TAX NEWS - DECEMber 2009

The path of 'leased' resistance

In April 2006, in perhaps what is a little known event, the International Accounting Standards Board (IASB or the Board) agreed with the US Financial Accounting Standards Board to consider a joint project on lease accounting.

However, it was not until three years later, in March 2009, that actual proposals were set out in a Discussion Paper (DP) entitled 'Leases: Preliminary Views'. The DP proposes that lease accounting should be based on the principle that all leases give rise to assets and liabilities. From the perspective of the lessee, the asset represents the right to use the leased asset and the liability consists of the obligation to make lease payments. Under this approach, all leases would come 'on balance sheet'.

In July 2009, the comment period for the DP closed. In this article, we provide an overview of the 300 responses received, and the challenges the IASB now faces.


Summary of responses

We reviewed the responses to the DP and characterised the nature of the responses into four categories as shown in figure 1. General concerns highlighted by respondents are that: the proposals will result in complexity and impose a burden on preparers that will outweigh the benefits; whether the IASB has sufficient resources to address all the issues in time for an Exposure Draft in 2010; and a desire for lessor accounting to be addressed concurrently with the project on revenue recognition.


Lessor accounting

Lessor accounting has often seemed a particularly controversial area. Our review bears this out, as figure 1 shows, with 89% of lessors strongly disagreeing with the right-of-use model.

Until recently, it appeared that the IASB had deferred the development of a new accounting model for lessors. However, in this DP, the Board invited comments on whether lessors should be included within the project and described two possible approaches.

A lessor would report, as follows:
- A finance receivable asset and derecognise some or part of the leased asset; or
- Both a finance receivable asset and a liability for a performance obligation.
- No rental income would be recorded under either approach.

In response, the Real Estate Equity Securitization Alliance (REESA) issued a comment letter setting out their view that real estate held as investment property should be excluded from the scope of the leasing model. Of the 300 responses, 23 supported this REESA letter. The majority of those 23 respondents are property lessors.

In addition to the REESA supporters, another 34 respondents argued that investment property should not be included in the scope of any new standard on leasing, principally because they believe the current standard - IAS 40 Investment Property - best presents fair and useful information to users of financial statements. For example, The Securities Commission of New Zealand stated that, "... replacing an accounting model that permits investment properties to be carried at fair value with a model that would not allow them to do so would not be an improvement to financial reporting ...", whilst The Royal Institution of Chartered Surveyors noted their view that IAS 40 "is clear and conforms
generally with market realities. No new standard should be imposed that diminishes this level of information ..."

A number of respondents took the view that accounting for investment property could be improved, but the proposals for lease accounting were not appropriate. For example, Allied Irish Bank Plc suggested that, "IAS 40 should be expanded to deal with the leasing of investment properties both from a lessor and lessee point of view as opposed to dealing with this issue in a general leasing standard."

Most respondents commented that lessee and lessor accounting should be dealt with simultaneously to identify any areas of inconsistency. Although many of those who did not comment on lessor accounting stated that they did not have enough information on the proposed changes to answer those questions. Nevertheless, 48 respondents agreed with the inclusion of investment property in the scope of the proposals. For example, Telstra (Australia) commented, "There should be one point of reference and a consistent set of accounting guidance for all lessor related assets, whether they are land, building or other assets."


Responses from those other than lessors and users

Our summary suggests that the lessee accounting proposals may be less controversial, as noted in table 1:


Table 1: Responses other than lessors and users
- Strongly disagree with the proposals: 36%
- Disagree with the proposals, but supportive of improvements to lease accounting: 23%
- Supportive of the proposals but concerned about the details: 32%
- Strongly supportive of the proposals: 9%


Respondents also raised concerns that the IASB was moving away from a principles to a rules-based approach associated with US GAAP (although some of those who supported the DP stated that convergence with US GAAP is one of the main reasons for their support). Those who disagreed with the proposals included United States Steel Corporation, which said, "Our main concern is that the proposed new standards will not reflect the intent of the parties or the substance of the lease transaction." Aggreko plc commented that the Proposals "… would not be meaningful to the user of accounts and will increase cost and complexity at the same time ...".

Many respondents agreed with the concepts in the DP, but were concerned about the impact on their business. For example, Shell International BV said, "Whilst we consider that a single accounting method for all leases will provide more clarity, the proposals will, however, have a considerable impact on the way in which preparers such as Shell administer, account for and report lease transactions." HSBC Holdings plc was concerned that "the cost of applying the right-of-use model to a large number of de-minimis non-core leases would significantly outweigh the benefits of this approach". Respondents who supported the proposals often did so because they took the view that the complexity and inconsistency of the current standards would be remedied, including the perception that the current standard is open to manipulation. For example, Financial Computer Systems, Inc said, "The right-of-use model … will greatly enhance comparability and transparency for financial statement presentation".


Responses from users

Despite the small number of responses received from users of financial statements and their representative groups, the thrust of their responses was quite striking. They all - to a greater or lesser extent - supported the proposals, as figure 1 shows.

Perhaps this is because the responses from users focused on the proposals from a lessee accounting point of view. Standard and Poor's stated that "We believe the most significant impact of the new model will be to remove the accounting distinction between operating and finance leases … a result we very much support. We have long regarded the distinction … as substantially artificial …".

Whilst The Corporate Reporting Users' Forum takes the view that "Overall, we felt the DP is heading in the right direction, creating a single accounting framework for leases which will be simpler and more understandable than the current standard."


Conclusion

The number and tone of the responses to the DP seem to indicate a good deal of concern about the proposals among interested parties - apart from the users of financial statements, who support it. An interesting, but not surprising, dilemma for the IASB. We support the IASB's approach for a lessee to present a single asset and single liability for lease arrangements, although we consider it important for the IASB to develop a rationale for the different accounting treatment afforded to non-lease executory arrangements.

In the case of lessor accounting, however, we share a number of the respondents' concerns. In our view, the questions raised by the IASB in respect of lessor accounting in the DP are only a fraction of those that will have to be addressed. The approach to lessor accounting under a right-of-use model must be consistent with the overall principles developed by the IASB in its Revenue Recognition project and the relationship with IAS 40 should be clarified.

A thorough assessment of lessor accounting is critical, in our view, to the IASB project on leases and should be performed concurrently with the ongoing development of the lessee model and the IASB's project on Revenue Recognition.