IFRS (International Financial Reporting Standard) 16 was introduced on 1st January 2019 as a new standard for lease accounting, replacing the previous IAS 17 accounting standard that was in place. This change to lease accounting, introduced by the International Accounting Standards Board (IASB) is one of the most significant changes in over 30 years, affecting a majority of companies reporting under IFRS and impacting the financial statements of lessees. The objective of the change to IFRS 16 is to ensure that companies are providing information on leased items in the same way and provide more transparency for the overall financial status.
With this blog post we will be showcasing how accountancy can be managed within Microsoft Dynamics 365 Business Central to be compliant with IFRS 16 standards.
What is IFRS 16?
The objective of IFRS 16 is to report information that:
- Faithfully represents lease transactions
- Provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.
To meet that objective, a lessee should recognise assets and liabilities arising from a lease.
A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.
What is a lease?
A lease is a transaction whereby an agreement is entered into by the lessor with the lessee for the right to use an asset by the lessee in return for a payment or series of payments for an agreed period.
There are two types of leases:
- Finance Lease
- Operating Lease
Finance lease is a lease in which all risks and rewards are transferred to the owner of the assets. Titles of the asset have the ability to be eventually transferred, if required. For example: Lease terms cover the entire economic life of the asset, even if the title is not transferred.
Any other lease other than finance lease is considered as operating lease.
With the introduction of IFRS 16 for accounting of contracts for operating leases (Excluding short term leases with terms of 12 months or less) and low value asset leases, the following implications are required to be followed by the lessee under IFRS 16:
- It will lead to an increase in assets that are capitalised as well as in loans that are booked as liabilities
- It will affect the income statement, as lease expenses will be replaced by higher depreciation charges and an interest expense.
How to manage the accounting in Business Centra
Lease accounting in Business Central can be managed in the following way:
1. The lease liabilities are initially measured at the present value of lease payments payable over the lease term, discounted at the rate implicit in the lease if that can be readily determined. If the rate cannot be readily determined, the lessee shall use their incremental borrowing rate
2. In order to calculate present value of lease payments, the following are required:
– Lease term
– Inception date
– Completion date of lease period
– Total lease payment payable as per the lease agreement
– Discounted rate or incremental borrowing rate
3. Using incremental borrowing rate & lease payment payable for each month of the lease period, we can calculate the present value of the lease payment for each month over the entire lease tenure.
(This calculation can either be made in an Excel spreadsheet, or the logic can be developed within Business Central)
4. After obtaining the present value of the total lease payments, an asset card can be created, with mapping to FA acquisition account as a “Right to Use Asset”. The dimension asset code & default in on the asset card. The depreciation policy on the asset card will be a straight line method with the number of months of depreciation equalling the lease term of the asset.
5. Fixed Asset GL Journal needs to be created by debiting asset number of the lease, which will post the entry “Right to Use Assets” & “Lease liability account”
6. Recurring General Journal must be created for debiting “Interest expenses” and crediting “Lease liability account” with the asset number.
7. Based on actual payments on a month-on-month basis, the payment journal will be processed along with the asset number dimension
8. Monthly depreciation will be calculated & posted, which will debit depreciation expenses and credit right to use of the asset
9. Further enhancements can be planned for automation for creation & posting of the entries mentioned above.