A draft lease accounting standard released by
the International Accounting Standards Board and the US Financial
Accounting Standards Board would bring all leases on balance sheet
– introducing more transparency to the rights and obligations
arising from leases.

The standard would also introduce more
complexity and lead to a substantial rise in company debts. One
industry group has gone as far as warning it could hamper the UK’s
economic recovery.

Existing accounting rules under both IFRS and
US GAAP depend on the classification of a lease. Classification as
an operating lease results in the lessee not recording any assets
or liabilities on the balance sheet.

The draft standard would require lessees to
book assets and liabilities for all leases; off balance sheet
accounting would no longer be allowed.

The proposal uses a right of use approach to
lease accounting for both lessees and lessors. This means the
liability for payments arising under the lease contract and the
right to use the underlying asset would be brought onto the
lessee’s balance sheet.

Long overdue

Deloitte Global IFRS leader Veronica Poole
said the draft standard is a “long overdue reality check” that will
introduce greater transparency.

“The downside to the standards, if
implemented, will be significantly increased liabilities on the
typical corporate balance sheet, which could have a knock-on effect
on key performance indicators,” Poole added.

“The result could be lower asset turnover
ratios, lower return on capital, and an increase in debt-to-equity
ratios, which could affect borrowing capacity or compliance with
loan covenants.” 

PwC UK director John Williamson suggested that
the boards’ efforts to align the leasing standard with other IFRS,
particularly in revenue recognition, has led to a level of
complexity in the measurement and re-measurement of leased assets
and obligations.

Williamson warned the impact of this
accounting will significantly increase the level of gearing of
businesses that currently use substantial amounts of operating
leases in their business.

“It will front end load the total expense for
depreciation and interest in the early periods of the lease, in
much the same way as if lessees had financed these assets with
debt,” he explained.

Contentious issues

The lessor accounting proposals are even more
contentious, Williamson added. The boards initially struggled to
agree on a preferred model for lessor accounting and compromised on
a hybrid version where some leases will be accounted for under a
performance obligation approach and others under a de-recognition
model.

“The reaction from the leasing industry has
understandably been very negative as neither model seems to be an
improvement on existing accounting and it s noticeably different
from the economic models the industry uses for pricing,” Williamson
said.

“The proposals also bear the hallmarks of
being rushed as the decision to include lessor accounting in the ED
was only re-instated in early 2009.”

KPMG Global IFRS leasing standards leader
Wolfgang Laubach said applying the new lease models will be a
challenge.

“We had hoped the leasing exposure draft would
reduce complexity and avoid the current situation of multiple
approaches that rely on rules to distinguish different types of
leases,” Laubach said.

“It’s disappointing this hasn’t
happened.  We still have the rules, just in a different
form.” 

Industry reaction

The UK Finance and Leasing Association (FLA)
warned that the propose standard could make asset finance harder to
obtain, which would hamper the UK’s economic recovery as it depends
on strong business investment.

The FLA said bringing operating leases on
balance sheet would mean businesses would have to prepare
theoretical estimates of the value and cost of the lease and
include these on their balance sheets. Julian Rose, Head of Asset
Finance at the Finance and Leasing Association said the proposals
involve “taking real numbers and replacing them with a mish-mash of
accountants’ assumptions, estimates and adjustments”.

“To propose imposing these arcane and costly
new regulations on UK businesses so soon after the recession makes
no sense,” he said.

Rose called on the IASB to carry out a proper
cost-benefit assessment and to drastically simplify its
proposals.

The lease accounting exposure draft was
developed following a discussion paper, released in March 2009,
which attracted more than 300 comment letters.

The exposure draft is open for comment until
15 December.

 

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