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Leasing business sector may see increases in reported assets, liabilities  

17 May 2013

IASB and FASB propose to bring leases on-balance sheet – but at what cost?

Fundamental changes proposed by the IASB and the FASB to lease accounting standards now open for comment have the potential to significantly increase the complexity of lease accounting.

The impact of the proposed changes will be greatly felt across industry sectors. Companies leasing high-value assets, such as shipping, airlines and other transport operators will see large increases in reported liabilities.

It will also have significant impact on many different lease transactions – ranging from leases of ‘big-ticket’ items such as manufacturing facilities, vessels, aircrafts, to leases of office space and smaller items such as company cars and computers.

The changes will fundamentally alter the impact of leases on an organisation's income statement and balance sheet, eliminating the distinction between capital and operating leases and the resulting off-balance sheet obligations.

Mr Reinhard Klemmer, Head of Department of Professional Practice at KPMG in Singapore cautioned: “Capitalising real estate and equipment leases on balance sheets to recognise the rights and obligations of lessees has always been the ultimate goal.

However, we question whether these proposals represent a sufficient improvement over existing standards in providing clarity to justify the considerable cost and complexity of implementation.”

How companies recognise new assets and liabilities, along with changes in lease income and expense arising from this proposal will also affect key financial ratios. This may consequentially affect compliance with debt covenants, employee compensation arrangements, tax balances and the ability to pay dividends.

For example, many retailers who are major property lessees may see large increases in liabilities under the proposed leasing standard. At the same time, companies with many low-value leases could face high implementation costs as they identify all leases and extract the data required to apply the new accounting models.

Other proposed changes

In addition to capitalising most leases to the balance sheet for lessees, a new proposal is to introduce a new lease classification test for non-property assets such as office equipment where a financing arrangement is involved in acquiring the asset.

Affecting both lessees and lessors, the change requires the lease expense to be “front-loaded” in the initial periods and decline over the lease term as interest is calculated on the basis of a reducing liability.

However, some operating leases, such as those involving land/or buildings which show consistent lease expense over the lease period will see no change. Such lease expenses will still be divided equally and recognised in the lessees’ income statement over the lease period.

Mr Klemmer continued: “The current proposal for leases is inconsistent with the Boards’ initial objective of introducing a single lease accounting model. It represents a major compromise by the Boards and is designed to make the proposals more palatable when applied to leases of property.”

The transition to the new proposals would require all existing leases and potential lease contracts to be re-analysed. There would also be an ongoing need for increased monitoring of leases to comply with the re-assessment requirements.

For some – particularly lessors and lessees with large existing leasing portfolios – the system changes required are likely to be significant.

Mr Kenny Tan, partner with Accounting Advisory Services at KPMG in Singapore who leads the leasing standard implementation said: “Implementing these proposals would be a real challenge for many organisations, as they would need to identify all their leases, extract key data, make new estimates and judgments, and perform new calculations. Companies will also need to consider how these proposals would affect their business practices, systems and processes and performance measurement.”

The proposed changes will also affect a company’s ability to accurately predict and forecast their assets and liabilities, due to the requirement to re-assess certain key estimates and judgments at the end of each reporting period.

Mr Klemmer concluded: “The Boards have made a strong case that it is time to improve a three-decade old lease accounting standard. Some see the proposed changes as a step forward. Others will see cost, complexity and conceptual compromise.”

Ultimately, it is not clear whether these specific proposals will satisfy financial statement users – or whether this is the best way to take this important project forward.”

The proposals are open for comment until 13 September 2013.

Notes to editors

The IASB refers to the “International Accounting Standards Board” and the FASB refers to the “Financial Accounting Standards Board”.