Lease accounting proposals come under fire

By: Pat Sweet, AccountancyLive

There are growing concerns that proposals announced by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) to bring most leases onto the balance sheet will prove costly and complex to implement.

The proposals are contained in a revised exposure draft issued by the two boards which also introduces a new lease classification test resulting in a ‘dual model’ for both lessees and lessors. This would preserve straight-line expense recognition for most leases of property, similar to operating leases today. However, there would be interest and amortisation expense recognition for most other leases, similar to finance leases.

Veronica Poole, Deloitte UK national head of accounting, said: ’The potential impact on business is huge and is likely to affect important key performance indicators significantly.’

Concerns centre on the amount of data gathering that will be necessary to comply with the proposals, particularly as leases will need to be monitored regularly in order to comply with re-assessment requirements.

Brian O’Donovan, partner in KPMG’s international standards group, said: ‘Implementing these proposals would be a real challenge for many organisations, as they would need to identify all their leases, extract key data, make new estimates and judgements, and perform new calculations. Companies will also need to consider how these proposals would affect their organisation and business practices.’

Ernst & Young’s lead on global IFRS, Ruth Picker, said the new proposals will call for significant changes to current practice.

‘The proposal would require the use of greater judgment and estimates, for example, when determining if the arrangement meets the definition of a lease or classifying a lease based on whether the lessee consumes more than an insignificant portion of the underlying asset. As most leases would be recorded on a lessee’s balance sheet, key metrics may change, for example, debt ratios and return on assets,’ Picker said.

Mark Beddy, Deloitte real estate partner, said: ‘With the top 50 groups in the FTSE disclosing lease obligations off balance sheet of over £100bn, and given that much of the UK’s £700bn commercial real estate is leased, these proposals will add billions of liabilities to property occupiers’ balance sheets.’

O’Donovan also warned that the proposals could affect a company’s ability to accurately predict and forecast assets and liabilities, due to the requirement to re-assess certain key estimates and judgements at the end of each reporting period, and so increase volatility.

Nigel Sleigh-Johnson, head of ICAEW’s financial reporting faculty, questioned the new ‘dual model’ for lessee expense recognition, saying: ‘This solution is a compromise too far, although it does address widely-held concerns about “front-loading” of costs.’

He added: ‘The transition to the new standard will certainly be challenging, and companies need plenty of time to prepare for the changes. Where the impact is significant, a priority will be communicating with investors and others users of the company’s financial reports, not least where major changes in the reported numbers do not reflect any change in the economics of the business.’

The FRC is hosting a discussion forum, including IASB staff, on the exposure draft on 10 July 2013.

The closing date for exposure draft responses is 13 September.