Accounting for Leases

In July 2006 the International Accounting Standards Board (IASB) in conjunction with the US Financial Accounting Standards Board (FASB) commenced a project to rewrite the current Leasing Accounting Standard (IAS17). In August 2010 the Boards issued an exposure draft (ED), proposing the ‘right-of-use’ accounting model. A lessee would make no distinction between finance and operating leases, and would record its right to use the underlying asset at the present value of the lease payments, and a liability to pay rentals, including contingent rentals. Lessor treatment would depend on whether the lease transferred significant risks or benefits of the underlying asset to the lessee.

As part of the consultation process, AELA members met with representatives of the accounting boards. Lessor representatives provided examples of recast lease contracts under the ED proposals, illustrating our major concerns. AELA’s submission on the ED was forwarded to IASB/FASB in December 2010. It concluded that the ED was not an effective improvement on the existing lease standard, and that additional time was required to address the fundamental concerns identified. Major deficiencies included that: capitalisation of amounts due under options and contingent rentals was inconsistent with the IASB Conceptual Framework; the performance obligation approach was inconsistent with the right of use model; the derecognition approach did not enable accretion of the residual asset; intangible assets were not included within the scope; lease expenses were front-end loaded; reassessment should only occur where a change in lease parameters has occurred; and transitional proposals had a substantial impact on lessee profitability.

AELA also participated with the other major international leasing bodies in a joint submission to IASB/FASB. This submission highlighted the key concerns of the global leasing industry, which were broadly consistent with the above issues raised in the AELA submission.

In the event the IASB/FASB Boards announced that revised proposals would be formulated, and a revised exposure draft (RED) was released in May 2013, retaining the requirement for all leases to be capitalised. The classification and pattern of expenses in the income statement had been particularly contentious, and the RED adopted a dual approach with Type A and Type B leases, the latter basically applying to non-equipment leases, to be accounted for using a straight-line expense approach. The RED was a considerable improvement on the original exposure draft, but significant contentious issues remained. AELA’s submission on the RED concluded that the current IAS17 accounting treatment should remain until a cogent case is advanced as to why amounts should be capitalised under operating leases but not other contractual obligations such as service contracts, and conveyed other specific concerns.

Notwithstanding widespread criticism, the two Boards persisted with the recognition of all leases on the balance sheet, measured at the present value of future lease payments, but decided on different treatments of lease expenses. The IASB proposed a ‘single lease model’ that requires the recognition of interest and amortisation for all leases, whereas FASB requires this treatment for finance leases but recording of the lease rental expense for operating leases. Service components of contracts were to be excluded from lease components.

The IASB released the long-awaited Leases International Financial Reporting Standard IFRS 16, replacing IAS 17, on 13 January 2016. For lessees, all leases are treated as finance leases, and reported on the lessee’s balance sheet, recognising the present value of lease payments. Lessor accounting is substantially unchanged. Short term leases (12 months or less) and leases of low value assets (such as personal computers) are exempted. The straight-line expense for operating leases is replaced with a depreciation charge for lease assets and an interest expense on lease liabilities (with the interest expense reducing over the life of the asset); this aligns the lease expense treatment for all leases. There is no change to the amount of cash transferred between the parties to a lease. IFRS 16 does not change accounting for service contracts; where leases and services are combined in a single contract, amounts related to services are not required to be reported on the balance sheet (although there is an option to allow a lessee to treat them both as a lease, instead of separating these components). The Standard becomes effective as from 1 January 2019. AELA is working with accounting firm KPMG on the preparation of a Commentary on the implications of IFRS 16 for lessees and lessors.