need to know / leases - project update - BDO International
need to know / leases - project update - BDO International need to know / leases - project update - BDO International
4 LEASES - A PROJECT UPDATE EXISTING GUIDANCE AND THE RATIONALE FOR CHANGE The existing accounting models under both IFRS and US GAAP require lessees to classify their lease contracts as either finance (capital) leases or operating leases. Under a finance lease, a lessee recognises the leased asset on balance sheet together with a corresponding lease liability which is subsequently accounted for as a financing transaction. Under an operating lease, leased assets and related gross liabilities are not recognised, with only a lease expense being recognised in profit or loss (usually on a straight line basis over the lease term). Under IFRS, the distinction between a finance and an operating lease is based on whether the lease transfers substantially all of the risks and rewards associated with the leased asset to the lessee. Under US GAAP, although specified criteria are used to determine the classification, the result is typically the same as under IFRS although the US GAAP ‘bright line’ thresholds can result in differences for some transactions. These models have been criticised for failing to meet the needs of users of financial statements, because, unless a lease is classified as a finance lease, rights and obligations that meet the definitions of assets and liabilities in the IASB and FASB conceptual frameworks are omitted from balance sheets. Transactions are frequently structured specifically to result in operating lease classification, and hence to avoid recording associated assets and liabilities. This leads to a lack of comparability and, because of the structuring of transactions to achieve a particular accounting result, to complexity. As a result, many users of financial statements adjust amounts presented in financial statements to reflect assets and liabilities arising from arrangements classified as operating leases.
LEASES - A PROJECT UPDATE 5 THE IASB/FASB PROJECT TO DATE In order to address the criticisms set out above, the IASB and the FASB (the Boards) initiated a joint project to develop a new approach to lease accounting that would result in most, if not all, assets and liabilities arising from lease contracts being recognised in an entity’s statement of financial position. While the main focus was on lessee accounting, proposals were also developed for changes to lessor accounting. An exposure draft (the ED) was issued in August 2010 which set out an accounting approach based on the premise that lease contracts result in lessees obtaining the right to use an asset for a specified period (the ‘right of use’ model). The proposals were controversial, and the Boards received almost 800 comment letters. In addition to publishing the ED for comment, the Boards: –– Initiated over 200 outreach meetings, including 7 round tables and 15 preparer workshops –– Prepared questionnaires that were completed by over 250 lessors and over 400 lessees –– Carried out targeted outreach during redeliberations with over 70 organisations. There was general support for the proposed ‘right of use’ model. However, the feedback received also included many comments that the detailed approach proposed in the ED was too complex, inconsistent with the economics underlying certain transactions and, for many companies, excessively costly to implement. In particular, there were concerns about complexity of measurement, costs associated with required reassessments during lease terms, accounting for multi element contracts (contracts which contain lease and non-lease components) and the proposed lessor accounting model. During their redeliberations, the Boards have made significant changes to the proposals set out in the ED. Consequently, as noted above, the proposals will be re-exposed in order to provide interested parties with an opportunity to comment on revisions that the Boards have proposed. BDO comment The Boards have addressed many of the concerns raised by constituents in response to the original proposals, and this has resulted in simplifications being made to the proposed model which would assist in making them more straightforward to implement. We welcome these developments. However, the proposals that we expect to be re-exposed for comment also include what some might regard as a compromise for leases of real estate. While we believe that the proposals would continue to bring a significant improvement to the quality of financial reporting, the extent of this improvement in accounting for leases of real estate would be more limited. The revised proposals for lessor accounting are also complex, and we anticipate that there may be calls for further simplification of the model in responses to the revised exposure draft.
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4 LEASES - A PROJECT UPDATE<br />
EXISTING GUIDANCE AND<br />
THE RATIONALE FOR CHANGE<br />
The existing accounting models under both IFRS and US GAAP require lessees <strong>to</strong> classify their lease contracts as either<br />
finance (capital) <strong>leases</strong> or operating <strong>leases</strong>. Under a finance lease, a lessee recognises the leased asset on balance sheet<br />
<strong>to</strong>gether with a corresponding lease liability which is subsequently accounted for as a financing transaction. Under an<br />
operating lease, leased assets and related gross liabilities are not recognised, with only a lease expense being recognised<br />
in profit or loss (usually on a straight line basis over the lease term). Under IFRS, the distinction between a finance and an<br />
operating lease is based on whether the lease transfers substantially all of the risks and rewards associated with the leased<br />
asset <strong>to</strong> the lessee. Under US GAAP, although specified criteria are used <strong>to</strong> determine the classification, the result is typically<br />
the same as under IFRS although the US GAAP ‘bright line’ thresholds can result in differences for some transactions.<br />
These models have been criticised for failing <strong>to</strong> meet the <strong>need</strong>s of users of financial statements, because, unless a lease<br />
is classified as a finance lease, rights and obligations that meet the definitions of assets and liabilities in the IASB and<br />
FASB conceptual frameworks are omitted from balance sheets. Transactions are frequently structured specifically <strong>to</strong><br />
result in operating lease classification, and hence <strong>to</strong> avoid recording associated assets and liabilities. This leads <strong>to</strong> a lack of<br />
comparability and, because of the structuring of transactions <strong>to</strong> achieve a particular accounting result, <strong>to</strong> complexity. As a<br />
result, many users of financial statements adjust amounts presented in financial statements <strong>to</strong> reflect assets and liabilities<br />
arising from arrangements classified as operating <strong>leases</strong>.
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