International and American accounting standards boards have jointly proposed an overhaul of the current international lease accounting standard IAS 17 in their exposure draft ‘ED 2010/9 Leases’. The proposals seek to significantly alter the way lease contracts are accounted for by both the lessees and lessors. The current distinction between ‘operating leases’ and ‘financial leases’ would go and the new accounting model will not allow ‘leases’ to be treated as an off-balance sheet item. Assets and liabilities of all leases as defined would be recognised by lessees.
Certain contracts currently classified under ‘leases’ are likely to be scoped out to mean ‘sale and purchase’ transactions. Under the proposals a contract would be considered a purchase or a sale if at the end of the term the contract transfers:
· control of the underlying asset; and
· all but a trivial amount of the risks and benefits associated with the entire underlying asset to another entity.
The proposal then mentions a debatable explanation of how a contract would normally meet both these criteria i.e. when the contract automatically “transfers title” to the underlying asset at the end of the contract or includes a bargain purchase option where it is reasonably certain, at the inception of the lease, that the lessee will exercise the option.
For lessees: Currently a lessee accounts for its right to the use of the leased asset by recognising an asset and a liability (financial leases), and a liability for all the payment obligations in the case of an operating lease. Under the new model a lessee would account for all leases covered within the scope of the draft by recognising an asset reflecting the right to use of the asset and a liability for its obligation to pay rentals.
For lessors: The draft proposes two accounting models for lessors; a ‘performance obligation’ approach where the lessor retains significant risks and benefits associated with the underlying asset, and a ‘derecognition approach’ in other cases. The lessor with an active portfolio of assets (and therefore retains significant risks associated with the assets) generating returns would apply the ‘performance obligation’ approach. Where the lessor appears to take merely a ‘credit risk’ (e.g. manufacturers selling products on deferred payments) through a lease contract, then the ‘derecognition’ approach apply.
Accounting services will need to be geared up to meet the requirements of the new standard expected in June 2011. The deadline for public comments on the proposals closes on 15 December 2010.
