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Round table preview: Debate heats up on lease accounting

The International Accounting Standards Board’s project to update lease accounting is one the most hotly debated items on the board’s agenda. The Accountant is co-hosting a round table that will bring together accounting and leasing experts to discuss the proposals. The International Accounting Bulletin previews the event.

IAS 17 Leases is one standard that is almost converged around the world and almost everyone knows it is wrong. This was the sentiment expressed by International Accounting Standards Board (IASB) member Jan Engström at an IFRS event in Milan this month. But while there might be consensus that IAS 17 is wrong, there is some debate about what alternative is right.

The IASB decided in mid-2006 that lease accounting needed to be reviewed and in March this year the board, in conjunction with the US Financial Accounting Standards Board, released a discussion paper putting forward preliminary views on what a new lease accounting standard could look like.

The discussion paper has caused some furore among the leasing community. Among the issues most hotly contested are an amendment that would bring more big-ticket leased items, such as aircraft, on balance sheet and a requirement for preparers to estimate the likely length of an extendable lease at each reporting date.

PricewaterhouseCoopers partner Peter Holgate will be one representative from the accounting community at a roundtable that will be hosted by The Accountant and Motor Finance magazine next month. Holgate says he is happy overall with the discussion paper. He thinks when the standard is finalised it will improve on current practice.

For Holgate, the biggest issue is the absence of lessor accounting in the discussion paper – it covers only lessee accounting.

“They are a stage behind on the lessor side and I think it is important to deal with both sides of it together. A coherent leasing standard really does need to deal with both lessors and lessees,” Holgate says.

IASB project director Rachel Knubley says the board has not yet decided what to do with lessor accounting. They plan to discuss it again in July and decide whether it should be included within the scope of the new standard.

Holgate concedes the most controversial issues are on the lessee side. Perhaps the most controversial is that the IASB is proposing the new standard will bring significantly more leases on balance sheet.

Under IAS 17, if the lessee has the right to use an asset for all of its lifespan, it is classified as a finance lease and held on balance sheet. However, if the lessee has only committed to pay for and use the asset for part of its life, it is classified as an operating lease and held off balance sheet.

The proposed solution is a ‘right of use’ model. This would mean, for example, that if a lessee has committed to lease an aircraft for eight years of a 20-year lifespan, they must recognise those eight years as an asset, and the obligation to pay rentals as a liability, and record it on balance sheet.

Holgate explains that the IAS 17 solution was unsatisfactory and the ‘right of use’ model provides a much better description of the commercial situation.

Another contentious element of the proposal is a requirement that, in the case of a lease with an extension or cancellation option, lessees must estimate the most likely lifespan of the lease at each reporting date.

Holgate explains that, while this is quite complicated, it is a complicated lease by virtue of the extension option, so it is hard to find a simpler solution.

There has been concern from lessees that this could mean an unmanageable extra burden in some cases.

But Holgate says this is an example of where materiality comes into play. He explains a change on policy that means a lease on small items is going to run for three rather than four years is something that is not going to happen regularly, but rather as a one-off change.

Knubley notes that requiring an estimate of how long a lease will run for puts judgment into the accounting. She says the board hopes it will also supply better information but that they are also hoping for feedback from users.

One area where there has been some confusion is how the standards would treat service contracts compared with similar leasing contracts.

Holgate says there is probably a bit more work that needs to be done in this area, which is currently covered by IFRIC 12.

“I imagine there is a bit of a gray area between a service contract and a lease and as I recall [the discussion paper] does not go into that great detail. It is probably something that could do to be worked on a bit more at the next stage when they publish the exposure drafts,” he says.

Comments on the leases discussion paper are due by 17 July. An exposure draft is due for release in the second quarter of 2010 and a final standard expected in 2011.

Problems with existing standards

Fail to meet the needs of users

• Users adjust financial statements to recognise assets and liabilities arising out of operating leases. This information should be supplied to them

• Two different accounting models means similar transactions can be accounted for differently

• Provides opportunities for structuring


• Difficult to define dividing line between finance and operating

• Conceptually flawed

• Rights and obligations that meet the definitions of assets and liabilities are not recognised

Source: IASB

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