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IFRS practical matters for the C-suite: What do the proposed lease accounting changes mean for you? - Proposed lease accounting model: lessors/lessees - EY - Global

What do the proposed lease accounting changes mean for you?Proposed lease accounting model:
lessors/lessees

The business value agenda offers examples of business objectives to which Internal Audit can align

What if the gaps were closed?

The transformation gap keeps many Internal Audit functions from becoming strategic and valued advisors to executive management and their boards of directors. Targeting approaches that help fi ll the gap will allow for enhanced performance.










What drives the gap?
Enablement gap
  • Traditional risk assessment and audit-planning approach
  • Not driven by business risk
  • Heavy focus on auditable units and locations
  • Limited use of data analysis and modeling
  • Limited training and development
  • Lack of effective prioritization
  • Unwillingness to change
  • Not focused on key business process improvements
Competency gap
  • Rotational resource model
  • Lack of scale to adequately staff certain areas
    • IT, international, treasury, taxes, supply chain
    • Fraud prevention and detection
  • Audit activity = available resources
  • Limited scope of traditional role of Internal Audit function
  • Alignment with strategic plan and initiatives to support
  • Industry/competitive insight

Sample value charter

Value statement   Value charter
Business value agenda/objectives

People

  • Highly engaged workforce
  • World-class safety

Performance product and process

  • No. 1 in quality
  • Market leadership
  • Market-leading availability
Profitable growth
  • Revenue
  • EPS growth
Critical success factors
  • People
  • Quality
  • Product
  • Velocity
  • Distribution
  • Emerging markets
  • Macroeconomics










Value attributes for Internal Audit
  • Leadership development
  • Subject matter knowledge
  • Training and certification
  • Utilization
  • Audit relevance to risks that matter most
  • Efficiency and effectiveness of audit process
  • Value impact on the business (process improvement)
  • Business relationships, insights and advisory focus
  • Six Sigma-principled
  • Risk coverage
Value scorecard measures
  • Staff placement/attraction to/from business
  • SMRs leveraged in the audit project(s)
  • Training hours, CPEs and certification attained
  • Team head count and utilization
  • High-risk areas addressed
  • Issues monitored and closed (H/M/L)
  • Recommendations made and implemented
  • BU executive interactions and key initiative inclusion
  • Costs contained/recovered and revenue enhancements identified/implemented
  • Emerging-markets insights and red flags monitored and reported

Whether a lessor or a lessee, the IASB/FASB exposure draft on lease accounting will affect you — in ways that go well beyond just accounting.

Lessees

The basic elements of the IASB’s proposed lessee model are:

  • Lessees would record an intangible asset for the right to use the leased item and a liability for the obligation to make lease payments (lease liability) — under the ‘right-of-use model’. The ‘risks and rewards’ model developed decades ago would be eliminated.
  • The initial lease liability would be measured based on estimates of the lease term, contingent rentals, term option penalties and residual value guarantees, using the lessee’s incremental borrowing rate to discount future payments to present value.
  • Lessees would reassess these estimates at each reporting date. Changes to the estimated lease term would adjust the related right-of-use asset and lease liability; changes due to contingent rentals and expected payments under term option penalties and residual value guarantees would be reflected in profit or loss if they relate to past or current periods, and to the right-of-use asset if they
    relate to future periods, with a corresponding adjustment to the lease liability.
  • The right-of-use asset would be amortised over the shorter of its useful life or the lease term. A leasee may revalue a right-of-use-asset in accordance with
    IAS 16 Property, Plant and Equipment. In addition, the right-of-use asset would be assessed for indicators of impairment at the end of each reporting period.
  • Lease payments would be allocated between interest expense and a reduction of the lease liability using the effective interest method, rather than be recognized as rental expense under the straight-line method.
  • Lease payments would be allocated between interest expense and a reduction of the lease liability using the effective interest method, rather than be recognised
    as rental expense under the straight-line methode or the lease term.

Lessors

For lessors recording their investment property at cost, the ED proposes two models, each to be used in different circumstances depending on the terms of the lease and their effect on the lessor.

Performance obligation approach — this approach would be used when the lessor retains exposure to significant risks or benefits associated with the leased asset (the ED provides criteria to consider in making that assessment).

This approach provides for essentially symmetrical accounting treatment to that of the lessee.

Similar to lessees, lessors would be required to make estimates and apply judgement upon adoption of the proposed standard, and at each reporting period.

The lessor would continue to recognise the leased asset and related depreciation expense. In addition, it would amortise its lease liability and amortise revenue over the lease term.

Lease payments received would be allocated between interest income and a reduction of the lease receivable using the effective interest method.

Derecognition approach — this approach would be used when the lessor is not exposed to significant risks or benefits associated with the leased asset.

Under this approach, the lessor essentially ‘sells’ a portion of the leased asset and recognises a net profit (or loss) at lease commencement equal to the difference between the present value of the lease payments and the carrying amount of the portion of the leased asset that is derecognised.

Over the lease term, the lessor also recognizes interest income using the effective interest method.

Under the proposed model, a lessor would record two assets

  • Financial asset for the lease receivable
  • Non-financial asset for the residual asset.

Under the current approach for accounting for a
finance lease, the lessor records one financial asset — the net investment in the lease (lease receivable), which consists of:

  • Present value of the lease payments
  • Unguaranteed residual value of the leased asset.

Inside

Related content:

  • Major improvements in store for lease contracts
    The IASB/FASB exposure draft on Leases will, if adopted, improve reporting on the effects of lease contracts. For a high level summary, see our supplement .
  • Leasing under IFRS and US GAAP: the proposed single model webcast, 30 September 2010
    Our webcast panel, including the IASB project manager on the leasing project, explore the new exposure draft on changes to accounting for leasing.

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