Lease Accounting - Standards reform back on track

Authored by George Tonks

The International Accounting Standards Board and the US Financial Accounting Standards Board have continued to discuss the reform of lease accounting since issuing their joint discussion paper in March. They are continuing on track to issue a formal exposure draft of the new accounting standard in Q2 of 2010, with the final standard following about one year later, so that it seems likely that changes will be effective from 2012. These changes are additional to the change in IAS 16 which results in some leasing companies reporting substantially increased turnover this year.

Having made the decision in 2008 that consideration of lessor accounting should be deferred, the Boards now seem determined to bring it back into this new accounting standard, with time spent at each of the last two monthly meetings on lessor issues. The Boards have also indicated that “in-substance purchases” should be outside the scope of the new accounting standard, although they have not clarified what that phrase means.

The IASB/ FASB proposals for revising lessee accounting are now well developed:

• Lessees will report an asset and a liability for any lease, with the initial asset and liability amounts equal to the present value of the minimum lease payments over the longest period for which the lessee is more likely than not to lease the asset;
• Each of the liability and asset will be amortised over the period of the lease on similar bases to those currently required for finance leases;
• Contingent rentals and residual value guarantees should be included within the balance sheet asset and liability, based on the expected value of payments;
• There should be a reassessment of the balance sheet asset and liability at each reporting date.

Their proposals for lessor accounting are beginning to take shape, but remain less definite at this stage:

• The balance sheet to show assets for the ownership of the asset and also for the amounts receivable from the lessee, together with a liability for the performance obligation to allow the lessee use of the asset;
• The initial measurement of the asset in respect of amounts receivable from the lessee should be the present value of those amounts. It seems likely that subsequent measurement will be on the amortised cost basis using an effective interest approach;
• The initial measurement of the liability in respect of the performance obligation should equal the value given to the amounts receivable from the lessee and the subsequent measurement of this liability should reflect the decrease in the lessor’s obligation to permit the lessee to use the asset;
• The lessor should not be permitted to recognise revenue at the start of a lease;
• The treatment by the lessor of lessee options and contingent rentals should mirror those for lessees.

The developments that will take place over the next few months will be important to lessors in terms of the attractiveness of leasing as a product with lease structures, profit recognition and capital requirements all being heavily affected by the outcome.

For more detail on the issues covered by this report please contact George Tonks on +44 (0)845 003 1000 or e-mail: george.tonks@invigors.com.