Financial Reporting Committee Rachel Knubley Senior Project ...

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We broadly support the proposals While there are some aspects of the proposals with which we disagree, we broadly support them. Indeed, we believe that the proposals have been well thought through and are well presented. We accept the boards’ analysis of the assets and liabilities arising under simple leases. We support the right-of-use model and agree with the boards’ decision to not to require a components approach to accounting for leases (though we appreciate that this causes the recognition of obligations in relation to lease options that would not otherwise meet the definition of a liability in the existing Conceptual Framework). Present value of obligation to pay rentals Discount rate We would prefer that the lessee’s incremental borrowing rate is used only if it is not practicable to estimate the rate implicit in the lease (as is the case under the existing standards). We believe that the estimate of the rate implicit in the lease provide the best estimate of the finance costs associated with the lease. Use of the rate implicit in the lease will therefore also give the best estimate of the right of use asset associated with the lease. Contingent rentals We do not support the probability-weighted estimate (or expected value) approach to measuring future contingent rentals. We are concerned that users will wrongly believe that the outcome is more accurate that that resulting from a less complex approach. We support the most likely rental payment approach because it will be workable in practice and will result in an obligation to pay rentals that will reflect a possible outcome. Moreover, we believe that this approach is consistent with guidance on making a ‘best estimate’ of an obligation provided in IAS37, which specifies the use of the expected value approach where the provision being measured involves a large population of items but where a single obligation is being measured states that “the most likely outcome may be the best estimate of the liability”. Changes in the obligation to pay rentals Consistent with the right-of-use principle underlying the proposed accounting model, we believe that a change in the obligation to pay rentals should be recognised as an adjustment of the right-of-use asset if it reflects a change in the right to use the asset. Otherwise it should be recognised in profit or loss. Accordingly, we believe that a change in the obligation to pay rentals resulting from a change in the expected lease term should be recognised as an adjustment to the right of use asset and a change resulting from a change in the estimate of future contingent rentals should be recognised in profit or loss (shown separately from the depreciation or amortisation of rightof-use assets). Embedded derivatives As a consequence of the boards’ decision not to require a components approach to accounting for leases, the effect of embedded derivatives in relation to contingent rentals and residual values will be taken into account in estimating the obligation to pay lease rentals. We therefore believe that it serves no purpose to separately account for those embedded derivatives that are not considered to be ‘closely related’ to the host lease contract. In the Page 2 of 12
interests of removing unnecessary complexity, we therefore believe that derivatives embedded within lease contracts should be excluded from the scope of IAS39. Short-term leases We agree with the boards that it may be difficult to define a short-term lease and that there is a risk that leases may be structured in order to take advantage of simplified accounting for short-term leases. However, the boards should recognise that if they do not take a pragmatic approach with regard to short-term leases we would end up in the situation where the hire of equipment such as vehicles, cranes and skips for a period of a few weeks or even days would be recognised as a right-to-use asset and fully depreciated within the same accounting period (thereby “grossing up” the movements on tangible and intangible assets and potentially distorting important capital replacement measures). As the effect of discounting would be immaterial in such cases, the accounting result would be the same as if the lease rentals were simply expensed, i.e. treated as if they were operating leases. Please feel free to contact me if you wish to discuss our comments on the proposals. Yours sincerely Chris Lucas Chairman The Hundred Group - Financial Reporting Committee Page 3 of 12
Page 1: Rachel Knubley Senior Project Manag
Page 5 and 6: CHAPTER 3: APPROACH TO LESSEE ACCOU
Page 7 and 8: Question 7 Do you agree with the bo
Page 9 and 10: We strongly oppose the expected out
Page 11 and 12: Question 20 The boards discussed tw

Financial Reporting Committee Rachel Knubley Senior Project ...

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