IFRS 16 Leasing & Lease Liability

Reclassification (IAS 1)
This is intended for aspirant FICO/RE-FX consultants who want to gain an insight into IFRS 16 solution
offered by SAP RE-FX for Leases and IAS 1 reclassification process of Lease Liability at the end of month.
This blog post will explain the basic concept of IFRS 16 and related accounting postings using SAP RE-FX , it
will also dig into one of the unexplored area of Lease Liability reclassification which many of us are not
familiar with.

The main idea of IFRS 16 is to eliminate off-balance sheet accounting for leases thereby eliminating the
difference between operating and finance leases. Previously operating leases payments were charged to P&L
but with the introduction of IFRS 16 in January 2016, operating leases are required to be reported as RoU
assets which in turn has favorable impact on operating profit, solvency, EBIT & EBITDA.

SAP RE-FX (Flexible Real Estate Management) module has played a pivotal role in assisting organization in
transitioning to new standards set by IFRS 16 for lessees. It can assist entities in leasing scenarios for Leased
In Properties, Buildings etc..

SAP RE-FX Function for IFRS 16 Compliance:

To meet the new rules as governed by IFRS 16, SAP RE-FX module came up with functionality of Valuation
contracts. Lease valuation contracts enable an organization to record the following in integration with Asset
Accounting and FI-GL.

1. Right Of Use assets capitalization with Net present value

2. Overall Lease liability computation
3. Lease Rental payments
4. Interest on lease rental using various methods
5. Deprecation posting with a special deprecation key which works in integration with RE-FX

Above postings are integrated postings and originate from Lease valuation contracts in SAP RE-FX. Apart
from above accounting entries, many organizations as part of the month end closing process require the
disclosure of lease liability postings by splitting it into short term (current) and long-term portion (non-
current). This is in line with the requirement set out by IAS 1 to regroup Lease liability into short term and
long term at the end of every month for financial statement presentation. Before diving into the details of
reclassification, i would like to explain the complete flow of accounting entries in IFRS 16 leasing solution
offered by RE-FX by building a practical scenario and its related accounting postings.

Note: If a company does not use Asset Accounting component, then Company can choose Direct Balance Sheet
Posting Integration Type in customizing RECECUST…Control Settings for Each Contract Type in Company
Code
Illustration:
We have a leased property for which company has entered into three years of Lease Agreement with a lessor
with payment frequency monthly to be paid in advance of every month . Monthly lease rental is 10,000 AED.
The interest rate is 2% which will be used to discount future cash flows to their present value. In this regard a
contract with value (10,000*36)=360,000 AED has been created with some critical information maintained in
the valuation parameters tab of the contract.

The general data tab includes details of contract start and end date, contract name etc, partner tab contains
information about lessor whose business partner has been created., object tab contains object assignments of
the contract including start of relationship, cost object assignment and object type. Posting parameters tab
contains frequency settings of contract, posting parameters (tax information, partner information etc) and
organization assignments. Condition tab of the contract contains various conditions of contract like Lease
Rental, Initial cost, incentives etc. For the sake of simplicity we have kept one condition ‘Lease Rental” in the
contract with full consideration to the IFRS 16 valuation.

From IFRS 16 perspective,valuation parameter and valuation tabs of the contract are the most important ones.
Valuation parameter tab of the contract that we created with value of 360,000 AED is shown below.

After running contract valuation, valuation tab of the contract will look like below. Here net present value has
been computed by using effective interest rate because 2% is annual interest rate , we have to compute
effective interest rate to arrive at the present value of the contract. Effective interest rate is used when interest
given is annual but lease rentals are paid monthly/quarterly.
Depreciation tab will look like below , for IFRS 16 leasing purpose a special depreciation key LEAX has been
provided by SAP with base method depreciation settings as “Depreciation from Real Estate Leasing”

Monthly lease rental to be paid to the landlord/supplier are shown in Clearing tab of valuation run. These are
the rentals for which either a PO has been created in procurement to pay rentals or we can also generate vendor
liability for these cash flows using partner cash flow postings (periodic postings RERAPP) in RE-FX for the
same contract.
Interest expense tab will look like below

Valuation Postings to Accounting:

So far we saw the valuation run results, valuation run execution is a prerequisite for the contract valuation
postings to accounting. Valuation postings of the contract is done via t code RECEEP-Post Valuation for
Contracts. In the first month a total of four entries will be posted which are shown as under.

a. RoU Asset Capitalization

Asset explorer AW01N will populate following value after above entry.

b. Transfer Posting

Second accounting entry which is posted by valuation run postings is Transfer posting which nullifies RoU
clearing account which was credited in first accounting entry. Transfer posting generates the total lease
liability amount , this lease liability amount is used by Regrouping Run (OBJREG) for a proportionate
posting into Short term lease liability ( lease liability value falling within one year) and long term liability
portion (lease liability value beyond one year). Accounting entry is shown below
c. Lease Payment (Lease liability reduction)

Lease liability is reduced based on the frequency of lease rental agreed with lessor. In our case it is monthly
hence lease rental is posted which results in the reduction of lease liability.

d. Interest Posting

Interest expense will be posted using the cost object assignment of the contract. SAP RE-FX Valuation Rule
customizing offers various interest calculation methods , we can have simple to complex interest calculations
in valuation contracts .
In all the subsequent months, posting of monthly lease rentals and interest expense will happen while its
equivalent invoice to supplier can be generated either from SAP MM or the same contract using periodic
posting of partner related cash flows.

IAS 1 and Closing Process in RE-FX Leasing:

Above postings were for the first month of first lease year, for all the subsequent months interest posting and
lease payment posting will occur in valuation posting run. At the end of every month there is a disclosure
requirement by IAS 1 to reclassify Lease Liability into Short term lease liability and Long term liability. SAP
has provided a special note 2624449 – Configuration of Special Ledger as preliminary work for closing
processes from RE-FX leasing (IFRS 16) to setup configuration needed for the reclassification of lease
liability.

To prepare for the closing process in RE-FX leasing, FI-SL (Special ledger) is used ,as we know in any of
closing process in FI, GL accounts forms the basis for closing monthly financials, if we choose GL accounts
for the closing process in SAP RE-FX, it will be very slow and difficult to aggregate lease liabilities balances
on account level at the end of month. This problem has been solved by creating a Special purpose ledger in FI-
SL . Here contract number and valuation rule are used to collect lease liability balances at the end of every
month for reclassification.

The implementation of note 2624449 adds three fields Financial Valuation Object Type
(VAL_OBJ_TYPE=RECL-Lease Liability), Financial Valuation Sub object (VALOBJ_ID_SL) and Financial
Valuation Object (VAL_OBJ_ID). Newly designed object based FI regrouping transaction OBJREG selects
RECL (Lease liability) values based on these valuation object fields from special ledger (FI-SL) to get the
reclassification percentage and then posts reclassification.
A special report RECEISRECLASSIFY – Info System: Reclassification has also been provided by SAP RE-
FX to show reclassification percentage at a key date for a Company code, contract type and sort method. We
will now come to the process of reclassification of lease liability considering our Lease valuation contract
210000007.

OBJREG – Regrouping of Valuation Objects:

In order to regroup/reclassify the lease liability/lease receivables for the valuation objects, SAP has provided
OBJREG t code. We will first look at the valuation cash flow position of contract 210000007 to see balance of
lease liability at the end period1 of first lease year and balance of lease liability >1 year.

Screenshot below has been taken from the valuation cash flow of overview tab of Lease contract. It shows the
complete lease schedule including interest, lease payments, depreciation with opening and closing balance of
lease cash flows. Looking at it we can easily arrive at the value which OBJREG should allocate at the key date
31.01.2020 to short term lease liability (liability portion <1 year) and long term lease liability (liability portion
>1 year) . Amounts in bold shows the posted valued via valuation posting RECEEP.
An overview of FI-SL document posted for the lease liability can be seen in below screenshot, we can view
this by displaying transfer posting FI document in FB03 and then going to environment…Document
environment… Relationship browser.

RE-FX special report RECEISRECLASSIFY which has been designed to show the lease liability
reclassification at a given date shows the results which will be verified by our postings in OBJREG. This
report uses Sort method settings (OBBU) which most of FI consultants must be familiar with.
OBJREG selection screen looks very similar to FAGLF101 T code which is essentially used for regrouping of
AP/AR in SAP Financials.

The tab Valuation object lets you specify the Identif. Val. Obj ID which we saw in our screenshot of
FAGLL03 for the lease liability GL . In the below screenshot , it is imperative to note that we have entered
lease liability GL 3118020 so that system reclassifies only its balances.
We can restrict GL based valuation in customizing for FI-SL ledger (in our case LG) T code GCL1. GL based
valuation can be setup in rule defined in GCL1..Select your ledger…Choose Assign Activity…Ledger
Selection…Rules by adding SAKNR in below rule.

After execution following will show , the explanation of the amount split has already been provided in
valuation cash flow overview screenshot. The values shown are in concurrence with RECEISRECLASSIFY
report.
If we select postings button , following sequence of postings will be shown for reclassification of Lease
Liability. Posting scheme works as valuation reclassification is done at the end of every month for disclosure
purpose and reversal posting is done at the first day of next period.

In above example only the non-current portion (> 1 year) has been posted according to our customizing which
is also a recommended setting as per SAP. The current portion (lease liability amount< 1 year) remains on the
lease liability account. Following reclassification entry was posted when we selected Post Documents
Immediately in first tab of OBJREG and its reversal entry was posted at the same time on 01.02.2020.
Recommended OSS Notes:
Following Notes are strongly recommended in order to gain an insight into the IFRS 16 lease valuation process
and closing process in RE-FX leasing.

https://launchpad.support.sap.com/#/notes/2255555
https://launchpad.support.sap.com/#/notes/ 2297363
https://launchpad.support.sap.com/#/notes/ 2516889
https://launchpad.support.sap.com/#/notes/ 2555105
https://launchpad.support.sap.com/#/notes/ 2580277
https://launchpad.support.sap.com/#/notes/ 2660070
https://launchpad.support.sap.com/#/notes/2699475
https://launchpad.support.sap.com/#/notes/ 2624449