The coming changes of lease accounting

Introduction

International Accounting Standard Board had issued exposure draft of Leases in August 2010. Subsequent feedbacks show broad support on recognising all leases on the statement of financial position. Existing models of lease accounting has been criticised for failing to meet

the needs of users of financial statements because they do not provide a faithful representation of leasing transactions. As a result, many users of financial statements adjust the amounts presented in the statement of financial position to reflect the assets and liabilities arising from operating leases.

The main proposal

The exposure draft proposes that lessees and lessors should apply a right-of-use model in accounting for all leases (including leases of right-of-use assets in a sublease) other than leases of biological and intangible assets, leases to explore for or use natural resources, and leases of some investment properties. For leases within the scope of the draft IFRS, this means that:

(a)  a lessee would recognise an asset representing its right to use the leased (‘underlying’) asset for the lease term (the ‘right-of-use’ asset) and a liability to make lease payments.

(b)  a lessor would recognise an asset representing its right to receive lease payments and, depending on its exposure to risks or benefits associated with the underlying asset, would either:

(i)   recognise a lease liability while continuing to recognise the underlying asset (a performance obligation approach); or

(ii) derecognise the rights in the underlying asset that it transfers to the lessee and continue to recognise a residual asset representing its rights to the underlying asset at the end of the lease term (a derecognition approach).

For leases of twelve months or less, lessees and lessors would be able to apply simplified requirements.

The exposure draft also proposes disclosures based on stated objectives, including disclosures about the amounts recognised in the financial statements arising from leases and the amount, timing and uncertainty of cash flows arising from those contracts.

Changes to lessee accounting

Leases were classified into two categories: finance leases and operating leases. Lessees would be most affected if they have a significant portfolio of assets held under operating leases, especially those with leases of property. At present, the lease payments arising from operating leases are accounted for by recognising them in the period in which they occur. The proposals would require lessees to recognise the assets and liabilities arising from those leases.

The new standard would result in significant changes in the measurement of the assets and liabilities arising from those leases because of the way the exposure draft proposes to account for options and contingent rentals. In addition, the pattern of income and expense recognition in profit or loss would change significantly.

Changes to lessor accounting

The proposed approach to lessor accounting would differ significantly from existing accounting standard. Depending on the extent to which a lessor retains exposure to risks or benefits associated with the underlying asset, a lessor would apply either a performance obligation approach or a derecognition approach.

If a lessor retains exposure to significant risks or benefits associated with the underlying asset, the lessor would continue to recognise the underlying asset and in addition recognise a right to receive lease payments and a lease liability. The lessor would be viewed as satisfying the lease liability continuously over the lease term, and therefore would recognise lease income continuously over the lease term.

If a lessor does not retain exposure to significant risks or benefits associated with the underlying asset, the lease would be accounted for in a way similar to the current accounting for finance leases. That pattern of income recognition is similar to the pattern of revenue recognition currently required for manufacturer/dealer lessors. However, there would be significant changes in the measurement of the right to receive lease payments, the recognition of lease income and the recognition and measurement of residual assets. For such leases, the lessor would satisfy the lease liability at the date of commencement of the lease by delivering the right-of-use asset to the lessee and thus would recognise lease income representing the sale of the right to use the underlying asset.

Effective date of the proposal

IASB proposed the accounting standard of lease to be published in the second half of 2011. The effective date will be subject to further announcement. As the accounting treatment for lease will change significantly, it is time for entities to evaluate the effect of changes.

The above information was extracted from IASB website. For more information, please visit to website www.ifrs.org.



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