Rio de Janeiro, September 12, 2013 CONTABILIDADE 0039/2013

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1 CONTABILIDADE 0039/2013 Rio de Janeiro, September 12, 2013 Mr Hoogervorst, Chairman International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom Subject: Leases Reference: Exposure Draft ED/2013/6 Dear Sir, Petróleo Brasileiro S.A. - Petrobras welcomes the opportunity to comment on the Exposure Draft named Leases. We believe this is an important opportunity for all parties interested in the future of IFRS and we hope to contribute to the progress of the Board s activities. Petrobras is a mixed joint stock corporation controlled by the Federal Brazilian Government and we perform as an integrated energy company in the following sectors: exploration and production, refining, oil and natural gas trade and transportation, petrochemicals, electric energy, biofuels and other renewable energy source distribution. One of the major energy companies in the world, our business plan foresees investments in the order of US$236.7 billion (of which US$147.5 billion will be related to our exploration & production activities in Brazil). The oil and natural gas industry is one of the world's largest and most capital-intensive industries and our operations require the involvement of different assets (such as vessels, platforms and drilling rigs) frequently employed and operated by third party contractors. The majority of our exploration and production activities are carried out in deep and ultradeep waters, and the proportion of our deep water activities will remain constant or increase due to the location of our pre-salt reservoirs in deep and ultra-deep waters. In this context, Petrobras is the company with the largest contracted fleet of floating rigs in the world, with contracts corresponding to 47.3% of the global backlog. Besides, we have important partnerships with major players in the oil and gas industry and our investments promote the development of the base-industry in Brazil. Considering the impact that the proposals could have on the way Petrobras reports its operations, we have carefully reviewed every aspect of the Exposure Draft. Our main conclusion is that the proposals do not properly define the boundaries between lease and non-lease arrangements. As a result, different types of non-lease arrangements could be classified as leases and we are aware that many entities are concerned about this possibility, especially in the drilling industry. In this context, we fail to understand how the proposals could reflect an improvement in current accounting. Investors would certainly be better served by enhanced disclosures instead of an imprecise accounting model. We are also aware that the Investor Advisory Committee has recently expressed a very similar opinion to the FASB. In order to achieve a more precise definition of a lease, we would strongly recommend the removal of paragraph 14 (a) and the clarification that the ability to derive the benefits from use must be based on the terms of the contract rather than over the asset itself. We believe 1

2 that these changes would permit the proper distinction between lease and non-lease arrangements. Lastly, for cost-benefit reasons and considering the benefit of information to be provided, we strongly recommend the Board to reduce the complexity in the following areas: calculation of the discount rate, lessor accounting and the requirements for the modified approach. We hope that our recommendations help the IASB in making the decisions necessary to develop and maintain principles-based standards of high quality. If you have any questions in relation to the content of this letter please do not hesitate to contact us Respectfully yours, /s/ Marcos Menezes Marcos Menezes Chief Accountant 2

3 Question 1 Do you agree with the definition of a lease and the proposed requirements in paragraphs 6 19 for how an entity would determine whether a contract contains a lease? Why or why not? If not, how would you define a lease? Please supply specific fact patterns, if any, to which you think the proposed definition of a lease is difficult to apply or leads to a conclusion that does not reflect the economics of the transaction. Response to question 1 Overall, we agree that a lease should be defined as a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. We also agree that the existence of a lease depends on the conveyance of the right to control the use of an identified asset. However, the Exposure Draft does not precisely explain the circumstances under which such conveyance takes place, creating a situation of uncertainty concerning the appropriateness of the impacts that the proposed accounting model could cause. In other words, the ambiguity embedded in the proposal would lead to an unnecessary subjectivity that could cause the improper classification of non-lease arrangements as leases. In our view, the conveyance of the right to control the use of an identified asset is a very straightforward concept. This is because the decisions about the use of the asset that most significantly affect its economic benefits must be exclusively related to the operation of the asset, as exemplified in paragraph 14(b) of the Exposure Draft. The ability to determine or change the operator of the identified asset (as exemplified in paragraph 14(c)) and the criteria for deriving benefits form the use of the identified asset (listed in paragraph 19) are mere conditions that must be satisfied before the customer is able to determine the operation of the identified asset, if the supplier is somehow involved with such operation. In this sense, we noticed that example 3 (contract for medical equipment) clarifies that the criteria in paragraph 19 could be satisfied even when a contract requires the customer to rely on the supplier, and we strongly disagree with that view. As for the example contained in paragraph 14(a), we would like to express our view that the ability to determine or change for what purpose an identified asset is employed is exactly the same as the ability to specify the output of an identified asset, as described in paragraph 17. These are universal abilities that every customer has in any type of contract and should never refer to the control of the use of an identified asset because this could lead to a misclassification of non-lease arrangements as leases. In this sense, we would strongly recommend the removal of paragraph 14(a). Notwithstanding our comments above, we believe paragraph 17 should be also improved to address situations in which the customer has the ability to specify the output, with some other decision-making rights relating to the use of the asset. We believe this situation could be addressed using criteria similar to the ones employed by the Board in IFRS 10, where it describes how to differentiate an agent from a principal. Question 2 Do you agree that the recognition, measurement and presentation of expenses and cash flows arising from a lease should differ for different leases, depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits 3

4 embedded in the underlying asset? Why or why not? If not, what alternative approach would you propose and why? Question 3 Do you agree that a lessor should apply a different accounting approach to different leases, depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset? Why or why not? If not, what alternative approach would you propose and why? Question 4 Do you agree that the principle on the lessee s expected consumption of the economic benefits embedded in the underlying asset should be applied using the requirements set out in paragraphs 28 34, which differ depending on whether the underlying asset is property? Why or why not? If not, what alternative approach would you propose and why? Response to questions 2, 3 and 4 We do not agree that the accounting for leases should differentiate according to the portion of consumption of the economic benefits embedded in the underlying asset. Except for tangible assets with indefinite useful lives such as land, any other tangible asset will have a decline of expected service potential as it is used, simply because the use itself unavoidably implies the consumption of some service potential. This remains true even if the consumption of service potential is insignificant enough not to affect the market value of the asset. In summary, when the underlying asset has a definite useful life, the lessor must price a lease to ensure that it obtains a desired return on its total investment in the underlying asset and also to recover an amount representing the portion of the underlying asset that the lessee is expected to consume during the lease term. Conceptually, we believe that lessors should account for leases as follows: (a) leases involving tangible assets with indefinite useful lives should be accounted for as type B leases; and (b) leases involving tangible assets with definite useful lives should be accounted for as type A leases. However, mainly because of the way residual values should be accounted for in type A leases, this approach would be extremely burdensome for lessors and could produce results with little informational value for users of financial statements. In this sense, we see the performance obligation approach, developed by the Board during the leases project, as a better solution if it were to be adopted as the single accounting model for lessors. This solution would be of particular advantage for a jurisdiction such as Brazil, where symmetry in the accounting by lessees and lessors is critical. This is because local individual financial statements need to be prepared with the use of equity method of accounting, in a manner that consolidated and individual financial statements have the same profit or loss and stockholders equity. This would not be achieved if intercompany leases are accounted for asymmetrically by related lessees and lessors. In the case of lessees, we believe that all leases should be accounted for as type A leases. This recommendation follows our request for symmetry in the accounting by lessees and lessors. In addition, we see the proposal for amortization of right-of-use assets under Type B leases as a plug, an amount that is not based on the declining service potential of the underlying asset. We do not agree with such proposal as we think that it would be inappropriate to link the accounting for a right-of-use asset with the consumption with the 4

5 underlying asset. For instance, even though land does not lose service potential to the lessor, the right-of-use over land held by the lessee does if the lease contract has a specified term. We also noticed that the presentation of information about lease arrangements depends heavily on whether the lease is Type A or B. As a result, lease information can be presented differently in the statement of financial position, in the statement of profit or loss and other comprehensive income and in the statement of cash flow. We believe this may confuse users since leases are not managed depending on whether they are Type A or B. Question 5 Do you agree with the proposals on lease term, including the reassessment of the lease term if there is a change in relevant factors? Why or why not? If not, how do you propose that a lessee and a lessor should determine the lease term and why? Response to question 5 In our view, the proposals on lease term are conceptually inaccurate as they consider that term options should be accounted for as part of a single lease assets and liabilities. We understand that this view has been structured by the Board during the Discussion Paper phase of the leases project, but the reasons presented in that document for rejecting a component approach (paragraph 3.32 of chapter 3) are mostly due to difficulties of practical application. Concerning the implementation aspects of the proposals for lease term contained in the Exposure Draft, we believe that the Board should clarify the precise meaning of the term significant, as it is employed in paragraph 25. Thresholds such as this will tend to create difficulties in practical application of the proposals. Question 6 Do you agree with the proposals on the measurement of variable lease payments, including reassessment if there is a change in an index or a rate used to determine lease payments? Why or why not? If not, how do you propose that a lessee and a lessor should account for variable lease payments and why? Response to question 6 We fully support the proposals on the measurement of variable lease payments. In particular, we see as very appropriate the proposal not to included variable payments based on use (other than fixed in-substance) in the measurement of the lease liability. Nevertheless, we have two recommendations on this matter. (a) Examples of variable payments Appendix A does not detail the circumstances under which variability can arise. This explanation can, however, be found in paragraph BC148. Nevertheless, we noticed that none of the circumstances listed mention the variability caused by the lessor s performance derived from the use of the asset. Even though these specific variable payments should tend to cause the contract to be classified as a non-lease, we still believe it is necessary to clarify their existence. 5

6 (b) Variable lease payments that are in in-substance fixed payments The Exposure Draft proposes the use of the very important, but still unexplained concept, of variable lease payments that are in in-substance fixed payments. This concept is only superficially addressed in some of the examples that accompany the Exposure Draft. In these examples, one might conclude that in-substance fixed payments generally involve the establishment of floor payments. If so, we fully agree with concept. However, the lack of clarity may lead some to interpret that in-substance fixed payments relate to the likelihood of expected variable payments. We fully disagree with this interpretation as it involves an executory component of the contract. Hence, we urge the Board to clarify that insubstance fixed payments do not include expected variable payments. Question 7 Paragraphs C2 C22 state that a lessee and a lessor would recognise and measure leases at the beginning of the earliest period presented using either a modified retrospective approach or a full retrospective approach. Do you agree with those proposals? Why or why not? If not, what transition requirements do you propose and why? Are there any additional transition issues the boards should consider? If yes, what are they and why? Response to question 7 We believe that only a modified retrospective approach should be permitted, in order to ensure comparability among entities adopting the standard. However, we would like to recommend a change in the modified retrospective approach so that, at the beginning of the earliest comparative period presented, lessees could recognize a right-of-use asset measured at the present value of the remaining lease payments, discounted using the lessee s incremental borrowing rate at the effective date. We also recommend as an additional relief that lessees and lessors should not apply the requirements in paragraphs 25 35, and in the comparative periods presented for short-term leases existing at the effective date. Our proposal is not only based in the reduction of costs that it would permit, but also on the informational gain that users of the financial statements would benefit from. This is because the right-of-use asset would be measured at a more updated amount representing the economic benefits expected to be obtained. There is no benefit in having the asset measured at an estimated historical cost which provides very little useful information. Question 8 Paragraphs and set out the disclosure requirements for a lessee and a lessor. Those proposals include maturity analyses of undiscounted lease payments; reconciliations of amounts recognised in the statement of financial position; and narrative disclosures about leases (including information about variable lease payments and options). Do you agree with those proposals? Why or why not? If not, what changes do you propose and why? Response to question 8 In our view, the proposal for increase in the amount of disclosures that would be required for lease contracts conflict with the premise adopted by the Board that the recognition of 6

7 lease assets and liabilities in the financial position of a lessee provides better information than having the information being disclosed in the explanatory notes. Despite adoption of this argument, the Board is proposing to simultaneously require recognition of lease assets and liabilities with an increase in the amount of disclosures. This raises the question of whether recognition would be in fact a better solution for users of financial statements and we notice that this same issue has recently been brought by the Investor Advisory Committee to the FASB. Question 9, 10 and 11 (FASB-only) Question 12 Do you agree that a right-of-use asset should be within the scope of IAS 40 if the leased property meets the definition of investment property? If not, what alternative would you propose and why? Response to question 12 We agree that a right-of-use asset should be within the scope of IAS 40 if the leased property meets the definition of investment property. Other comments (a) Discount rates One aspect of the proposals that will involve a considerable amount of complexity for preparers and, in special, lessees, is the determination of the discount rates to be used in measuring lease liabilities. Estimating these rates requires certain knowledge about the risks and returns of leased assets, which the lessee generally does not have. The lessee will focus on the risks and returns of its own operations, of which the leased asset is a component, but generally not the main one. Therefore, we would like to recommend that, as a practical expedient, the Board should permit portfolio approaches in estimating discount rates of lease liabilities. We would also like to point out that the discount rate issue may become extremely relevant depending on the final decision of the Board concerning the definition of leases. If the definition proposed by Board in the Exposure Draft is adopted, many contracts that involve more than the use of an asset may be classified as leases, as alerted by us in our response to question 1. In this case, incremental borrowing rates could drastically differ from the rates lessors charge lessees. This is because the incremental borrowing rate will not incorporate many of the risks factored by the lessor when it charges the lessee. Therefore, we urge the Board to consider our comments on the definition of leases. (b) Use of thresholds The Exposure Draft makes intensive use of thresholds. Some of these can be found in paragraphs 11 (less than substantially all), 25 (significant economic incentive) and 36 (substantive change). Thresholds tend to create difficulties in practical application of the standards and their use generally lacks the proper conceptual explanation. Therefore, we recommend the Board to clarify as much as possible the meaning of each threshold included in the Exposure Draft. 7

8 (c) Sale and leaseback The Board proposes in paragraph 112 that a transferor should consider some additional criteria in order to evaluate whether a sale took place and it is considered to have the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. We have the understanding that there is no conceptual basis for having two distinct criteria to determine control transference, one based on the draft of revenue recognition and other based on some indicators derived from IAS 17 in addition to the ability to direct the use. In this sense, we would like to recommend the removal of the criteria derived from IAS 17 to determine whether a sale took place (paragraph 112). However, as a result of a leaseback, we recommend that the transferor s gain should be limited to the consideration received from rights conveyed to the transferee after a leaseback (which is not under transferor s control) minus its historical cost. Consideration received from rights conveyed to the transferee after a leaseback equals to total consideration received from an asset sale minus the present value of leaseback payments. (d) FX gains or losses According to the proposals in the Exposure Draft, FX gains or losses would be accounted for as required by IAS 21. We would like emphasize that the proposals for lease accounting could drastically increase profit or loss volatility for lessees and this is particularly problematic for companies that operate in emerging economies. Also, the requirements of IAS 21 seem inappropriate for lease arrangements, in which the liability is directly linked to leased asset. We believe the Board should further discuss this issue before completing the project on lease accounting. We would also like to point out that current IFRSs do not mention that lease obligations could be designated as hedging instruments in hedges of foreign currency risk. We believe this clarification is necessary. (e) Oil and Gas Joint Operating Agreements The oil and natural gas industry generally constitutes Joint Operating Agreements (JOA) to share risks and costs. In this arrangement, working interest owners join together for drilling, developing, and operating a jointly owned or unitized property (or properties) according to a written agreement executed by the parties with no separate vehicle. As a result, each investor-venturer owns an undivided interest in each asset and is proportionately liable for its share of each liability. The contractual arrangement establishes the parties rights to the asset that is operated jointly, and how output or revenue from the asset and operating costs are shared among the parties. Each joint operator accounts for its share of the joint asset and its agreed share of any liabilities, and recognises its share of the output, revenues and expenses in accordance with the contractual arrangement. According to the proposals in the Exposure Draft, a contract does not contain a lease when a capacity portion is not physically distinct from the remaining capacity of the asset. In the perspective of each investor-venturer, their rights under contracts represent a capacity portion of an asset that is not physically distinct from the remaining capacity of the asset. Neither would each venture individually consume substantially all of the asset s capacity. 8

9 Ultimately, none of the ventures controls the use of the underlying asset. Therefore under a JOA, the proposed lease definition would not be satisfied. We urge the Board to clarify this issue. (h) Examples The Exposure Draft is accompanied by illustrative examples. However, we would like to state our opinion that the examples provided little help in understanding how the principles should be applied and which factors had more importance in reaching a conclusion. 9