Overview of lease projects
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 the longest probable lease term.
Lessees will apply either a straight-line model or ‘accelerated’ model to expense recognition depending on the extent of consumption of the underlying asset over the lease term and whether the leased asset is real estate or other assets.
The straight-line model 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 accelerated model will reflect the front end loading effect of the interest expense similar to current finance leases.
For leases of real estate the straight-line model is applied unless the lease term is for the major part of the economic life of the underlying asset or the present value of the fixed lease payments account for substantially all of the fair value of the underlying asset.
For leases of other assets the accelerated model is applied unless the lease term is for an insignificant portion of the economic life of the underlying asset or the present value of the fixed lease payments is an insignificant portion of the fair value of the underlying asset.
Lessors will apply either a 'receivable and residual' model or ‘operating lease’ model 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.
Investment properties are now intended to be within scope for lessor (having been out of scope for much of the ED discussions) but since the operating lease model is likely to be applicable in most cases this should have relatively little impact.
The above points reflect the compromises reached in the IASB and FASB discussion in June 2012 although the implications of these proposals continue to be worked through. A formal re-exposure of the leasing proposals is now envisaged for the first quarter of 2013 with a comment period of 120 days.
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.
IFRS Publications