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Lease accounting overhaul - the wider implications

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13th Jan 2011
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Changes to lease accounting will be finalised later this year and are expected to have significant implications for businesses that depend on leases.

The exposure draft - originally published on 17 August by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) - will effectively force listed companies to recognise on their balance sheets lease contracts as liabilities or assets.

Since August the new measures have been received mainly with widespread derision, the most recent scorn coming from supermarket giants Sainsbury and Tesco describing the proposals as "unintuitive" and "inconsistent".

Paul Fearn, group finance director for Tesco, said: "We believe that the proposals fail to properly reflect the substance of leasing transactions, introduce accounting inconsistencies and significant financial statement distortions, thereby failing to meet the needs of users."

In addition, the car trade association Leaseurope issued a letter in response to the proposals, expressing concern over the need to completely overhaul existing lease accounting and the relative costs and benefits.

The level of antipathy the proposals have stirred was aired in Leaseurope's comment letter on 15 December:

"Leaseurope remains concerned that the Boards' focus in developing a new accounting model for leases has been on a marginal sub-category of lease transactions that are very different from the vast majority of leases that businesses enter into. Instead of concentrating on sophisticated, high-value, structured deals, we urge the Boards to reconsider their proposals in light of the reality of the leasing market, which is comprised of millions of low-value plain vanilla contracts providing the use of straightforward business equipment."

While the supermarket and automotive industries have put their cards on the table, what other reactions will the changes provoke and how will they affect businesses in other industries?

Steve Collings, director at Leavitt Walmsley Associates, commented: "The supermarkets are up in arms about it seemingly because they lease all their vehicles through operating leases, the payments of which are charged straight against profit. They do not recognise an asset in the balance sheet, nor do they recognise a corresponding creditor – this is exactly what the IASB and FASB are trying to get rid of [off balance sheet finance]."

The IASB and FASB have basically said the reason for the change is because regardless of who owns the risks and rewards of the assets, leases will always give rise to rights and obligations which meet the recognition criteria of an asset/liability. 

The rights are allowing the lessee to enjoy the use of the asset, while the obligations are the lease payments to the lessor.

Collings continued: "Companies are up in arms because this will create a liability which previously did not exist which will affect issues such as gearing ratios and for those companies who have loan covenants, increases in liabilities could well end up breaching those covenants."

What the IASB and FASB are proposing has been on the cards for many years and the concept of 'off balance sheet finance' has been a bugbear for the standard-setters for some time now.

One industry where the new lease accounting proposals are particularly relevant is in aircraft leasing.

Interestingly, more than 90% of the world's aircraft leasing business is based at Shannon airport in western Ireland, and 75% of leased aircraft are still owned by Irish businesses.

One adviser in the Irish aircraft leasing sector recently told AccountingWEB.co.uk: "The industry doesn't fundamentally disagree with the IASB's sentiment about off-balance sheet financing, but it is concerned about implementation.
 
"The new leasing treatments involve a change to the provenance of the assets, which in turn can affect banking provisions and the cash extracted from securitisation packages. Many lease finance deals have a cash roll-off arrangement, where an amount of revenue will be ring-fenced for lease payments and when you get to a certain level, the rest of the cash can be released into the business. The new standard may affect these formulas."

The adviser concluded: "People need to sit down and look at everything. They don't know what will be affected and it involves what were secure, long-term, contract-based revenues. And when money is tight, it affects your ability to pay down debt."

Additional positive words have come from Dr Nigel Sleigh-Johnson, head of ICAEW's financial reporting faculty: "With some refinement, the proposed improvements to lessee accounting may provide the basis for much-needed and better information on lease obligations to users of financial statements. However, this positive view may be overshadowed by concerns over the proposals that relate to lessor accounting."

Sleigh-Johnson continued: "The question is whether the different three model system proposed will be seen as fit for purpose and provide the simplification required. The key is to end up with a standard that is both operational in practice and capable of producing the information needed by users of financial statements. With this in mind, ICAEW will be studying the detail of the proposals, assessing their impact and talking to constituents and the standard setters."

Due to the significant impact of the proposed lease accounting change, it is not too early to start analysing the impact on your business.

The proposed changes are not expected to be effective until 2013 and there are certain steps that can be taken from the perspective of financial compliance but also internal resources.

While reaction has been mixed to the new lease accounting proposals and the extent of the implications, it may be a good time for clients to start discussions with lenders about modifying existing loan agreements and for taking a good look at the tax implications.

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By HannahP
11th Mar 2011 07:18

leasing industry

These proposed changes should be made not only benefiting the business's owners but rather listen too to the clients' claims. Financial transactions, particularly the leasing industry should think well of leading obligations and assets to stable state and lesser conflicts regarding its accounting.

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