Proposals on lease accounting will significantly affect industries
London, 18 August 2010 - The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) yesterday released a proposal to improve the accounting for leases under both IFRS and US GAAP. The proposal is designed to provide a single model for lease accounting for both lessees and lessors – a “right of use” approach.
Ernst & Young’s Global IFRS Leader, Ruth Picker says, “The proposal represents a fundamental change to lease accounting. All assets and liabilities arising under lease contracts within the scope of the proposed standard would be recognized in the statement of financial position. The proposal is intended to address concerns about current accounting for leases under both IFRS and US GAAP, even though the relevant standards are similar. Concerns include the classification criteria between finance and operating leases, which can result in different accounting for economically similar lease transactions, and that material assets and obligations arising from operating leases are not recorded in the financial statements. We welcome the Boards’ efforts to create a converged and consistent approach to lease accounting but believe that there are important conceptual and practical issues that need to be resolved. Importantly, the new proposals represent a fundamentally different approach to recording executory contracts, which may have follow-on effects to other non-lease arrangements.”
Impact on lessees
Picker adds, “For lessees, the proposed changes would result in recording a liability for the obligation to make lease payments and an asset representing the right to use the leased asset. Estimates of the lease term, including renewals and contingent rents must be made not only at inception of the lease, but at every reporting date in order to determine the appropriate measure of the right of use asset and lease liability. This is a significant difference from current accounting requirements. Entities with numerous leasing contracts with contingent rentals, renewal options or residual value guarantees, such as retail companies, will be most affected.
Impact on lessors
Ruth Picker says, “For lessors, the proposed changes would require that entities assess whether they retain exposure to the significant risks or benefits associated with the leased asset, and based on that assessment determine whether to apply the performance obligation or derecognition approach. Under the performance obligation approach, if the significant risks and benefits associated with the leased asset are retained by the lessor, the lessor keeps the underlying asset on its balance sheet. It also recognizes a right to receive lease payments and a liability representing its performance obligation to the lessee. A net lease asset or liability is then reflected on the lessor’s balance sheet. While this may not result in a major net difference between the existing accounting by lessors with operating leases, the gross accounting is a significant change. Under the derecognition approach, if the lessor does not retain exposure to the risks and benefits associated with the leased asset, it derecognizes that part of the asset and retains only its residual interest. For entities in the equipment leasing industry, for example, this could result in lessors recording a gain at the start of the lease.
“The proposed lease accounting model will have a pervasive effect on the operations and financial reporting of entities engaged in leasing activity. It is important that all entities assess how they will be affected and provide feedback to the IASB and FASB.”
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