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IASB scraps dual lease accounting model

THE IASB has reversed its position on lease accounting in a decision that signifies yet another blow to the chances of convergence between US and global accounting standards.

In a document, the global standard setter said it has “tentatively” decided to adopt a single model for lease expenses, scrapping the dual approach agreed with US counterpart FASB last year.

Under the new approach, the IASB is reverting to a simplified version of the model first proposed in 2010 that would require the recognition of interest and amortisation for all leases recognised on a lessee’s balance sheet. FASB, on the other hand, has retained the dual model which distingishes between operating and finance leases.

The project was launched back in 2006 when convergence was still a buzzword. A discussion paper was released in 2009 and two exposure drafts followed in 2010 – in which both boards proposed a single lessee model – and 2013 when the dual model was proposed. The majority of leases are not reported on balance sheets under existing rules and that approach has been criticised for failing to provide a faithful representation of leasing transactions.

On the basis of feedback received, the IASB said it concluded that a model that separately presents interest and amortisation for all leases would provide “information that is useful to the broadest range of investors and analysts”.

“The model is easy to understand – a lessee recognises fixed assets and financial liabilities, and corresponding amounts of amortisation and interest. It also avoids any structuring that might arise from having different accounting for different leases,” the IASB said.

But the change in direction means that the IASB and FASB have drifted even further apart on their joint attempts to converge IFRS and US GAAP. Last month, the two boards revealed they had failed to find a converged solution for how financial instruments should be accounted for.

In the case of leases, the IASB said the difference between it and the FASB’s position will result in “little difference” for many lessees for portfolios of leases.

“Some would claim that the two standard setters’ convergence efforts have floundered in this core area of financial reporting, but it is important to also remember that they agree on many very important things, such as how leases should be defined and the basic premise that assets and liabilities should be recognised for major leases. That in itself is no small an achievement,” said Nigel Sleigh-Johnson, head of ICAEW’s financial reporting faculty.

“The most important thing is that the new IFRS standard, when it is completed – possibly as early as next year – should help investors and analysts by removing the need for them to guesstimate the extent of a company’s lease liabilities based on the disclosures it provides in the notes to the financial statements. It will also aid comparison between companies’ reported numbers.”

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  • Sean T Egan

    Having two expense models is certain to make lease accounting more confusing. The FASB approach with two types of leases will introduce more subjectivity into the entire accounting process – something that is not at all helpful. If one accepts that leases should be recognized on the balance sheet as a liability, then the expense should be recognized as one would recognize a debt obligation. Clearly financial statement preparers will require more sophisticated technology tools and enhanced policies and procedures in order to maintain the required record keeping.

  • The claim that a one lease model is simpler
    does not address the need to provide lenders with info critical to their lending decision and that is which leased assets are owned (under capital leases) and which assets are merely rented and disappear in a bankruptcy liquidation (the leased asset is returned to the lessor). The 2 lease model gives lenders the info they need. Lessees will have to keep 2 sets of books to continue to give lenders info they need. Failing to properly classify operating lease liabilities as non debt liabilities will cause debt limit covenant breaches. The FASB understands this and made the right
    call.

    Consider that local US tax laws require lessees to pay property tax on equipment leased under capital leases while no property tax is due on operating
    lease assets (it is the lessor’s obligation) Again the need for 2 sets of books. The FASB understands this and made the right call.

    The claim that the one lease model and 2 lease model create results that are not materially different ignores that the one lease model front ends lease
    costs and creates a permanent lost equity and a permanent deferred tax asset. For large banks this means the need to raise over a billion dollars/euros in an environment where they already have capital issues. The claim also ignores inflation and growth so that the one lease model will cause lessees to always report lower earnings due to the front loading as they
    continue to lease in larger volumes.

    Don’t count on the IASB successfully issuing a Leases standard with a one lease lessee model as the European Union must approve all new accounting standards and they are opposed to the IASB position.
    In fact the IASB is trying to exempt small ticket/”non core” asset leases from capitalization to gain EU approval. The net result would be that lots of leases
    that in the aggregate for any one preparer may be material would remain off balance sheet if they expand exemptions but that would solve their political
    issues. The FASB is not looking to exempt more leases as that would defeat the purpose of capitalizing all leases. In fact the FASB’s current position keeping the current classification tests while capitalizing operating leases will find little opposition as it best reflects the substance of leases while reflecting operating leases on balance sheet as non physical assets and non debt liabilities and in the P&L as operating costs. It is important to note that
    the FASB position will capitalize more leases yet continue to allow the accounting, tax and legal views of a lease to mesh. It is the compliance and complexity “friendly” solution that provides lenders, preparers, bank regulators and credit analysts with the info on operating lease obligations that they have today but would lose under a one lease model.