Leases: preliminary views

Comments from ACCA to the International Accounting Standards Committee, July 2009.

ACCA is pleased to have this opportunity to respond to the above discussion paper (DP), which was considered by ACCA’s Financial Reporting Committee.


Given that this is a discussion paper on the general accounting approach to be adopted in any future standard, we are responding not only with changes to full IFRS in mind, but ultimately also with the accounting principles which would might be incorporated into a future version of IFRS for SMEs.

The DP does not adequately deal with a number of issues, for example the question of the scope of any new standard (Q1) and lessor accounting (Q25 to 29). This seems unsatisfactory in what is meant to be a fundamental revision to lease accounting. On lessor accounting there seem good reasons why the same principles should be applicable to both parties to the transaction. We note that since issuing the DP the Board appears to have decided to try and cover lessor accounting as well in any new standard. There must however be a proper due process for that to happen.

We are not convinced of the overall approach of the application to all leases of the right-of-use (ROU) asset and the obligation to pay rentals (OPR) as a liability. IASB and FASB should work instead on the improvement of the distinction between the in-substance purchases of assets and other leases and on better disclosure of financial commitments under other leases. This is dealt with more fully under our answer to Q4 below. Our answers to Q5 onwards are therefore on the basis that the proposed model would apply to a more restricted group of leases (those that effect an in-substance purchase of the asset).

An increasing proportion of finance around the world is being provided under Islamic principles and by Islamic financial institutions. Under these principles the majority of leases would not be recognised as assets by the lessees. The proposals in the DP would move IFRS accounting further away from that position and open up the differences between the two systems even further. This seems an unhelpful development.


Should the existing scope of lease accounting standards be retained for any new standard?

No. While we accept that this may seem a practical answer for the purposes of this discussion paper, this is an unsatisfactory approach when it will come to preparing the exposure draft of a new standard. The existing standards date back many years and a revision has been considered for over 13 years. A fundamental reconsideration of lease accounting should be comprehensive and review the definition of a lease and the scope exclusions. We note that there is a separate project on extractive activities and therefore the current scope exclusion for mineral rights may be appropriate. However the proper accounting for arrangements which might form the boundaries of leases (such as take-or-pay contracts, outsourcing and other service contracts, and the licensing of intangibles) needs to be part of this project.


Should there be exclusions for short term leases or leases of non-core assets?

No. These are likely to be too difficult to define in a general way and to lead to inconsistent approaches which would reduce comparability or to bright-line definitions that might be open to similar manipulations as the current standard. While we note that the current project on financial statement presentation may include a distinction of core/non-core which might help here, we fail to see why in principle assets and liabilities should be recognised only in one context but not in the other. Any new leasing standard can of course emphasise that if the effects of leasing are immaterial to the activities of a company there is no obligation for them to be accounted for separately.

As noted in our general comments above we do not support the overall effect of this DP in proposing the capitalisation of all leases. We would not support exclusions from capitalisation on the basis of short term or non-core leases, but would restrict capitalisation to in-substance purchases of assets.


Do you agree with the boards’ analysis of rights and obligations and assets and liabilities arising in a simple lease contract?

No. A fuller explanation of both of these are required and their recognition needs more justification than simply that it meets the definition in the conceptual framework. The nature of the ROU asset created is rather different from other assets – its quality is different, the ability to pledge or realise it may be restricted for example. The boards must justify why some financial commitments are treated as executory contracts and not recognised, while all lease obligations would be recognised.


Do you support the proposed approach of recognising a right-to-use asset and a liability to pay rentals?

No. We would support retaining the present approach of trying to distinguish in-substance purchases (ISP) from rentals.

The difference in quality of the ROU asset as compared to other assets has been noted in our answer to Q3 above. These considerations are much less significant when in comes to in-substance purchases effected via a lease. As noted above the consistency of the treatment of the OPR in comparison to other obligations and commitments needs to be considered if the principal argument is that the OPR meets the definition of a liability under the Framework. We also note that the DP has extended the OPR beyond the Framework’s definition of a liability with its treatment of options to renew or purchase.

The DP’s proposals are likely to involve significant extra compliance costs for preparers in implementing the more elaborate accounting treatment for the vast majority of leases which are currently dealt with as operating leases.


A components approach or a single right-to-use asset and single obligation to pay rentals (OPR)?

Yes. As noted above in our general comments we are considering this as applying to ISPs. The single asset and liability appears to be the simpler and the more attractive approach.


Do you agree that the lessee’s obligation to pay rentals should be at their present value using the lessee’s incremental borrowing rate?

No. In the context of a lease which is an ISP a fair value of the asset is likely to be available, and so having the implicit rate inherent in the lease would be the preferred discount rate with the lessee’s incremental borrowing rate as a fall back. If the model of capitalisation were being extended beyond ISPs to all leases then the implicit rate is likely to be unavailable and the incremental borrowing rate might be more appropriate as the norm.


Do you agree with the Boards’ tentative decision to measure the lessee’s right-to-use asset at cost?

Yes. The only realistic alternative is to measure this at fair value. Recognition at fair values would also raise the possibility of the recognition of ‘day 1 profits’ (being any immediate profits being the difference between the cost of the liability and the value of the asset acquired). A cost approach is also more consistent with the measurement of the majority of comparable owned assets (under IAS16 for instance).


Do you agree with the boards’ tentative decision to adopt an amortised cost approach to subsequent measurement of the obligation to pay rentals and the right–to-use asset?

Yes. We find this consistent with the subsequent measurement of comparable assets as noted above, and also with the measurement of most comparable financial liabilities in IAS39.

QUESTION 9: Should a new leasing standard permit a lessee to elect to measure its OPR at fair value?

No. We have two main reasons for this view

  • Optional treatments in accounting standards are inherently undesirable in terms of the comparability of financial statements.
  • The recognition of the changes in own credit standing in an entity’s financial statements should generally be prohibited and certainly should be restricted to cases where there are matching changes in assets and liabilities. We see no such considerations applying in the case of leases.


Should the lessee be required to revise its obligation to pay rentals to reflect changes in its incremental borrowing rate?

No. We would prefer to retain consistency for example with IAS39 where liabilities are stated at amortised cost based on the original effective interest rate. No clear case for doing otherwise is put in the DP. If however there were to be revisions they would only be appropriate when the forecast cash flows had changed significantly.


In developing their preliminary views the boards decided to specify the required accounting for obligation to pay rentals. Do you agree?

Yes, this is probably the preferable approach. While we would like to see broad comparability between the accounting for lease obligations and other financial liabilities, they are rather different in nature (the inextricable link to an asset and the uncertain nature of the cash flows with contingent rentals for example) and therefore there might need to be divergent treatments in some regards.


Should the decrease in value of the right-to-use asset be described as rental expense rather than depreciation?

No. We would support the division between an interest cost and a depreciation charge for leases that are ISPs, as in the current leasing standard and in line with other standards such as IAS39 and 37 where liabilities are discounted. For other leases we would not favour the application of the capitalisation model and the costs should continue to dealt with as a simple rental expense.


The boards tentatively decided that the lessee should recognise an OPR for a specified lease term and that should be the most likely lease term.

Do you support the proposed approach?

Yes. The most likely lease term is probably the better and more straightforward approach than a weighted probability approach. Extending the lease term from the minimum period of commitment to the most likely term is important in helping to identify ISPs that are currently classified as operating leases. 


There should be reassessment of the lease term at each reporting date and any resulting changes in the OPR should be recognised as an adjustment to the carrying amount of the right-to-use asset. Do you agree?

Yes. The alternative would be to recognise any changes in profit and loss, which would seem to run counter to the whole concept of the ROU asset.


Do you agree that purchase options should be accounted for in the same way as options to extend or terminate a lease?

Yes, as for Q14 above.


Do you agree that the lessee’s obligation to pay rentals (OPR) should include amounts payable under contingent rentals?

Yes. As with options to renew or extend dealt with in Q13 above, including contingent rentals in the OPR may help to identify properly leases which are ISPs.


Should the obligation for contingent rentals be calculated on a weighted probability basis or on the most likely rental?

It is not clear how often there would be a significant difference between the outcomes of the two methods as the range of possibilities would need to be considered in reaching the most likely. With most contingent rentals the outcomes will be at a point along a range, rather than a binary ‘extend or terminate’ option. We find that the most likely approach is more consistent with lease terms in Q13 and seems to allow a more straightforward approach.

Q18. Lease rentals contingent on a rate or an index. Should the obligation be measured at the rate at inception of the lease, or should it reflect subsequent changes in the rate?

In our view the obligation should reflect subsequent changes.


Do you agree that changes in estimated contingent rentals should be reflected in remeasurement of OPR?



Should changes in the OPR for changes in estimated contingent rentals be reflected in the P&L or as an adjustment to the right-of-use asset?

The adjustment should be to the carrying value of the asset. This is consistent with the whole basis of the approach of the DP that the value of the asset is determined by the value of the liability.


Should residual value guarantees be accounted for in the same way as contingent rentals?



Should the lessee’s OPR be presented separately in the statement of financial position or included in other financial liabilities?

Not necessarily. What is important is that the information on the extent of the lease liabilities is available to users either by way of separate presentation on the face of the statement of financial position or by way of analysis in the notes of an overall figure for financial liabilities.


Which of the three approaches to the presentation of the right-to-use asset do you support?

Presentation of the ROU asset according to the nature of the leased asset – that is the treatment in paragraph 8.9(a) – though in our view only leases which are ISPs would be involved anyway.


Any other lessee issues?

Chapter 9 identifies a number of other issues the boards have not yet resolved on including

  • sale and leasebacks
  • initial direct costs
  • where service arrangements are also included.

All of these seem significant issues to us which need to be considered and to be dealt only after due process.


Do you think that a lessor’s right to receive rentals under a lease meets the definition of an asset?


This chapter describes two possible approaches to lessor accounting under the right-of-use model (a) derecognition of the leased item by the lessor or (b) recognition of a performance obligation by the lessor.

Which of these two approaches do you support?


Should the boards explore when it would be appropriate for a lessor to recognise income at the inception of the lease?

We support in principle there being comparability between lessor and lessee accounting. As noted above we do not agree with the approach of the DP on the treatment of all leases. Lessor accounting, furthermore needs more extensive consideration than is provided by this DP. In the light of this we have not answered these three questions any more fully.


Should accounting for investment properties be included within the scope of any proposed new standard on lessor accounting?

No, not where the investment property is accounted for under the fair value option in IAS40. Where dealt with under the amortised cost option there seems more reason to include any lease within the scope of a leasing standard.


Are there any other lessor accounting issues not described in this DP that the boards should consider?

Lessor accounting as noted above needs more extensive consideration than is provided by this DP. Sub-leases is a question that should be considered. Clearly the questions of the interest rate to apply, the effect of tax allowances, the issues of accounting for extension/terminations option, contingent rentals and guarantees all need to be considered from a lessor perspective as well.


Last updated: 12 Apr 2012