IFRS 16 – When to report a lease
IFRS 16 / CPC 06 – Leases brought significant impacts to the vast majority of Brazilian companies, clearly on the side of lessees, since most part of the contracts that used to be considered as expense only and recorded at the time of their effective payment, now need to be recorded in their entirety in the balance sheet of lessee companies, need to be amortized and booked in a manner not required previously.
For instance, with the adoption of IFRS 16, a company that is party to a lease contract of business office that usually starts with 36 months, now has to keep account of the full contract in its balance sheet in the assets and liabilities, considering the total contract value, and subsequently will have to record the expense monthly with interests included in the contract and run the depreciation of the lease contract, recording the expense in the income, which never had to be done in this respect. Are you surprised with this treatment? Let’s get a better understanding of how this works in practice.
Identifying a lease contract
Not all lease contracts are necessarily covered by IFRS 16, contracts lasting less than 12 months and contracts where the underlying asset is low value, do not need to be booked under the terns required by the technical statement, and, therefore, the company can keep accounts as it used to.
But let’s consider a company that signed a lease contract of a commercial real property for 36 months, for the amount of R$ 5,000.00 per month, that is R$ 180,000.00 per year, in this case we have a lease covered by the rule, since the term exceeds 12 months and the asset is not low value, so let’s see the next steps:
Having identified the contract, we need to keep accounts thereof recording an asset and a liability, but pay attention, the contract value must be recorded at present value at a rate specified in the contract or at the standard market rate the lessee company would have to pay if it were to contract a loan amounting to the total contract value, in this case we will consider that the interest rate is 8% per month, in which case the present value of the 36 installments deducted at the monthly interest rate is R$ 127,444.21. Now let’s go to accounting
D – Right of use asset – R$ 127,444.21
C – Payable leases liability – Current – R$ 52,876.71 – 12 installments
C – Payable leases liability – Non-current – R$ 74,567.51 – 24 installments
With this record, the company fully reports the lease contract as a commercial lease and also registers the right of use asset at its present value on the operation date.
Recording financial expense
As mentioned before, the amount of interests deducted from the total contract to bring the monthly installments to the present value, is now recorded as expense in the income, for that simply calculate the 2% on the balance recorded in the current and non-current liability, recording an increase in the amount of the liability, offsetting the financial expense as described below:
D – Financial expense Interests – Income – R$ 2,548.88
C – Payable leases liability – Current – R$ 1,057.53 – 2% on the installments of the Current liability
C – Payable leases liability – Non-current – R$ 1,491.35 – 2% on the installments of the non-current liability.
Recording monthly payment
For monthly payment, the regular process that would be used if the contract was only accrued and paid monthly, applies. We basically use banks against liability:
D – Payable leases liability – Current – R$ 5,000.00
C – Banks – Current Asset – R$ 5,000.00
Observe that, in fact, the payment did not deduct R$ 5,000.00 from the debit balance in the liability, since we increased the liability balance when we record the interests incurred in the period, in practice, the total payable lease balance was deducted by R$ 2,451.12 (5,000.00 – 1,057.53 – 1,491.35).
As for depreciation, we need to follow CPC 27 – Fixed Assets regulates to perform the monthly depreciation, this rule establishes that the depreciation needs to be calculated according to the asset’s service life, in this case we have a contract with a 36-month term, so the contract will be depreciated by 1/36th monthly so that, at the end of the lease period, the contract is fully recorded as an expense and the right of use asset is fully amortized:
D – Depreciation expense – Income – R$ 5,000.00
D – Right of use asset – R$ 5,000.00
Written by Maikon Luiz, Head of Operations BR of Drummond Advisors