New Accounting Standard in China- Leasing Standard | Financial Changes to Businesses

A- Background

 

Due to the provisions in the previous leasing standard for operating leases, lessees do not recognize their acquired rights to use assets and rental payment obligations in the balance sheet, nor are they reflected in the balance sheet, resulting in the financial statements of lessees not fully reflecting the acquired rights to use and obligations assumed as a result of lease transactions.

 

In order to standardize the recognition and measurement of leasehold rights of use and the presentation of related information in the financial statements and to increase the comparability with international financial statements regarding IFRS 16 effective since 1 of January 2019（the same as China Accounting Standards for Business Enterprises No. 21 – Leasing effective since 1 of January 2019）, this new lease standard has been formulated and requires listed company and large enterprise with lease payment periods on or after January 1, 2021 to commence implementation if they meet the applicable conditions.

 

Here, we start to discuss the financial changes brought by the new standard to the lessee, and at the same time, in the subsequent explanation and case study, the content that is difficult to understand such as discount rate, leaseback sale and interest fee will not appear, so as to facilitate the understanding.

 

B- Definition of Lease

 

A lease is an act in which the lessor cedes the right to use an asset to the lessee for a certain period of time for consideration. The cession of the right of use mentioned here is something that the lessee can actually control.

 

For example, if the lessee leases a large printing equipment and the lessor gives the equipment to the lessee for daily use, it can be seen that the lessee can actually occupy the equipment and control the right to use it.

 

Particular attention is paid to the rights related to items such as copyrights and patents for films, videos, scripts and manuscripts acquired through license agreements, and the leasehold rights to use land acquired by way of grant, allocation or assignment, which are not applicable to the new lease guidelines.

 

C- Elements of Exemption

 

Exemption from the application of the new lease standard is normally granted if either of the following two elements are met:

• The lease term of the entire lease contract does not exceed (including) 12 months.
• The value of the asset recognized in each contract subject is low (depending on the size of the enterprise, market guidance and the value determined in other government local regulations).

For small businesses, the value of the contract subject matter can normally be considered low if it is less than CNY 40,000.

 

D- The difference between the previous and new standards in the use of accounting items

 

Accounting Item Category	New Standard	Previous Standard
Asset	Right-of-use assets – cost Right-of-use assets – depreciation	/
Liability	Lease liabilities – Payable Lease liabilities – unrecognized financing fee	/
Profit and loss	Period expenses – depreciation fee Finance costs – financing fee	Period Expenses – Leasing fee

 

E- Presentation of the previous and new standards in the financial statements

 

Statement Type	New Standard	Previous Standard
Balance Sheet	Right-of-use asset account (New-add) Lease liability account (New-add)	Not reflected
Profit Sheet	Depreciation of right-of-use assets Unrecognized financing fee	Records only leasing Fee
Cash Flow	Reflects the repayment of principal of lease liabilities, and unrecognized financing fee, which are charged to different positions in the statements	Reflects only cash flows from operating activities

 

As a result, the new standard allows users of the statements to clearly understand the right to use the assets of the enterprise and the future rental payment obligations, so that they can manage the assets of the enterprise more effectively and regulate the cash flow of funds.

 

F- Case Study

 

Since the new lease standard is the more difficult one to understand and apply among the three new standards in 2021 (new revenue, new finance and new lease), we will help you understand the new standard through a case study.

 

Example:

 

Company A, a chip manufacturer, leases a large photolithography equipment from Company B for the production of on-board chips for new energy vehicles. The contract period is from March 1, 2021 to February 28, 2026. Company B has delivered the lithography machine to Company A. Company A should pay Company B the monthly rent of 300,000 yuan by the end of each month after receiving the invoice at the beginning of each month. Now, without considering VAT, tax benefits for new energy enterprises, discount rate, maintenance costs, etc., we stand in the position of the lessee, Company A, and analyze it briefly.

 

Under the previous standard, after Company A receives the invoice every month, it pays Company B the lease expense, which is directly included in the current profit and loss and not reflected in the balance sheet, which is the absence of the reflection of the statement of the leasing behavior of the enterprise. It is therefore difficult for the statement users to understand the leasing behavior of the enterprise and the future payment obligation, they can only understand the profit and loss situation of the enterprise from the income statement.

 

Under the new standard, firstly, the lease contract period between Company A and Company B is more than one year, the total amount of the contract is large and the lithography machine can be physically possessed and controlled, so the new lease standard should be applied. Secondly, Company A recognizes the right-to-use asset and lease liability of 300 (thousand) * 12 (months) * 5 (years) = CNY 18 million based on the subject matter of the contract when the contract becomes effective. Moreover, the depreciation period of the right-of-use asset is recognized as 60 months according to the contract. Finally, Company A’s finance accrues depreciation expense of 300,000 yuan on March 31, and when the rent is paid for the month, the lease liability account is offset and the financial statement is issued as follows (to make it easier to understand, we simulate the financial statements of both the old and new standards, in million yuan):

 

New Standard Balance Sheet				Old Standard Balance Sheet
Right-of-use assets	1800	Lease liabilities	1800-30	All information on leasing operations and the amounts incurred are not reflected.
Depreciation of assets	(30)	Total equity	0
Total statement	1770	Total statement	1770
New Standard Profit Sheet			Old Standard Profit Sheet
Operating expenses	Depreciation	30	Operating expenses	Lease Fee	30

 

In summary, through the accounting of the new leasing standard, the statement user can clearly understand the overall financial data of the enterprise, and at the same time, the enterprise’s assets can be increased. If the user of the statement is the acquired party, the increase of total assets is also a favorable weight at the negotiation table.

 

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