United Kingdom

Leases 

If the current proposals as issued in exposure draft ED/2013/6 are enacted, the new lease accounting standard will see significant changes to accounting for lease contracts, in both property and equipment leases. While the impact will be greater for lessees, there are also some significant changes for lessors.
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“What is called for is nothing less than a wholesale strategic rethink on whether companies should buy assets rather than lease them”

Nick Chandler, Partner in Accounting Advisory Services  

 

Overview of leases project

  • In May 2013, the IASB and FASB (the Boards) published a revised exposure draft (the 2013 ED), which updated the proposals published in the 2010 exposure draft.
  • The Boards received over 600 comment letters on the 2013 ED and have held subsequent outreach meetings to assess the many diverse views and concerns of the large constituent base of investors, analysts, regulators, preparers and others. Based on the feedback received, the Boards are re-deliberating the proposals in the 2013 ED, with potentially signficant changes. The points below reflect the proposals set out in the 2013 ED.
  • For lessees, leases, other than leases with a maximum term of twelve months, will all be recognised as a right-to-use asset and a financial liability, increasing debt and gearing.
  • The initial measurement of the asset and liability is based on a lease term that includes the non-cancellable period together with renewal options that the lessee has significant economic incentive to exercise.
  • Lessees will apply either an 'accelerated' model (Type A) or a straight-line model (Type B) to expense recognition depending on the extent of consumption of the underlying asset over the lease term and whether the leased asset is property or not.  The straight-line model (Type B) will adjust the amortisation of the right-to-use asset and interest expense on the financial liability to achieve an annual constant lease charge similar to current operating lease expense.  The Type A model will reflect the front end loading effect of the interest expense similar to current finance leases. Variable lease payments not included in the liability will be expensed as incurred.
  • For leases of property assets, the straight-line model (Type B) is applied unless the lease term is for the major part of the remaining economic life of the underlying asset or the present value of the lease payments account for substantially all of the fair value of the underlying asset.
  • For leases of assets that are not property, the accelerated model (Type A) is applied unless the lease term is for an insignificant part of the total economic life of the underlying asset or the present value of the lease payments is insignificant relative to the fair value of the underlying asset at the commencement date.
  • Lessors will apply a 'receivable and residual' model to Type A leases or an ‘operating lease’ model to Type B leases depending on the classification criteria set out above. Under the receivable and residual model, the original underlying asset will be de-recognised and a lease receivable and a residual asset recognised with any resultant profit on the lease being recognised in profit or loss. For Type B leases, existing operating lease guidance would apply.
  • Leases are identified as contracts where fulfilment depends upon the use of an identified asset and the contract conveys the right to control the use of the identified asset.
  • Remeasurement of the liability and asset will occur for changes to the lease term; changes in factors that affect the exercise of options; changes in amounts payable under residual value guarantees; changes to an index or a rate used to determine lease payments; and any resultant changes in the lease discount rate.
  • Investment properties are now within scope for lessors (having been out of scope for much of the ED discussions) but since the operating lease/Type B model is likely to be applicable in most cases, this should have relatively little impact.
  • The effective date for the standard has yet to be set.

Practical issues

  • Management will have to explain the impact of the changes to stakeholders, including analysts, shareholders, lenders and other creditors. 
  • Banking covenants may have to be renegotiated.
  • Management will be required to make considerable judgements when determining the appropriate classification of the individual leases and the value of lease payments.  This would include assessments of the economic life of the underlying asset and the likelihood of lease renewals.
  • Finance and non-finance staff will require training in the revised standard and its impact on financial reporting.
  • The tax and deferred tax impact on the leases will need to be considered and potentially reassessed.
  • Entities with numerous leases may require investment in or modification of systems.