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 :
- 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.
- 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.
- 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
