Lease accounting set for a shake-up: KPMG

Lease accounting set for a shake-up: KPMG

• Significant changes to IASB and US FASB accounting standards
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• Would affect both lessees and lessors
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• Would increase liabilities and impose a costly transition for many
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• Complexity, multiple approaches and rules would remain
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A new Leasing Exposure Draft released today jointly by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) would affect nearly every entity, says KPMG New Zealand.

“The changes particularly would affect entities with significant operating leases of large, expensive assets such as aircraft. Others who would be affected include those with leased assets in the mining, construction and transport sectors as well as entities with leased buildings, including head offices and retail premises,” says Simon Lee, National Technical Director, KPMG.

He says that these changes would impact most entities.

“Any entity with operating leases would have to alter significantly how it accounts for these in both the statement of financial position and statement of comprehensive income.”

Mr Lee says lessees with operating leases coming onto the statement of financial position would experience an increase in assets and liabilities and often would see a front-ending of expenses in the statement of comprehensive income. Even for a lease currently classified as a finance lease, the lease liability may be higher initially.

These proposals will have particular relevance to lessees who are restructuring or renegotiating covenants, who should take these potential changes into account now.

The proposals are a response to long standing criticism of current lease accounting which is seen by some as too permissive of off balance sheet accounting by lessees and dominated by a plethora of rules. In their recently revised work plan update the IASB and FASB identified leasing as one of the five high priority issues for significantly improving current accounting and convergence.

Some see the changes as a step forward for lessee accounting, allowing a clearer picture of an entity’s assets and payment obligations. From a financial statement user’s perspective many analysts already make changes to incorporate operating leases in their assessments and these proposals are likely to assist them. Others may see the changes as adding complexity.

Entities may struggle to determine the value of leases for recognition in the statement of financial position as the measurement method would change for both lessees and lessors. Retailers, for example, would be required to estimate the present value of rents based on turnover or inflation over the life of a 10 to 20 year retail lease for each leased store, revisiting those estimates each time they report.

“When you consider that many entities only forecast over periods of three years, there could be a lot of crystal ball gazing taking place,” cautioned Mr Lee.

Mr Lee says lessors also would be impacted by the proposed changes with two very different models proposed, the performance obligation approach and the derecognition approach. Under the performance obligation model, the lessor would recognise the leased asset, an asset for the lease rentals and a liability for permitting use of the leased asset. Under the derecognition model, the lessor would derecognise the leased asset and recognise an asset for the lease rentals and a residual value asset for its interest in the leased asset at the lease end. The performance obligation approach would be more likely to apply to lessors with leases that currently are classified as operating, while the derecognition approach would be more likely to apply to leases that currently are classified as finance leases.

Lessors who currently treat leases as investment property at fair value will be relieved that they are exempt from the new proposals.

The transition to the new proposals would require every existing lease to be reanalysed. In some cases, particularly for lessors and lessees with large leasing portfolios, the system changes required are likely to be significant.

Mr Lee closed, noting that “Applying the new lease models will be a challenge. We had hoped the Leasing Exposure Draft would reduce complexity and avoid the current situation of multiple approaches that rely on rules to distinguish different types of leases. It’s disappointing this hasn’t happened. We still have the rules, just in a different form.”

“One thing is certain; there will be considerable accounting changes for every entity that has lease arrangements. An adequate transition time will be crucial once this standard is finalised.”

ENDS

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