Leases: on balance sheet - but at what cost?
In a major shake-up of lease accounting, the IASB and FASB have
issued their latest proposals for lease accounting that would bring
most leases on-balance sheet for lessees. A dual model would apply,
based on a new lease classification test, which would affect the
profile of lease income or expense recognised over the lease term.
The impacts of these proposals, e.g., balance sheet and income
statement volatility, would be felt across all sectors.
With the release on 16 May of the IASB’s and FASB’s joint
exposure draft (ED) Leases, discussions have restarted on
this controversial topic. The Boards’ approach maintains their key
objective of getting leases on balance sheet. Under the proposals,
all leases, other than those with a maximum term of twelve months,
would come on-balance sheet.
The current focus on whether a lease is an operating lease
(off-balance sheet) or a finance lease (on-balance sheet) would be
irrelevant. The proposals introduce a dual model whereby lessees
would recognise an expense either on a front-end loaded or straight
line basis. The model applied by a lessee is determined by whether
the underlying asset is property or not and the extent of the
consumption of that asset over the lease term. Lessees of a
non-property asset with a lease term that is not insignificant
compared to the life of that asset would recognise an expense on a
front-end loaded basis.
Lessors would use the same lease classification test, which would
result in many non-property lessors, and some property lessors,
recognising a lease receivable and a residual asset rather than the
Implementing the proposals could be a real challenge for many
entities and the impacts, including significant effort to identify
leases and extract lease data, changes in financial metrics, and
balance sheet and income statement volatility, are likely to be felt
across all sectors. In particular, entities that lease
high-value assets of any nature would see significant increases in
reported liabilities and entities with large volumes of lower-value
leases could face high implementation costs, e.g., to address lease
identification, classification, measurement and transition.
Whilst the concept of recognition by lessees of a right-to-use
asset and a lease liability has been a constant throughout the
project, some of the other key proposals are likely to attract much
- re-introduction of a dual model for lease classification (for
income statement purposes) along with a different and untried
classification test for property and non-property leases;
- front-end loading of combined interest and depreciation
expense on most non-property leases;
- change to the definition of a lease such that a lease exists
only when the contract is over the use of an identified asset that
the lessee controls for a period of time. This forms a new
distinction between leases (on-balance sheet) and service
contracts (off-balance sheet). The ED contains further
guidance on what constitutes an identified asset and how the right
to control the use of an asset is demonstrated;
- expectation that the asset and liability will be re-measured
during the lease period (increasing the need to continually
monitor leases); and
- the requirement to reassess all existing and potential lease
contracts on transition.
Although many of the key proposals have been debated for some
time, there is still an expectation that the proposals will generate
a significant level of response to the IASB. The comment
deadline is 13 September 2013 and we encourage you to consider
responding to the IASB on these potentially significant proposals
for lease accounting.
The ED, along with the IASB’s Snapshot document that seeks to
explain the proposals, is available here.
KPMG IFRG Limited’s newly-released New
on the Horizon: Leases considers the ED’s detailed
proposals and provides KPMG’s insight on these proposals. KPMG’s
press release raises questions on whether the proposals provide
sufficient improvement over current lease accounting to satisfy
financial statement users, or justify the considerable cost and
complexity of implementation.
No effective date for the intended standard has been announced
although it appears unlikely that entities will be required to adopt
this prior to the effective date for the revenue standard (1 January