09 September 2013

FEE commented on IASB ED Leases

FEE acknowledges the significant work performed by IASB to address concerns expressed with respect to the previous IASB proposals. In particular, FEE believes that the latest proposals on the determination of the lease term and the accounting for variable payments represent an improvement over the previous ED.

FEE also considers that the revised definition of a lease provided in the ED, in particular the modification of the criteria in IFRIC 4 to distinguish a service from a lease, also represents an improvement. FEE believes that focusing on control of the asset is appropriate since this is consistent with the focus in other recent standards/proposals (in particular on revenue recognition and in IFRS 10). However, FEE regrets that the IASB has not followed FEE´s suggestion to clearly establish why a lease contract constitutes an executed, rather than an executory, contract. This is regrettable since work on this matter may have resolved some of the issues that led to the introduction of a dual-model.

On the issue of the definition of a lease, FEE does not believe that the level of consumption of the underlying asset should be used to establish whether a contract is a lease or whether the right-of-use model should be used. If one accepts that a lease is an executed contract, the degree of consumption of the underlying asset does not appear to be a relevant factor to the existence of a lease. However, as indicated above, FEE believes that the determination of why/when a lease is an executed contract is a question that remains to be addressed.

Despite the improvements noted above, FEE does not support the ED on conceptual and practical grounds. FEE acknowledges that the introduction of a dual-model is the result of an attempt by the IASB to respond to criticisms made with respect to the previous ED. However, FEE believes that the proposals in the ED are overly complex and not robust conceptually. Further, application of a dual-model would fail to respond to one of the key criticisms made with respect to IAS 17 which is that leases of similar assets are accounted for differently by different entities as a result of slightly different contractual terms or different assessments of these similar terms.

Indeed, FEE believes that establishing a single accounting model, preferably symmetrical between lessees and lessors, is a prerequisite in order to achieve transparency and understandability in financial reporting. FEE believes that this single model could be based on the right-of-use model, subject to further work being performed on the conceptual basis underlying such a model.

While FEE is unable to support the proposal in the ED, it acknowledges that users have been requesting more transparency around the obligations from leases.

Accordingly, FEE supports the suggestion by EFRAG that the Board should bring improvement to the existing requirements of IAS 17 without delay through relevant and meaningful disclosures. As suggested by EFRAG, such disclosures could address information about minimum commitments and maximum potential further cash flows disaggregated by category of underlying asset.

Concurrently, the Board should take advantage of its current project on the conceptual framework to address the fundamental and cross-cutting issues. Once these questions have been dealt with, the Board will be in a better position to propose robust improvements to lease accounting.

Conceptually, FEE believes that the right-of-use is based on the notion that an asset is a bundle of rights, one of them being the right-of-use. However, it may be premature to use a definition of asset that seems to go beyond the current definition in the conceptual framework. Accordingly, FEE believes that the issues surrounding the right-of-use asset should be considered as part of the current work of the IASB on the conceptual framework. These issues include how to distinguish the right-of-use from the other rights conveyed by an asset, how the right-of-use asset is consumed and how control over the right-of-use is obtained.

Another key aspect that should be examined as part of the project on the conceptual framework relates to the recognition of a liability for amounts arising from options and variable payments.

The ED requires that a lessee recognises a liability for fixed payments due over periods covered by renewal options and for the exercise price of purchase options, if the lessee has a significant economic incentive to exercise the related options. While this is similar to the current requirement in IAS 17, it nonetheless appears inconsistent with other requirements in IFRS (in particular IAS 37) that consider that economic compulsion does not constitute a valid basis for recognising a liability. This fundamental aspect in the definition of a liability merits further consideration.

Similarly, the recognition and basis for measurement of variable payments arising from usage or performance also deserve appropriate consideration as part of the project on the conceptual framework to ensure that clear principles are established that can be applied across IFRS.

Once these key concepts are established, the development of a robust right-of-use model for the lessee and the lessor should be possible. However, FEE can already consider that the Type-B model does not represent a conceptually sound model, whether from the perspective of lessees or lessors.

From the perspective of lessees, the lack of conceptual basis in the proposed accounting treatment for Type-B leases is evidenced by the fact that the statement of financial position treatment for these leases is not consistent with their treatment in P&L and in the statement of cash flows (it results in a financing liability for which the expense is not a financing charge and for which the cash outflows are classified as operating). The ED also introduces an amortisation method for the right-of-use asset (in the Type-B model) that is inconsistent with methods generally applied to assets under IFRS.

From the perspective of lessors, the key conceptual problem with the proposed accounting treatment for Type-B leases is that, if one accepts that the right-of-use is an asset in its own right, it appears inconsistent for the lessor not to derecognise that right considering that the lessee recognises that same right on the basis that it controls it.

In addition to the above conceptual deficiencies noted, FEE is concerned about the practical difficulties that would likely arise from the implementation of the ED proposals for the preparers and their auditors.

In particular, the proposed basis for classification between Type-A and Type-B leases (based on a presumption reflecting the nature of the underlying asset, with a rebuttal of the presumption based on the level of consumption) is complex. If, contrary to FEE´s opinion, the IASB was to pursue a dual-model approach, FEE believes that the classification should be based solely on the level of consumption of the underlying asset by the lessee (without regards to the nature of the underlying asset).

Press release

Comment letter to IASB

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