and amortization) will increase with the application of IFRS16. EBITDAR (Earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs) will be mostly untouched.

Figure 8: Further Information Material

For additional information material, refer to the following:

IASB:
http://www.ifrs.org/Current-Projects/IASB-Projects/Leases/Pages/Leases.aspx
http://en.wikipedia.org/wiki/International_Financial_Reporting_Standards

FASB:
http://www.fasb.org/jsp/FASB/Page/BridgePage&cid=1351027207574
http://en.wikipedia.org/wiki/Financial_Accounting_Standards_Board

HGB (Germany):
http://de.wikipedia.org/wiki/Handelsgesetzbuch

Other local standards

Figure 9: IFRS Leasing Example: Leased Building for 3 Years

To determine the value of the liability, the repayment for each period has to be calculated with the specified interest rate (in this case 6%). The sum of repayments for all periods is the value of the liability. In this example, the contract contains yearly payments in arrears and no further obligations. Here, the values for right-of-use (RoU) and liability are the same. This example uses the straight-line approach for the depreciation so for the yearly depreciation value, the RoU is divided by the number of periods.

Figure 10: IFRS Leasing Example: Leased Building for 3 Years with Initial Costs

Compared to the previous example, the value of the RoU is increased directly by the value of the initial costs (in this case 6.000€). An increased RoU value leads to an increase in depreciation because of the higher value which needs to be depreciated by the end of the contract term (3 years in this example). Initial costs do not impact the liability or the interests. Hence, the liability and the interests are unchanged from the previous example where there were no initial costs.

Figure 11: IFRS Leasing Example: Leased Building for 3 Years with Initial Costs and Service Costs

Compared to the previous example, the contract includes service costs in this case. Service costs are not relevant for the calculation of RoU or liability. However, service costs need to be linearized over the whole contract term. To linearize, sum up all service charges (in this example 900€ + 1.000€ + 1.100€ = 3.000€). The sum of the service charges is then divided by the number of periods (in this case 3 as we have a 3 year contract). The service costs are linearized with the same value in each period (3.000€ : 3 Periods = 1.000€/Period).

New SAP Real Estate Functions

Figure 12: Overview on New SAP Real Estate Functions

The SAP Real Estate Management solution for lease accounting is a functional extension of SAP Real Estate Management. It is based on contracts and includes the following functions:

• Contract objects for lease contracts
• Definition and assignment of valuation rules for contract conditions
• Mass maintenance transaction for creating and changing valuation rules
• Valuation run and valuation postings (including simulation and cancelation)
• Separate authorizations for the maintenance of normal and valuation-related contract data
• Customizing settings for the definition of valuation rules (including account determination)

Figure 13: Implementation approaches

As the new functions for lease accounting represent a functional extension for SAP Real Estate Management, there are different approaches for implementation projects. The implementation approach depends from the functional scope to be implemented as well as from the existing SAP system landscape. If your company already uses SAP Real Estate Management, the new functions can be used additionally. After defining the customizing settings for valuation rules and for valuation postings the valuation rules and other valuation-relevant data for contracts can be maintained and the valuation process can be started. Existing contracts will be complemented by additional registers for valuation-relevant data. If your company does not already use SAP Real Estate Management, the valuation functions can still be used. In this case, it is necessary to implement the contract management functions and to define the settings for the accounting integration (using SAP FI, SAP FI-AA and SAP CO). Optionally, further master data objects and functions of SAP Real Estate Management can be implemented in later project steps.

Depending on the project approach, a sandbox system (based on the productive system and enhanced with the necessary support packages) for the design and prototyping phases can be used. Following this approach, the evaluation and the definition of system settings can be performed based on real contract data.

From the perspective of Financial Accounting, the following approaches and functionalities are available:

• SAP S/4HANA Finance
• New GL Ledger Approach
• New GL Account Approach
• Classic GL

On the other hand, there are different approaches within asset accounting, as follows:

• New asset accounting
• Classic asset accounting with new depreciation calculation
• Classic asset accounting with old depreciation calculation

Furthermore, it is possible to use direct posting functions without integration to the asset accounting component. In the figure, Supported Accounting Approaches, the available approaches to financial accounting and asset accounting are described.

Figure 15: Release Information and Important SAP Notes (I)

In the following SAP notes you find detailed information related to lease contracts and the valuation process:

• 2255555 Release note: valuation of Leasing contracts
• 2254013 SAP Real Estate: release for SAP S/4 HANA

SAP note 2255555 also refers to other important SAP notes regarding lease contracts and contract valuation

The first delivery is by the following support packages for each component:

• EA_APPL: 606 SP 17, 616 SP 10
• SAP_FIN: 618 SP 03, 720 SP05, 730 SP04
• EA-FIN: 617 SP12, 700 SP9; S4CORE 100 SP3

Follow-up enhancements and corrections will be made on basis of the first delivery support package.

Figure 16: Release Information and Important SAP notes (II)

Please consider, that it is crucial, that the system settings are up-to-date. Therefore it is necessary, to implement all SAP notes related to the contract valuation functionality. You can find the necessary SAP notes in SAP note 2255555 (Release note: Valuation of leasing contracts).

If you need to create a customer message related to the contract valuation, please use SAP component RE-FX-LA (RE-FX Lease Accounting).