Changes to LEASE Accounting, What Are the MAIN PROPOSALS?

As mentioned before in my post “Latest Changes for Lease Accounting”, on 16 May 2013, the IASB and the FASB published for public comment a revised ED outlining proposed changes to the accounting for LEASES. The proposal aims to improve the quality and comparability of financial reporting by providing greater transparency about leverage, the assets an organization uses in its operations and the risks to which it is exposed from entering into leasing transactions.

In detail, the core principle of the proposed requirements is that an entity should recognize assets and liabilities arising from a lease. This represents an improvement over existing leases requirements, which do not require lease assets and lease liabilities to be recognized by many lessees.

In accordance with that principle, a lessee would recognize assets and liabilities for leases with a maximum possible term of more than 12 months. A lessee would recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the leased asset (the underlying asset) for the lease term.

The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee would depend on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. For practical purposes, this assessment would often depend on the nature of the underlying asset.

For most leases of assets other than property (for example, equipment, aircraft, cars, trucks), a lessee would classify the lease as a Type A lease and would do the following :

1. recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments; and
2. recognized the unwinding of the discount on the lease liability as interest separately from the amortization of the right-of-use asset.

For most leases of property (i.e land and/or a building or part of a building), a lessee would classify the lease as a Type B lease and would do the following :

1. recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments; and
2. recognize a single lease cost, combining the unwinding of the discount on the lease liability with the amortization of the right-of-use asset, on a straight-line basis.

Similarly, the accounting applied by a lessor would depend on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. For practical purposes, this assessment would often depend on the nature of the underlying asset.

For most leases of assets other than property, a lessor would classify the lease as a Type A lease and would do the following :

1. derecognize the underlying asset and recognize a right to receive lease payments (the lease receivable) and a residual asset (representing the rights the lessor retains relating to the underlying asset);
2. recognize the unwinding of the discount on both the lease receivable and the residual asset as interest income over the lease term; and
3. recognize any profit relating to the lease at the commencement date.

For most leases of property, a lessor would classify the lease a a Type B lease and would apply an approach similar to existing operating lease accounting in which the lessor would do the following :

1. continue to recognize the underlying asset; and
2. recognize lease income over the lease term, typically on a straight-line basis.

When measuring assets and liabilities arising from a lease, a lessee and a lessor would exclude most variable lease payments. In addition, a lessee and a lessor would include payments to be made in optional periods only if the lessee has a significant economic incentive to exercise an option to extend the lease, or not to exercise an option to terminate the lease.

For leases with a maximum possible term (including any options to extend) of 12 months or less, a lessee and a lessor would be permitted to make an accounting policy election, by class of underlying assets, to apply simplified requirements that would be similar to existing operating lease accounting.

An entity would provide disclosures to meet the objective of enabling users of financial statements to understand the amount, timing and uncertainty of cash flows arising from leases.

On transition, a lessee and a lessor would recognize and measure leases at the beginning of the earliest period presented using either a modified retrospective approach or a full retrospective approach (HRD).

Read Also :

1. FASB-IASB Propose Major Changes to Lease Accounting
2. New Accounting Proposal on Leasing Portends Big Changes

Latest Changes for LEASE Accounting

On 16 May 2013, the International Accounting Standards Board (IASB) and the US based Financial Accounting Standards Board (FASB) published for public comment a revised Exposure Draft (ED) outlining proposed changes to the accounting for leases. The proposal aims to improve the quality and comparability of financial reporting by providing greater transparency about leverage, the assets an organization uses in its operations and the risks to which it is exposed from entering into leasing transactions.

Background of the Changes

The existing accounting model for leases under IFRS and US GAAP requires lessees and lessors to classify their leases as either FINANCE Leases or OPERATING Leases and account for those leases differently. For example, it does not require lessees to recognize assets and liabilities arising from operating leases, but it does require lessees to recognize  assets and liabilities arising from finance leases.

Further, the IASB and the FASB initiated a joint project to improve the financial reporting of leasing activities under IFRS and US GAAP in the light of criticisms that the existing accounting model for leases fails to meet the needs of users of financial statements by developing a revised draft standard on LEASES. The boards developed the proposals in this revised ED after considering responses to their Discussion Paper titled Leases : Preliminary Views, which was issued in March 2009, and the IASB’s initial ED Leases and the proposed FASB Accounting Standards Update, Leases (Topic 840), which were issued in August 2010.

In particular :

1. many, including the US Securities and Exchange Commission (SEC) in its report on off-balance-sheet activities issued in 2005 and a number of academic studies published over the past 15 years, have recommended that changes be made to the existing lease accounting requirements to ensure greater transparency in financial reporting and to better address the needs of users of financial statements. Many users often adjust the financial statements to capitalize a lessee’s operating leases. However, the information available in the notes to the financial statements is often insufficient for users to make reliable adjustments to a lessee’s financial statements. The adjustments made can vary significantly depending on the assumptions made by different users.
2. the existence of two very different accounting models for leases in which assets and liabilities associated with leases are not recognized for most leases, but are recognized for others, means that transactions that are economically similar can be accounted for very differently. That reduces comparability for users and provides opportunities to structure transactions to achieve a particular accounting outcome.
3. some users have also criticized the existing requirements for lessors because they do not provide adequate information about a lessor’s exposure to credit risk (arising from a lease) and exposure to asset risk (arising from its retained interest in the underlying asset), particularly for leases of assets other than property that are currently classified as operating leases.

The boards decided to address those criticisms by developing  a new approach to lease accounting that requires an entity to recognize assets and liabilities for the rights and obligations created by leases. The new approach would require a lessee to recognize assets and liabilities for all leases with a maximum possible term (including any options to extend) of more than 12 months.

This approach should result in a more faithful representation of  a lessee’s financial position and, together with enhanced disclosures, greater transparency of a lessee’s financial leverage.

The new approach also proposes changes to lessor accounting that, in the board’s view, would more accurately reflect the leasing activities of different lessors.

Who would be affected by the proposals?

The proposed requirements would affect any entity that enters into a lease, with some specified scope exemptions. The proposed requirements would supersede IAS 17 Leases (and related interpretations) in IFRSs and the requirements in Topic 840, Leases, (and related Subtopics) of the FASB Accounting Standards Codification.

The ED is open for comments until 13 September 2013.

The ED of this proposed changes of lease accounting can be downloaded from here : www.ifrs.org

The Objective and Scope of IAS 12, INCOME TAXES

The OBJECTIVE of IAS 12 is to prescribe the accounting treatment for INCOME TAXES.

The principal issue in accounting for income taxes is how to account for the CURRENT and FUTURE tax consequences of :

1. the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognized in an entity’s statement of financial position; and
2. transactions and other events of the current period that are recognized in an entity’s financial statements.

It is inherent in the recognition of an asset or liability that the reporting entity expects to recover or settle the carrying amount of that asset or liability. If it is probable that recovery or settlement of that carrying amount will make future tax payments larger (smaller) than they would be if such recovery or settlement were to have no tax consequences, IAS 12 requires an entity to recognize a DEFERRED TAX LIABILITY (DEFERRED TAX ASSET), with certain limited exceptions.

IAS 12 requires an entity to account for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves. Thus, for transactions and other events recognized in PROFIT OR LOSS, any related tax effects are ALSO RECOGNIZED in PROFIT OR LOSS. For transactions and other events recognized OUTSIDE PROFIT OR LOSS (either in OTHER COMPREHENSIVE INCOME or DIRECTLY IN EQUITY), any related tax effects are also recognized OUTSIDE PROFIT OR LOSS (either in other comprehensive income or directly in equity, respectively).  Similarly, the recognition of deferred tax assets and liabilities in a business combination affects the amount of goodwill arising in that business combination or the amount of the bargain purchase gain recognized.

IAS 12 also deals with the recognition of DEFERRED TAX ASSET arising from UNUSED TAX LOSSES or UNUSED TAX CREDITS, the presentation of income taxes in the financial statements and the disclosure of information relating to income taxes.

IAS 12 shall be applied in accounting for income taxes, which include all domestic and foreign taxes which are based on taxable profits. Income taxes also include taxes, such withholding taxes, which are payable by a subsidiary, associate or joint venture on a distribution to the reporting entity.

This standard does not deal with the methods of accounting for government grants or investment tax credits. However, this Standard does deal with the accounting for temporary differences that may arise from such grants or investment tax credits (HRD).