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10 LEASES - A PROJECT UPDATE Subsequent accounting The subsequent accounting would depend on the nature of the underlying asset. There would be two types of leases, with the classification being based on the extent of consumption of the leased asset during the lease term. Determining the type of lease The two proposed types of leases are: –– The finance approach (or the interest and amortisation approach, or accelerated expense approach) –– The straight line approach. While this would appear similar to the current finance vs operating lease distinction, the distinction between the two types of lease under the proposals would be different. The underlying principle in distinguishing between the approaches would be based on whether the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term. If it does then the transaction would be looked at as a ‘financing transaction’ and the income statement would reflect a pattern of financing income or expense. The principle would be applied using a practical expedient based on the nature of the underlying asset, such that leases of property (including land and/or a building or part of a building) would be accounted for using the straight line approach unless: –– The lease term is for the major part of the economic life of the underlying asset; or –– The present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset. Leases of assets other than property would be accounted for using the finance approach (accelerated expense) unless: –– The lease term is an insignificant portion of the economic life of the underlying asset; or –– The present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset. During an IASB webcast in July 2012, the Staff presented a slide with the following examples: Truck (4 years) 3 Vessel (20 years) 1 Vessel (5 years) 1 More than Insignificant Car (3 years) 4 Commercial property (30 years) 1 Insignificant Commercial property (10 years) 1 Aeroplane (8 years) 2 Assumed economic life: 1. 40 years 2. 25 years 3. 10 years 4. 6 years BDO comment It would appear that most leases (except for leases of real estate) would be regarded as being for more than an insignificant portion of the underlying asset and would therefore be accounted for under the finance approach. For example, the slide indicates that, if a the lease term of a vessel is five years and the assumed economic life 40 years, the staff believes that there is need for further judgment since this might suggest that the lessee consumes more than an insignificant portion of the underlying asset over the lease term.
LEASES - A PROJECT UPDATE 11 Accounting for the lease Under both the finance and straight line approaches, the lessee would measure the liability to make lease payments at amortised cost using the effective interest method and the right-of-use asset at amortised cost (subject to impairment), unless it was to be revalued. The difference between the two approaches is the way in which the right-of-use asset would be measured after initial recognition, and the associated effect on the income statement. Under the finance approach, the right-of-use asset would be amortised on the same basis that the lessee would apply to the underlying asset (and therefore in a way that reflects the pattern of consumption of the expected future economic benefits of the right-of-use asset). The lease liability would be accounted for using the effective interest method (that is, in the same way as a conventional loan). Interest and amortisation expenses would be recognised separately in the income statement. BDO comment Assuming the right-of-use asset was amortised on a straight line basis, the effect would be that the overall income statement charge would be greater in the early periods of a lease in comparison with later periods, due to the larger interest expense. This ‘front loading’ would be increased if the right-of-use asset was amortised on a reducing balance basis. In addition, the amortisation expense will be included within operating results, with the interest expense being included within finance charges. Assuming the arrangement would be accounted for as an operating lease under IAS 17, in addition to the ‘front loading’ of the combined amortisation and finance charge, the finance element will be eliminated from operating results. Entities will need to consider carefully the effect on their reported results, and the associated effect on aspects such as bank covenants, employee remuneration arrangements linked to reported results (including share-based payments), and on key metrics that they report to the markets and other users of their financial statements. Under the straight-line approach the amortisation of the right-of-use asset is measured each period as a balancing figure such that the total lease expense would be recognised on a straight-line basis, regardless of the timing of lease. In addition, and in contrast to the finance approach, the two components of the lease expense would be recognised as one single amount to be charged to operating results in the income statement. A lessee may have a significant economic incentive to exercise a purchase option. In such cases, because the lessee would be assumed to acquire the underlying asset, the right-of-use asset that is recognised by the lessee would be amortised over the whole economic life of the underlying asset rather than over the lease term. The following examples illustrate the difference between the finance and straight line approaches.
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