NEED TO KNOW. Leases The 2013 Exposure Draft

Transcription

1 NEED TO KNOW Leases The 2013 Exposure Draft

2 2 LEASES - THE 2013 EXPOSURE DRAFT TABLE OF CONTENTS Introduction 3 Existing guidance and the rationale for change 4 The IASB/FASB project to date 5 The main proposals 6 Definition of a lease 6 When would a contract contain a lease? 6 What would be the lease term? 6 What would be a significant economic incentive? 6 Scope 8 Contracts that contain lease and non-lease components 9 Lessee accounting 10 Initial recognition and measurement 10 Subsequent accounting 12 Presentation 18 Lessor accounting 19 Recognition and measurement 19 Type A leases 19 Type B leases straight-line approach 22 Presentation 22 Amounts included in lease payments 23 Variable lease payments 23 Purchase options 26 Residual value guarantees 26 Term option penalties 26 Reassessment of the discount rate 27 Short-term leases 27 Sale and leaseback transactions 27 Disclosure 28 Consequential amendments business combinations 29 Transition 30 Lessees 30 Lessors 30 Comparison of the IASB and FASB proposals 32

3 LEASES - THE 2013 EXPOSURE DRAFT 3 INTRODUCTION This publication sets out key proposals about the future of lease accounting, based on the most recent discussions of the IASB and the FASB during their joint project to revise the accounting requirements. If, as appears likely, the proposals are finalised on the basis of decisions taken to date, a wide range of entities will be affected. In May 2013 The International Accounting Standards Board (IASB) issued exposure draft 2013/06 Leases (the 2013 ED) for public comment, which sets out proposed changes to the accounting for leases. The 2013 ED has been developed through a joint project with the US Financial Accounting Standards Board (FASB) GAAP in the light of criticisms that the existing accounting model for leases fails to meet the needs of users of financial statements. This publication updates the previous BDO Need to Know publication, Leases A Project Update, that was issued in September Lessees Lessees would record assets and liabilities for a wide range of leases that are currently not recognised on balance sheet For leases of items that are currently accounted for as operating leases, except for leases of property, the single amount currently included within operating results in the income statement would be split into operating and finance components For leases of property, although assets and liabilities will be recognised on balance sheet, the lease expense recognised in profit or loss will continue to be on the same basis as under IAS 17 Leases, in most cases resulting in a constant expense over the lease term. Lessors For leases of items other than most leases involving property, lessors would adopt an approach in which the leased asset is partially derecognised and a separate lease receivable recognised (previously known as the receivable and residual approach) For leases of property, in many cases an approach similar to operating lease accounting in accordance with IAS 17 would be retained. Lessors and lessees would have an accounting policy choice (election is made by class of assets) whether to apply the new guidance to short-term leases (i.e. those leases with a maximum possible term, including any options to renew, of 12 months or less). For some entities, the effect on their financial statements would be very significant, with this extending to include not only the statement of financial position (or balance sheet) but also their comprehensive income and cash flow statements. The IASB has indicated that it intends the proposals to be effective for annual reporting periods beginning on or after 1 January Because of the significance of the effect of the proposals on their financial statements, it may be appropriate for entities to start assessing the effect of the proposals on their financial statements, and in particular the consequent effect on related arrangements including: Lending agreements, including key ratios and covenants Employee remuneration arrangements, including bonus schemes linked to reported profits and share-based payments; and Investor communications. The boards are aware of the potential effect of the proposals, and that they will affect almost every reporting entity, with some having many leases. The boards will consider these and other relevant factors when finalising the effective date.

4 4 LEASES - THE 2013 EXPOSURE DRAFT EXISTING GUIDANCE AND THE RATIONALE FOR CHANGE The existing accounting models under both IFRS and US GAAP require lessees to classify their lease contracts as either finance (capital) leases or operating leases. Under a finance lease, a lessee recognises the leased asset on balance sheet together with a corresponding lease liability which is subsequently accounted for as a financing transaction. Under an operating lease, leased assets and related gross liabilities are not recognised, with only a lease expense being recognised in profit or loss (usually on a straight-line basis over the lease term). Under current IFRS, the distinction between a finance and an operating lease is based on whether the lease transfers substantially all of the risks and rewards associated with the leased asset to the lessee. Under US GAAP, although specified criteria are used to determine the classification, the result is typically the same as under IFRS although the US GAAP bright line thresholds can result in differences for some transactions. These models have been criticised for failing to meet the needs of users of financial statements, because, unless a lease is classified as a finance lease, rights and obligations that meet the definitions of assets and liabilities in the IASB and FASB conceptual frameworks are omitted from balance sheets. Transactions are frequently structured specifically to result in operating lease classification, and hence to avoid recording associated assets and liabilities. This leads to a lack of comparability and, because of the structuring of transactions to achieve a particular accounting result, to complexity. As a result, many users of financial statements adjust amounts presented in financial statements to reflect assets and liabilities arising from arrangements classified as operating leases.

5 LEASES - THE 2013 EXPOSURE DRAFT 5 THE IASB/FASB PROJECT TO DATE In order to address the criticisms set out above, the IASB and the FASB (the Boards) initiated a joint project to develop a new approach to lease accounting that would result in most, if not all, assets and liabilities arising from lease contracts being recognised in an entity s statement of financial position. While the main focus was on lessee accounting, proposals were also developed for changes to lessor accounting. An exposure draft (the 2010 ED) was issued in August 2010 which set out an accounting approach based on the premise that lease contracts result in lessees obtaining the right to use an asset for a specified period (the right-of-use model). The proposals were controversial, and the Boards received almost 800 comment letters. In addition to publishing the 2013 ED for comment, the Boards: Initiated over 200 outreach meetings, including 7 round tables and 15 preparer workshops Prepared questionnaires that were completed by over 250 lessors and over 400 lessees Carried out targeted outreach during redeliberations with over 70 organisations. There was general support for the proposed right-of-use model. However, the feedback received also included many comments that the detailed approach proposed in the 2010 ED was too complex, inconsistent with the economics underlying certain transactions and, for many companies, excessively costly to implement. In particular, there were concerns about complexity of measurement, costs associated with required reassessments during lease terms, accounting for multi element contracts (contracts which contain lease and non-lease components) and the proposed lessor accounting model. Consequently, significant changes have been incorporated into the 2013 ED. BDO comment The Boards have addressed many of the concerns raised by constituents in response to the 2010 ED, and this has resulted in simplifications being made to the proposed model which would assist in making them more straightforward to implement. We welcome these developments. However, the 2013 ED also includes what some might regard as a compromise for leases of property. While we believe that the proposals would continue to bring a significant improvement to the quality of financial reporting because leased assets and associated liabilities would be brought on balance sheet, the extent of this improvement in accounting for leases of property would be more limited. The revised proposals for lessor accounting are also complex, and we anticipate that there may be calls for further simplification of the model in responses to the 2013 ED.

6 6 LEASES - THE 2013 EXPOSURE DRAFT THE MAIN PROPOSALS The main objective of the project has been maintained, which is that for most leases with a term of one year or more lessees will record assets and liabilities. There will be two approaches to be followed to determine the amounts to be recorded in profit or loss; one will result in a higher overall charge in the early periods of a lease due to the effect of finance charges on the lease liability which will decline as the obligation declines over the lease term, while the other will normally result in an overall constant charge to profit or loss over the lease term. The approach to be followed will depend on the extent of consumption of the economic benefits embedded in the leased asset over the lease term. For lessors, there will also be two approaches which will be based on the same classification criteria used by lessees. One approach will result in the recording of the sale of part of the leased asset (representing the portion of the asset s economic life that has effectively been disposed of), while the other will result in accounting that is similar to current guidance for operating leases. DEFINITION OF A LEASE When would a contract contain a lease? An entity would determine whether a contract contains a lease on the basis of the substance of the contract, by assessing whether the fulfilment of the contract depends on the use of a specified asset (an asset that is explicitly or implicitly identifiable) and whether the contract conveys the right to control the use of that specified asset for a period of time. A right to control the use of an asset is conveyed if the lessee has the ability to direct the use, and receive the benefit from that use throughout the lease term. The requirement for the arrangement to cover a specified asset is an important distinction, as it means that it would be necessary to be able specifically to identify the asset (for example, an item of plant and machinery or a building). A physically distinct portion of a larger asset could also be a specified asset (for example, the first floor of a building, floors 10 to 15 of a 20 storey building or an identified 100 square metre area of a 1,000 square metre commercial space). However, if a portion of an asset cannot be specifically identified (for example, a specified proportion of the capacity of a pipeline or of a fibre optic cable network) that portion is not a specified asset. What would be the lease term? The lease term would be the non-cancellable period for which the lessee has contracted with the lessor to lease the underlying asset, together with the effect of any options to extend or terminate the lease when there is a significant economic incentive for an entity to exercise an option to extend the lease, or for an entity not to exercise an option to terminate the lease. What would be a significant economic incentive? In assessing whether there is a significant economic incentive to exercise an extension or termination option, at the commencement date, a lessee and a lessor would consider contract-based terms (terms that are included in the lease contract), asset-based factors (for example significant leasehold improvements made by the lessee that might have material value when a lease extension option is due to be exercised and would be lost if the lessee exercised the termination option) market-based and entity-based factors (for example management intent). All these factors would be considered together and the existence of only one factor would not necessarily, by itself, signify a significant economic incentive to exercise an option.

7 LEASES - THE 2013 EXPOSURE DRAFT 7 The lease term would be reassessed only when there is a significant change in relevant factors, meaning that the lessee would either now have, or no longer have, a significant economic incentive to exercise an option. The thresholds for evaluating the extent of a lessee s economic incentive to exercise options to extend or terminate a lease and options to purchase the underlying asset would be the same for both initial and subsequent assessment. However, changes in market-based factors (such as market rates to lease a comparable asset) after lease commencement would not, in isolation from changes in other factors, trigger a change in the assessment. These other factors include (but are not limited to) any of the following: Contractual terms and conditions for the optional periods compared with current market rates such as the amounts of lease payment in optional periods, variable and contingent payments and the terms of additional extension options (for example, an exercise price that is currently below market rates) Leasehold improvements that might have significant economic value for the lessee when an option becomes exercisable Costs relating to a change in the lease such as costs related to negotiation, relocation, identifying a new asset for the lessee or returning the underlying asset to the lessor The importance of the underlying asset for the lessee s business. BDO comment The Boards decision not to include future changes in market rental rates as a standalone triggering event when reassessing whether there is a significant economic incentive to exercise options to extend or terminate a lease might initially seem odd. However, this was in response to comments received by the Boards that, if changes in market rental rates were included in the analysis, this could result in excessive complexity in financial reporting. This is because the effect could be excessive volatility in the carrying amounts of assets and liabilities, as part or all of the arrangements subsequently fell within or moved outside the recognition threshold. It is not entirely clear from the 2013 ED what the linkage is between market rental rates and management intent. We believe that the latter should be taken into account. For example, this might then include an entity s intentions on whether to relocate, and an entity s intent to exercise a lease extension option with the intention of subletting the existing premises at a profit. The IASB Staff included the following example to support the decision to exclude changes in market rental rates (IASB Board paper, May 2011): Lessee A has a 10-year lease for its corporate headquarters in a large metropolitan area with annual payments of CU150,000. The lease has a 5-year renewal option at the same annual payment of CU150,000. During the 10 years, the following occurs to annual market rates for the lease of comparative real estate: a) At the end of year 3, there is an increase in demand. The annual market rate increases to CU300,000 b) At the end of year 6, a local recession drives the annual market rate to CU50,000 per year c) At the end of year 8, because of tax incentives instituted by the local jurisdiction to stimulate the economy, an increase in demand results in the market rate increasing to CU320,000 per year d) At the end of year 10, the market rate is still CU320,000. However, Lessee A has decided that it has changed its business model to lower costs by decentralizing its management. It now estimates that it needs a much smaller space for its corporate headquarters and does not exercise the option to extend the lease term. The example does illustrate that, if market rental rates were to be taken into account it would be possible for the assessment of whether the extension option would be exercised to change on a number of occasions. This would result in the five year extension period being included or excluded from the lease asset and liability at various points. However, it does not clearly address the potential for management to decide to relocate, and also exercise the lease extension option with the intention of subletting the existing premises at a profit.

8 8 LEASES - THE 2013 EXPOSURE DRAFT SCOPE The proposed scope means that the new requirements would apply to all leases (including subleases) except for: Leases of intangible assets for lessors which will be dealt by the new IFRS Revenue from Contracts with Customers BDO comment As noted in paragraph BC83 of the Basis for Conclusions, the IASB did not want to prevent a lessee from applying the proposals to leases of intangible assets, therefore it decided to propose that a lessee need not apply lease accounting to leases of intangible assets, rather than such leases being excluded from the scope of the proposals. Because lessees would have a choice about whether to apply lease accounting to leases of intangible assets, lessees will need to apply IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors in determining an appropriate accounting policy for leases of intangible assets. Leases for the right to explore for or use minerals, oil, natural gas and similar non-regenerative resources Leases of biological assets Leases of service concession arrangements within the scope of IFRIC 12 Service Concession Arrangements Short-term leases (these are leases with a maximum possible term, including any options to renew, of 12 months or less). This means that leases of non-core assets (that is, assets not related to an entity s main business activities), and long term leases of land, would be within the scope of the proposals. In addition, there is no scope exclusion for assets that are often treated as inventory, such as non-depreciating spare parts, operating materials, and supplies, if these are associated with the leasing of another underlying asset. This represents a significant further change for some entities. The 2013 ED proposes that lessees and lessors would have an accounting policy choice when accounting for short-term leases (i.e. those leases with a maximum possible term, including any options to renew, of 12 months or less) of either applying the lease accounting requirements in full, or following a simplified approach. Under this accounting policy choice, a lessee would have the option of recognising lease payments in profit or loss on a straight-line basis over the lease term, while a lessor would have the option of recognising lease payments receivable on either a straight-line basis or another systematic basis, if that is more representative of the pattern in which income is earned from the underlying leased asset. This accounting policy choice would be available by class of underlying asset to which the right-of-use relates.

9 LEASES - THE 2013 EXPOSURE DRAFT 9 CONTRACTS THAT CONTAIN LEASE AND NON-LEASE COMPONENTS For contracts that contain lease and non-lease components, the 2013 ED would require each component to be identified and accounted for separately. A lessee would allocate payments due under the overall contract as follows: If the price of each component is observable, the lessee would allocate the payments on the basis of the relative standalone purchase prices (the price at which a lessee would purchase a component of a contract separately) of individual components If the purchase price of one or more, but not all, of the components is observable, the lessee would allocate the payments on the basis of a residual method If there are no observable purchase prices, the lessee would account for all the payments required by the contract as a lease. Application guidance is included in the proposals, to assist lessees in determining what is meant by an observable price. The 2013 ED states that a price is observable if it is the price that either the lessor (or similar suppliers) charge for similar leased good or service components on a stand-alone basis. A lessor would allocate payments to be received in accordance with the forthcoming IFRS Revenue from Contracts with Customers (currently scheduled for release in quarter three 2013).

10 10 LEASES - THE 2013 EXPOSURE DRAFT LESSEE ACCOUNTING Initial recognition and measurement At the date of commencement of a lease, a lessee would recognise and measure a right-of-use asset and a liability to make lease payments. The date of commencement of a lease is the date on which the lessor makes the underlying asset available for use by the lessee. The date of commencement of a lease may be different from the date of inception of the lease, which is the earlier of the date of the lease agreement and the date of commitment by the lessor and lessee to the principal terms of the lease; this can be earlier than the commencement date. In the 2010 ED, the IASB made a distinction between the recognition date (commencement of lease) and the date on which the lease assets and liabilities would be measured, which was the date of inception of the lease. This was similar to existing guidance in IAS 17 Leases. This approach was eliminated during redeliberations by the boards and is not included in the 2013 ED. The 2013 ED includes guidance that covers costs incurred, and lease payments made, by lessees after the date of inception of a lease but before its commencement date (such as costs of the lessee relating to the construction or design of an underlying asset). In addition, a lease might meet the definition of an onerous contract between its date of inception and date of commencement, meaning that the costs of the lease are greater than the economic benefits to be received from the use of the leased asset. In those cases, it would be accounted for in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets until the date of commencement. A lessee would measure its obligation to make lease payments at the present value of the lease payments, discounted using the rate the lessor charges the lessee. If that rate could not be readily determined then the lessee would use its own incremental borrowing rate. The rate that a lessor charges the lessee is a rate that takes into account the nature of the transaction as well as the terms and conditions of the lease. Generally, this is the rate implicit in the lease. The lessee s incremental borrowing rate is the rate of interest that, at the commencement date of the lease, the lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset with a similar value to the right-of-use asset. The rate implicit in a lease is the rate of interest that, at a given date, causes the sum of the present value of payments made by a lessee for the right to use an underlying asset and the present value of the amount a lessor expects to derive from the underlying asset following the end of the lease term, to equal the fair value of the underlying asset. BDO comment In theory, the rate implicit in the lease calculated by a lessor should be similar to the rate which is calculated by the related lessee. However, the rates may be affected by differences between the lessee s and lessor s estimates of the residual value of the underlying asset at the end of the lease. The rates may also be affected by taxes or other factors known only to the lessor.

11 LEASES - THE 2013 EXPOSURE DRAFT 11 The right-of-use asset is measured as the amount of the liability to make lease payments, plus any initial direct costs incurred by the lessee and lease payments made to the lessor before the commencement date. Initial direct costs are those costs that are directly attributable to negotiating and arranging a lease, that would not have been incurred had the lease transaction not been entered into. In some leases the underlying asset may need to be constructed or redesigned for use by the lessee. A lessee may be required to make payments relating to the construction or design of the asset. Such costs that are related to the construction or design of an underlying asset, are accounted in accordance with other applicable Standards such as IAS 2 Inventories or IAS 16 Property, Plant and Equipment. When a lessee controls the underlying asset before the commencement date, the transaction is a sale and leaseback transaction. Costs relating to the construction or design of an underlying asset do not include payments made by the lessee for the right to use the underlying asset. Payments for the right to use the underlying asset are lease payments, regardless of the timing of those payments. Any lease incentives provided by the lessor to the lessee would be deducted from the initial measurement of the right-ofuse asset. Where a right-of-use asset is amortised on a straight-line basis to a nil residual value, the accounting result for the incentive will be the same as under current guidance in SIC-15 Operating Leases Incentives, but it will be different where amortisation is not on a straight-line basis.

12 12 LEASES - THE 2013 EXPOSURE DRAFT Subsequent accounting The subsequent accounting would depend on the nature of the underlying asset. There would be two types of leases, with the classification being based on the extent of consumption of the leased asset during the lease term. (i) Determining the type of lease The two proposed types of leases are: Type A For most leases of assets other than property (for example, equipment, aircraft, cars, ships, trucks, photocopiers etc.), a lessee would classify the lease as a Type A (previously known in the boards discussions as the finance approach or the interest and amortisation approach, or accelerated expense approach). Type B For most leases of property (i.e. land and/or a building or part thereof), a lessee would classify the lease as a Type B lease (previously known in the boards discussions as the straight-line approach). While this would appear similar to the current finance vs. operating lease distinction, the distinction between the two types of lease under the 2013 ED would be different. The underlying principle in distinguishing between the two types would be based the extent to which the lessee acquires and consumes the underlying asset over the lease term. The principle would be applied using a practical expedient based on the nature of the underlying asset, such that leases of property (including land and/or a building or part thereof) would be accounted for as a Type B lease, unless: The lease term is for the major part of the economic life of the underlying asset; or The present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset at the commencement date of the lease. Leases of assets other than property would be accounted for as Type A leases unless: The lease term is an insignificant portion of the economic life of the underlying asset; or The present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset at the commencement date of the lease.

13 LEASES - THE 2013 EXPOSURE DRAFT 13 During an IASB webcast in July 2012, the IASB Staff presented a slide with the following examples: Truck (4 years) 3 Vessel (20 years) 1 Vessel (5 years) 1 More than Insignificant Car (3 years) 4 Commercial property (30 years) 1 Insignificant Commercial property (10 years) 1 Aeroplane (8 years) 2 Assumed economic life: years years years 4. 6 years The boards noted that, for most leases, determining whether the underlying asset is property or not would be a relatively straight-forward assessment. This should be a qualitative assessment that would require entities to conclude on the most important element of a lease, which should be relatively clear for most leases. The boards also noted that if an entity is unable to identify the primary asset, this may indicate that there is more than one lease component in the contract, which would then require each component to be classified and accounted for separately (refer to section above). BDO comment It would appear that most leases (except for leases of property) would be regarded as being for more than an insignificant portion of the underlying asset and would therefore be accounted for as Type A leases. For example, the slide in the July 2012 IASB webcast indicates that, if for example the lease term of a vessel is five years and the assumed economic life 40 years, the IASB Staff believe that there is need for further judgment as this may suggest that the lessee consumes more than an insignificant portion of the underlying asset over the lease term. The illustrative examples that accompany the 2013 ED include two examples. The first example deals with a lease of a non-property item. The present value of the payment is around 28% of the underlying asset s fair value and the lease term is around 17% of total economic life. The lessee determines that since the item is a nonproperty asset and the lease term and present value of lease payments are both more than insignificant part of the value of the underlying asset, the lease should be classified as a Type A lease. The second example deals with the lease of a building (i.e. property). In that example the present value of the payment equals 75% of the underlying asset s fair value and the lease term is around 38% of total economic life. The lessees determines that since the item is property, the lease term is not for a major part of remaining economic life, and the present value of lease payments is not substantially all of the fair value of the underlying asset, the lease should be classified as a Type B lease.

14 14 LEASES - THE 2013 EXPOSURE DRAFT (ii) Accounting for the lease For both Type A and Type B leases, the lessee would measure the liability to make lease payments at amortised cost using the effective interest method. The lessee can measure the right-of-use asset in accordance with one of three below methods (except if a lessee elects to apply the recognition exemption for short-term leases): Amortised cost (subject to impairment) In accordance with the fair value model in IAS 40 Investment Property if the underlying asset meets the definition of investment property and the lessee applies the fair value model as an accounting policy The revaluation model in IAS 16 if all assets within the class of the leased asset are revalued. The difference between the Type A and Type B leases is the way in which the right-of-use asset would be measured after initial recognition, and the associated effect on the income statement. For Type A leases, the right-of-use asset would be amortised on the same basis that the lessee would apply to the underlying asset (and therefore in a way that reflects the pattern of consumption of the expected future economic benefits of the rightof-use asset). The lease liability would be accounted for using the effective interest method (that is, in the same way as a conventional loan). Interest and amortisation expenses would be recognised separately in the income statement. BDO comment Assuming the right-of-use asset was amortised on a straight-line basis, the effect would be that the overall income statement charge would be greater in the early periods of a lease in comparison with later periods, due to the larger interest expense. This front loading would be increased if the right-of-use asset was amortised on a reducing balance basis. In addition, the amortisation expense will be included within operating results, with the interest expense being included within finance charges. Assuming the arrangement would be accounted for as an operating lease under IAS 17, in addition to the front loading of the combined amortisation and finance charge, the finance element will be eliminated from operating results. Entities will need to consider carefully the effect on their reported results, and the associated effect on aspects such as bank covenants, employee remuneration arrangements linked to reported results (including )share-based payments), and on key metrics that they report to the markets and other users of their financial statements. However, in many cases lessees will have leased assets which are at different stages of their lease terms. Consequently, while the question of front loading may be relevant for one Type A lease in isolation, it is likely that on a portfolio basis the effect will be less significant. For Type B leases, the amortisation of the right-of-use asset is measured each period as a balancing figure such that the total lease expense would be recognised on a straight-line basis, regardless of the timing of lease. In addition, and in contrast to a Type A lease, the two components of the lease expense would be recognised as one single amount to be charged to operating results in the income statement. A lessee may have a significant economic incentive to exercise a purchase option. In such cases, because the lessee would be assumed to acquire the underlying asset, the right-of-use asset that is recognised by the lessee would be amortised over the whole economic life of the underlying asset rather than over the lease term. The following examples illustrate the difference between the Type A and Type B leases.

15 LEASES - THE 2013 EXPOSURE DRAFT 15 Example 1 Illustration with equal lease payments in each period A lease contains the following key terms: Lease term: 6 years Lease payments: Annual payments, made at the end of each year, of CU75 Lessee incremental borrowing rate (assuming the rate the lessor charges cannot be readily determined): 4%. The effect on the lessee s statements of financial position and comprehensive income is as follows: Periods Total expenses TYPE A LEASE Balance sheet Right-of-use assets 393 (1) 328 (5) Liability to make lease payments 393 (1) 334 (4) Income statement Interest on lease liability (2) Amortisation expense (3) Total lease expense TYPE B LEASE Balance sheet Right-of-use assets 393 (1) Liability to make lease payments 393 (1) 334 (4) Income statement Total lease expense 75 (6) Total lease expense by lease Type Type A lease Type B lease (1) The present value of the lease payments discounted by the incremental borrowing rate. (2) The present value of the liability to make lease payments at beginning of the period multiplied by the incremental interest rate. (3) For Type A leases, the right-of-use asset s amortisation expense is calculated by dividing the right-of-use asset carrying amount on commencement of the lease by the lease term of six years. (4) The present value of the liability to make lease payments at beginning of the period less the principal part of each lease payment 393-(75-16)=334. (5) =328. (6) Accretion of interest on the liability of 16 plus amortisation of the right-of-use asset at a balancing figure amount of 59 (which is also used as the principal part of the lease payment) to give a total charge of 75.

16 16 LEASES - THE 2013 EXPOSURE DRAFT Example 2 Uneven lease payments A lease contains the following key terms: Lease term: 6 years Lessee incremental borrowing rate: 4% Lease payments: annually in arrears. Periods Lease payment The effect on the lessee s statements of financial position comprehensive income is as follows: Periods Total expenses TYPE A LEASE Balance sheet Right-of-use assets 384 (1) 320 (5) Liability to make lease payments 384 (1) 362 (4) Income statement Interest on lease liability (2) Amortisation expense (3) Total lease expense TYPE B LEASE Balance sheet Right-of-use assets 384 (1) 325 (7) Liability to make lease payments 384 (1) 362 (4) Income statement Accretion interest (included in total lease expense below) (6) Total lease expense Total lease expense by Type Type A lease Type B lease (1) The present value of the lease payments discounted by the incremental borrowing rate. (2) The present value of the liability to make lease payments at beginning of the period multiplied by the incremental interest rate. (3) In the finance approach the right-of-use asset s amortisation expense is calculated by dividing the right-of-use asset carrying amount on commencement of the lease by the lease term of six years. (4) The present value of the liability to make lease payments at beginning of the period less the principal part of each lease payment 384-( )=362. (5) =320. (6) The right-of-use asset amortisation charge is a balancing number so that the total expense (including accretion of interest on the liability) will be 75 in each period. (7) Difference between the accreted interest and the lease payment (384-(75-15)).

17 LEASES - THE 2013 EXPOSURE DRAFT 17 Reassessment The proposals would require a lessee to reassess the carrying amount of each of its lease obligations if facts or circumstances indicated that there had been a significant change in those obligations since the previous reporting period. Changes in obligations could arise as a result of reassessments of: The lease term Variable lease payments linked to an index or a rate Whether a purchase option will be exercised Other amounts that may become payable (for example, under residual value guarantees). Changes in lease payments that are due to a reassessment in the lease term would result in a lessee adjusting its obligation to make lease payments and its right-of-use asset, as these relate to future periods. Reassessment Residual Value Guarantees Some leases include a clause under which the lessee guarantees the amount of the residual value of the leased asset at the end of the lease term (a residual value guarantee). Amounts expected to be payable under a residual value guarantee on the commencement date are included in the lease liability and right-of-use asset. An increase or a decrease in the amount expected to be payable under a residual value guarantee can arise from a decrease or an increase in the expected value of the underlying asset at the end of the lease term. Changes in lease payments after the commencement date that are due to a reassessment of amounts payable under residual value guarantees would change the obligation to make lease payments and be recognised: a) In net income to the extent that those changes relate to current or prior periods and; b) As an adjustment to the right-of-use asset to the extent those changes relate to future periods. Right-of-use asset The IASB has retained the option in the 2010 ED, such that a lessee is permitted to measure a right-of-use asset at its revalued amount, less any amortisation and impairment losses. The requirements are consistent with those set out in IAS 16 Property, Plant and Equipment, in that all assets in that class of property, plant and equipment would be required to be revalued. This links to the right-of-use assets being presented within the category of property, plant and equipment to which the underlying asset would be allocated if it was owned by the lessee. Right-of-use asset Impairment IAS 36 Impairment of Assets would be applied at each reporting date to determine whether a right-of-use asset is impaired, and for the purposes of the recognition of any impairment loss. Foreign exchange differences Foreign exchange differences related to the liability to make lease payments would be recognised in profit or loss, consistent with the guidance in IAS 21 The Effects of Changes in Foreign Exchange Rates.

18 18 LEASES - THE 2013 EXPOSURE DRAFT Presentation A lessee s presentation of amounts arising from leased assets would depend in part on whether the leases were classified as Type A or as Type B. 1. For right-of-use assets and lease liabilities included in the statement of financial position, a lessee would either disclose amounts relating to leases as separate line items, or include those amounts in primary statement line items that contain other items and disclose the right-of-use assets and lease liabilities in the notes to the financial statements. This presentation is required to be separate for the right-of-use assets and lease liabilities that represent Type A and Type B leases. If right-of-use assets and lease liabilities are not presented as separate line items in the statement of financial position: a. The right-of-use assets should be included within the same line item as the corresponding underlying assets would be presented as if they were owned, and b. The note disclosures would be required to indicate the line item in the statement of financial position in which the right-of-use assets and lease liabilities have been included. 2. For a Type A lease, the lessee would recognise the unwinding of the discount on the lease liability (interest expense) and the amortisation expense associated with the right-of-use asset separately in the statement of comprehensive income. For a Type B lease, the lessee would present the two amounts together. This means that, for a Type A lease, combining interest expense and amortisation expense in the statement of comprehensive income, and presenting this as a single amount of lease or rent expense, would be prohibited. 3. In the statement of cash flows a lessee would present lease payments in the cash flow statement in the following way: For Type A leases: The element of lease payments relating to principal repayments would be included within financing activities. Lease payments relating to interest would be classified in accordance with IAS 7 Statement of Cash Flows. This classification will depend on the accounting treatment of the interest amounts; interest expense will fall within the scope of IAS 23 Borrowing Costs when determining amounts that could be capitalised, which could affect the cash flow classification. For Type B leases: The payments would be included within operating activities. For both Type A and Type B leases, variable lease payments that are not included in the measurement of the lease liability, and payments in respect of short-term leases that are not capitalised, would be included within operating activities.

19 LEASES - THE 2013 EXPOSURE DRAFT 19 LESSOR ACCOUNTING Recognition and measurement The proposals within the 2013 ED use the same classifications as for lessees, being: Type A Previously known as the receivable and residual approach Type B An approach similar to operating lease accounting in accordance with IAS 17 Leases. The distinction between the two Types would be based on the same criteria used for lessee accounting (the extent of consumption of the leased asset during the lease term) with the same practical expedient if the underlying asset is property (land and/or a building or part of a building). Other than for leases where the underlying asset is property, Type A leases would be those in which the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term. Leases of investment property measured at fair value which are classified as Type B or short-term leases would be within the scope of IAS 40 Investment Property and the lessor would continue to recognise the underlying asset and recognise lease income over the lease term. Type A leases The lessor would apply the following accounting: At the commencement date derecognise the carrying amount of the underlying asset (if previously recognised) At the commencement date recognise a receivable for the right to receive lease payments at the present value of the lease payments, discounted using the rate the lessor charges the lessee, plus direct costs. The receivable would subsequently be measured at amortised cost using the effective interest method Recognise the residual asset as an allocation of the carrying amount of the underlying asset. The initial measurement of the residual asset would comprise three amounts: i. The gross residual asset, measured at the present value of the estimated residual value at the end of the lease term discounted using the rate the lessor charges the lessee plus ii. The present value of expected variable lease payments if the lessor reflects expectations of these payment in the rate it charges the lessee and the payments are not included in the lease receivable less iii. The unearned profit (that is, the element of any difference between the fair value and book value of the leased asset that relates to the retained, residual, asset), measured as the difference between the gross residual asset and the allocation of the carrying amount of the underlying asset. Subsequently measure the gross residual asset by accreting this to the estimated residual value at the end of the lease term using the rate the lessor charges the lessee Defer recognition in profit or loss of any gain relating to the residual asset until the point at which that asset is sold or released Present the gross residual asset and any deferred gain together as a net residual asset Apply IAS 36 Impairment of Assets, when assessing whether the residual asset is impaired Recognise in profit or loss: a) The unwinding of the discount on the lease receivable as interest income; b) The unwinding of the discount on the gross residual asset as interest income; and c) Variable lease payments that are not included in the lease receivable in the periods in which that income is earned.

20 20 LEASES - THE 2013 EXPOSURE DRAFT Example 3 Lessor Type A lease (payments in arrears) A lease contains the following key terms: Lease term: 4 years Expected life of the leased asset: 10 years Lease payments: CU502, annually in arrears Interest rate charged to the lessee: 2.84% Fair value of leased asset on commencement of the lease: CU4,040 Carrying amount of the leased asset on commencement of the lease: CU3,840 Expected carrying amount of the leased asset at the end of the lease term: CU4,040x6/10=CU2,424. The effect on the lessor s statements of financial position and comprehensive income is as follows: Periods Balance sheet Lease receivable 1,873 (1) 1,424 (8) Gross residual asset 2,167 (2) 2,229 (7) 2,292 2,357 2,424 Deferred gain (107) (5) (107) (107) (107) (107) Net residual asset 2,060 (3) 2,121 2,185 2,250 2,317 Income statement Day 1 profit 93 (4) Interest income on the lease receivable (6) 53 (6) Interest (accretion) income on the residual asset 62 (7) Total interest income (1) Present value of lease payments (n=4, payment=502, I=2.84%). Subsequently measured by using the effective interest method. (2) Represents the Expected carrying amount at the end of lease term at present value discounted by the incremental interest rate. (3) Carrying amount of asset less derecognised part of asset (3,840-1,780=2,060). The part of the asset that is derecognised in the lease is calculated by multiplying the carrying amount of the asset by the ratio between the present value of the lease payment (e.g. the fair value of the derecognised part) and the all asset s fair value (3,840x1,873/4,040=1,780). (4) Profit on partial derecognition is measured as the difference between the present value of lease payments (1,873) and the derecognised part of the asset (1,780). (5) Deferred gain is the difference between the gross residual asset (2,167) and the net residual asset (2,060) at lease s commencement. (6) Lease receivable at beginning of a period multiplied by the interest rate (1,873x2.84%=53). (7) Subsequently the gross residual asset is measured in a manner similar to effective interest rate. The carrying amount at beginning of the period is multiplied by (1+ interest rate) (2,167x2.84%=2,229). The accretion income is 2.84%x2,167=62. (8) Calculated by using the effective interest method (1,873x2.84% 502=1,424). A lessor would apply the guidance in IAS 39 Financial Instruments: Recognition and Measurement, to assess whether the lease receivable is impaired. Changes in lease payments that are due to a reassessment in the lease term would result in an adjustment being made to the receivable and to any residual asset, the combined effect of which would be recognised in profit or loss.

21 LEASES - THE 2013 EXPOSURE DRAFT 21 BDO comment The lessor accounting for Type A leases would be the most complex of the models to be applied. For example, the accounting to be applied for the residual asset retained by the lessor is not simply to maintain the retained portion of the book value during the lease term, subject to impairment. Instead, the calculation is based on the following steps: 1. The expected residual value of the portion of the leased asset that has been retained by the lessor is calculated. This is based on the fair value of the asset at the commencement of the lease (in the example above this is CU4,040, a CU200 increase in comparison with the existing depreciated cost of CU3,840). 2. The expected residual value is then discounted back for the lease term, using the interest rate that the lessor charges the lessee. This gives the present value of the residual asset at the commencement of the lease (in the example above this is CU2,167). This amount will not appear in the lessor s statement of financial position, instead representing a memo amount that is required for the purposes of the overall calculation. 3. The difference between the present value of the residual asset and the existing depreciated cost that has been recorded by the lessor is established. This difference is equal to the amount of the fair value increase (in this example, CU200) that relates to the residual asset that has not been disposed of by the lessor (in this example, CU107). The reason for this approach is to ensure that the lessor does not recognise any profit in respect of the residual asset that has not been disposed of, instead only recognising profit of the amount of the asset that relates to the lease term (in this example CU93). The operation of the calculation means that the total of the profit relating to the two components of the leased asset that are disposed of and retained (CU93 and CU107) will always equal the difference between the fair value and existing book value of the asset at the lease commencement date (CU200). 4. The accretion of the revalued residual asset (step 2 above) is then added each period to the carrying amount of the recognised residual asset (in the example above, this is CU2,060 at commencement of the lease). The difference between the gross and net residual asset (in the example above, CU107 which is the fair value uplift that relates the portion of the asset that is not covered by the lease), remains the same throughout the lease term. It does not initially seem clear why the residual asset recognised by the lessor is accreted each year using the amount that is calculated on the basis of the revalued amount of the asset. However, it is consistent with the whole asset approach that is required to be applied for the purposes of sale and leaseback transactions. It reflects the fact that the lessor charges the lessee for the use of the entire underlying asset during the lease term, because the lessor cannot generate any economic benefits from the asset during the lease term other than amounts due from the lessee. The overall approach is that the whole of the leased asset is derecognised, with the retained portion then being recognised at the discounted amount of its expected depreciated fair value at the end of the lease. This amount is then reduced to the extent of the portion of the difference between the existing carrying amount of the leased asset, and its fair value, at the commencement date of the lease that relates to the residual asset that the lessor has retained. Although, from a conceptual perspective, this would seem largely to be an appropriate approach it is complex. Some might also question why the recognised (net) residual asset is accreted using amounts calculated on the basis of the revalued amount of the asset. This is because a portion of the accretion then represents part of the revaluation (because the accretion is based on the revalued amount and not the lower existing carrying amount). Under the 2013 ED, this would be recognised in profit or loss as finance income, but under IAS 16 Property, Plant and Equipment any revaluation credit would be recorded in Other Comprehensive Income. Others may have concerns about the accretion of a non-financial asset, as accretion is normally applied only to financial assets and liabilities. However, the approach set out in the ED reflects comments that were received in response to the 2010 ED. These noted that if recognition of time value in the residual asset was prohibited, this would fail to reflect the way in which leases are priced and so the economics of leasing arrangements would not be reflected in financial statements. Lessors would instead measure the asset at an artificially low amount during the lease term, and then recognise an artificially large gain if the underlying asset was sold at the end of the lease term. In addition, the accretion of the residual asset is similar to the accounting approach followed for a residual asset which is embedded in the net investment in a lease that is currently accounted for as a finance lease in accordance with IAS 17.

22 22 LEASES - THE 2013 EXPOSURE DRAFT Type B leases straight-line approach The proposed model is similar to the current operating lease model. A lessor would not recognise a lease receivable and would continue to recognise the underlying asset. Lease payments receivable would be recognised as income on a straightline basis or another systematic basis, if more representative of pattern in which income is earned from the underlying asset. The differences between the two types of leases can be summarised as follows: Type A leases Type B leases Statement of financial position 1. Receivables right to receive lease payment (present value plus direct costs). 2. Residual asset The IASB has proposed that revaluation of the residual asset should be prohibited. Leased asset measured at fair value or cost. Income statement Profit on transfer of ROU (presentation based on business model). Interest income on both the lease receivable and the residual asset. Rental income-straight-line basis or another systematic basis. Depreciation or fair vale changes. Presentation A lessor of a Type A lease would include the following information: In its statement of financial position, present either: The lease receivable and the residual asset separately from other assets on the face of the statement, adding to a total for lease assets The lease receivable and residual asset as one amount for leased assets, with those two components being disclosed in the notes. In its statement of comprehensive income or disclose in the notes: Income arising from leases If disclosed and not presented, notes should reference the line item where income is presented Present lease income and lease expense in either separate line items or net as a single line item, on the basis of which best reflects the lessor s business model. In its cash flow statement, classify cash inflows from leases within operating activities.

23 LEASES - THE 2013 EXPOSURE DRAFT 23 AMOUNTS INCLUDED IN LEASE PAYMENTS Variable lease payments Variable lease payments are payments that arise under the contractual terms of a lease because of changes in facts or circumstances occurring after the date of inception of the lease, other than the passage of time. For example, increases in lease payments might be linked to a benchmark interest rate, and some retail property lease payments are linked to the value of the lessee s sales that are made from the leased property. Some variable lease payments would not be included in the measurement of the right-of-use asset, the lessee s lease liability and the lessor s receivable. However, the following variable lease payments would be included: 1. Lease payments that are in-substance fixed lease payments, but are structured as variable lease payments in form. For example, lease payments might be calculated on the basis of a base fixed amount plus a variable supplemental amount. If that case, the base amount would be treated as being fixed lease payments, even though the total amount payable would be variable. 2. Lease payments that depend on an index or a rate (for example, a lease where future increases in lease payments are linked to a benchmark interest rate). These would be included in the lessee s liability to make lease payments and the lessor s right to receive lease payments in the following way: Lease payments that depend on an index or a rate would be measured initially using the index or rate that exists at commencement of the lease. These payments would be reassessed at the end of each reporting period using the rate that exists at that date. Lessees would reflect changes in the measurement of lease payments that depend on an index or a rate in net income to the extent that those changes relate to the current reporting period and as an adjustment to the right-of-use asset to the extent that those changes relate to future reporting periods. Lessors would recognise changes in the receivable due to reassessments of variable lease payments that depend on an index or a rate immediately in profit or loss. In circumstances where a lease contract includes variable lease payments that are excluded from the lease receivable at the lease commencement date: If the rate the lessor charges the lessee does not reflect an expectation of variable lease payments, the lessor would not make any adjustments to the residual asset with respect to variable lease payments. This is because the amounts allocated to the portion of the leased asset that is derecognised on lease commencement, and therefore the amount allocated to the residual asset, will not be affected by any estimates of future variable lease payments. The effect of variable lease payments would be reflected in net profit or loss for the period. If the rate the lessor charges the lessee does reflect an expectation of variable lease payments, the lessor would adjust the residual asset on the basis of the variable lease payments that are actually received in each reporting period. This would be achieved by recognising a portion of the cost of the residual asset as an expense when variable lease payments are recognised in profit or loss. BDO comment It might not seem entirely clear why a distinction is made between the two scenarios set out above. However, the rationale for this adjustment is that when a lessor does expect to receive variable lease payments, the base amount (excluding any variable amount) that the lessor charges is less than the expected actual lease income. As a consequence, because the lease income used for the purposes of the lessor s accounting will exclude variable receipts, a smaller amount is allocated to the portion of the leased asset disposed of, with the residual asset carrying amount being correspondingly higher. The adjustment to the residual asset for variable lease payments actually received therefore acts as a true up of the residual asset carrying value for each reporting period. Because no adjustment is made to the residual asset on commencement of the lease to reflect expected variable lease income, no adjustment would be made to the residual asset for any difference between actual variable lease payments and the amounts that the lessor expected to receive at the lease commencement date.

24 24 LEASES - THE 2013 EXPOSURE DRAFT Example 4 Variable lease payments dependent on Consumer Price Index (CPI) A lease contains the following key terms: Lease term: 4 years Lessee incremental borrowing rate is: 5% The lease is classified as a Type B lease There are no initial costs Lease payments: annual lease payments of CU16,500 payable in advance (i.e. at the beginning of each year) Lease payments for each year will vary each year based in the movement in the Consumer Price Index (CPI). Date (Year) Consumer Price Index The lessee determines that all of the remeasurement relates to future periods and adjusts the carrying amount of the rightof-use asset as follows. BDO comment The proposals do not specifically address how an entity determines which portions of the lease payment reassessment adjustment relate to the current or prior periods (and should be expensed), and which relate to future periods (and should be used to adjust the carrying amount of the right-of-use asset). In this example the lease payments are made in advance. As at period end, the future lease payments are determined based on the movement in the CPI during the current year. Therefore, in this example, the lease payment reassessment adjustment as at period end relates to only those lease payments that cover future periods, and do not affect those lease payments made during the current year. However, this adjustment will dependent on the specific terms of each lease arrangement (e.g. whether lease payment are made in arrears or in advance, and over what period the CPI movement is measured). Periods Right-of-use asset (1) 61,434 48,313 33,503 17,424 - Lease liability (2) 44,934 31,417 33,503 16,343 - Payment (adjusted to CPI) 16,500 16,896 17,160 17,424 - Adjustments to the right-of-use asset and to the lease liability from changes in CPI (3) N/A 1, Lease expense Interest expense (4) N/A 2,247 1, Amortisation expense (5) N/A 14,253 15,325 16,343 17,424 Total lease expense N/A 16,500 16,896 17,160 17,424

25 LEASES - THE 2013 EXPOSURE DRAFT 25 (1) The right-of-use asset at the commencement date is the present value of all the future lease payments (including the first payment due at the beginning of the first year). In subsequent periods, the right-of-use asset is adjusted for amortisation expense (see (5) below) and changes in the CPI. For example the right-of use asset s balance at the end of year 1 is calculated in the following way: Opening balance 61,434 Adjustment in regard to CPI (3) 1,132 Amortization (14,233) Closing balance on year 1 48,313 (2) The lease liability at the commencement date is the present value of the future lease payments, less the first payment due at the beginning of the first year of the lease term (i.e. deemed to be at commencement date). Therefore the journals at commencement date would be: Dr Right-of-use asset 61,434 Cr Lease liability 44,934 Cr Cash 16,500 (Journals to recognise lease at commencement date where payments are due in advance) In subsequent periods, the lease liability is adjusted for accrued interest expense, annual lease payments and changes in CPI. For example the lease liability balance ate the end of year 1 is calculated the following way: Opening balance at commencement date (refer above) 44,934 Accrued interest (see (4) below) 2,247 Adjustment in regard to CPI (see (3) below) 1,132 Payment (16,896) Closing balance on year 1 31,417 (3) The lessee s adjustment to changes in CPI is the difference between the present value of the revised and the original lease payments, discounted using the rate determined at the commencement date. CPI adjustment: Year 1: 44,934 x 1.05 x ([128/125] -1) = 1,132 Year 2: 31,417 x 1.05 x ([130/128] -1) = 515 Year 3: 16,343 x 1.05 x ([132/130] -1) = 264 (4) Interest expense calculation: Year 1: 44,934 x 5% = 2,247 Year 2: 31,417 x 5% = 1,571 Year 3: 16,343 x 5% = 817 (5) The difference between the annual lease payment that is set at the beginning of the period (adjusted for changes in the spot CPI rate) and the interest expense. Note: The lessee does not reassess the discount rate because a change in variable lease payments that depend on an index does not require the discount rate to be reassessed.

26 26 LEASES - THE 2013 EXPOSURE DRAFT Purchase options Lessees (lessors) would include the exercise price of a purchase option (including bargain purchase options) in the measurement of the lessee s liability to make lease payments (the lessor s right to receive lease payments), if the lessee is considered to have a significant economic incentive to exercise the purchase option (see the section covering lease term above). Residual value guarantees Amounts expected to be payable by the lessee under residual value guarantees are included in lease payments. Lessors would not recognise amounts expected to be received under a residual value guarantee until the end of the lease. However, the lessor would consider those guarantees when determining whether the residual asset is impaired. For lessees, as noted above, changes in lease payments that are due to a reassessment of residual value guarantees would change the obligation to make lease payments and be recognised: a) In net income to the extent that those changes relate to current or prior periods, and b) As an adjustment to the right-of-use asset to the extent those changes relate to future periods. Term option penalties The accounting for term option penalties would be consistent with the accounting for options to extend or terminate a lease. That is, if a lessee would be required to pay a penalty if it does not renew the lease and the renewal period has not been included in the lease term, then that penalty would be included in the recognised lease payments.

27 LEASES - THE 2013 EXPOSURE DRAFT 27 REASSESSMENT OF THE DISCOUNT RATE The discount rate would be reassessed when the changes below were not reflected in the initial measurement of the discount rate: 1. When there is a change in lease payments that is due to a change in the assessment of whether the lessee has a significant economic incentive to exercise an option to extend a lease or to purchase the underlying asset. 2. When there is a change in lease payments that is due to the exercise of an option that the lessee did not have a significant economic incentive to exercise. 3. A reference interest rate, if variable lease payments are determined using that rate. The revised discount rate would be the spot rate at the reassessment date (that is, the rate that would be applied to a new lease that was entered into on that date), which would then be applied to the remaining lease payments (for example, the remaining payments due in the initial lease plus the payments that relate to an extension period or to the exercise of a purchase option). SHORT-TERM LEASES A short-term lease is a lease that, at the date of commencement of the lease, has a maximum possible term, including any options to renew, of 12 months or less. Cancellable leases would meet the definition of short-term leases if the initial noncancellable period, together with any notice period, is less than one year. A lessee would be permitted to elect, as an accounting policy choice for each class of underlying asset(s), not to apply the proposed requirements to leases that meet the definition of short-term leases. Instead, a lessee could recognise the lease payments from short-term leases in profit or loss on a straight-line basis over the lease term. A lessor would be permitted to elect, as an accounting policy choice for each class of underlying asset(s), to account for all short-term leases by not recognising lease assets or lease liabilities and by recognising lease payments in profit or loss on a straight-line basis over the lease term, unless another systematic and rational basis was more representative of the time pattern in which use is derived from the underlying asset. This would result in an accounting approach which would be similar to operating lessor accounting in accordance with IAS 17 Leases. SALE AND LEASEBACK TRANSACTIONS The first step would be to determine whether a sale had occurred, which would be assessed using the control criteria to be set out in the new IFRS Revenue from Contracts with Customers. If no sale had taken place, then the entire transaction would be accounted for as a financing arrangement. When a sale of an asset has occurred and the asset is leased back, the transaction would be accounted for as a sale and then a leaseback. If the consideration was at fair value, the gains and losses arising from the transaction would be recognised when the sale occurred. If the amount of consideration was not fair value, the assets, liabilities, gains and losses recognised would be adjusted to reflect current market rentals. The seller/lessee would adopt the whole asset approach in a sale and leaseback transaction. This means that in a sale and leaseback transaction, the seller/lessee sells the entire underlying asset and leases back a right-of-use asset relating to the underlying asset.

28 28 LEASES - THE 2013 EXPOSURE DRAFT DISCLOSURE The main disclosure requirements for lessees would include: Information about the nature of the leases Information about significant assumptions and judgements made such as whether a contract contains a lease and the allocation of consideration A reconciliation of opening and closing balance of right-of-use assets disaggregated by class of underlying asset separately for Type A leases, Type B leases and right-of-use assets measured at revalued amounts A reconciliation of the opening and closing balance of lease liabilities separately for Type A leases and Type B leases including interest and unwinding of discount A maturity analysis of the undiscounted cash flows that are included in the lease liability Information about the principal terms of any significant lease not yet commenced Expenses recognised in the period for variable lease payments that were not included in the lease liability. The main disclosure requirements for lessors would include: A table of all lease related income items recognised in the reporting period disaggregated into: (a) For Type A leases, the profit, recognised at lease commencement (split into revenue and cost of sales if that is how the lessor has presented the amounts in the statement of comprehensive income) (b) For Type A leases, the interest income on the lease receivable (c) For Type A leases, the interest income on the residual asset (d) Variable lease income (e) Short-term lease income (f) For Type B leases, the lease income relating to lease payments receivable. A qualitative description of purchase options in leasing arrangements (including the extent to which the entity is subject to such agreements) A reconciliation of the opening and closing balance of the lease receivable and residual assets A maturity analysis of the undiscounted cash flows those are included in the right to receive lease payments (at least the undiscounted cash flows to be received in each of the first five years after the reporting date and a total of the amounts for the years thereafter). The analysis should reconcile to the right to receive lease payments Information about the basis and terms on which variable lease payments are determined Information about the existence and terms of options, including for renewal and termination. Additional disclosure requirements for lessors of Type B leases would include: A maturity analysis of the undiscounted future non-cancellable lease payments (at least the undiscounted cash flows to be received in each of the first five years after the reporting date and a total of the amounts for years thereafter) Minimum contractual lease income and variable lease payment income within the table of lease income The cost and carrying amount of property on lease or held for leasing by major classes of property according to nature or function, and the amount of accumulated depreciation in total Information about leases that are not within the scope of the receivable and residual approach, including the basis on which variable lease payments are determined, the existence and terms of options (including renewal and termination) and any restrictions imposed by lease arrangements.

29 LEASES - THE 2013 EXPOSURE DRAFT 29 CONSEQUENTIAL AMENDMENTS BUSINESS COMBINATIONS The acquirer in a business combination would not recognise assets or liabilities at the acquisition-date for leases that, at that date, have a remaining maximum possible term under the contract of 12 months or less. If the acquiree is a lessee, the acquirer would recognise and measure a liability to make lease payments at the present value of future lease payments as if the lease contract was a new lease at the acquisition-date together with a right-of-use asset equal to the liability to make lease payments. The right-of-use asset would be adjusted for any off-market terms in the lease contract and for any other intangible asset associated with the lease, which may be evidenced by market participants willingness to pay a price for the lease even if it is at market terms. If the acquiree is a lessor in a Type A lease, the acquirer would recognise and measure a receivable at the present value of future lease payments at the acquisition-date and a residual asset as the difference between the fair value of the underlying asset at the acquisition-date and the carrying amount of the right to receive lease payments. If the acquiree is a lessor of a Type B lease, the acquirer considers the terms and conditions of the lease in measuring the acquisition-date fair value of the underlying asset. If the acquiree has short-term leases then the acquirer would not recognise separate assets or liabilities related to the lease contract at the acquisition-date. BDO comment It appears that, in contrast to an entity that enters into short-term leases, that the acquirer would not have the option of recognising assets and liabilities arising from short-term leases.

30 30 LEASES - THE 2013 EXPOSURE DRAFT TRANSITION The transitional requirements would apply at the beginning of the earliest comparative period presented in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, with some reliefs. Lessees The lease was accounted for as Finance lease Operating lease Operating or finance Transition No adjustments to carrying amounts. Reclassify lease assets and lease liabilities as right-of-use assets and lease liabilities arising from Type A leases. The lessee would not apply the reassessment requirements regarding the lease liability. Recognise liabilities measured at the present value of the remaining lease payments, discounted using the lessee s incremental borrowing rate as of the effective date for each portfolio of leases with reasonably similar characteristics. Recognise right-of-use assets equal to the proportion of the liability to make lease payments at lease commencement calculated on the basis of the remaining lease payments. For Type B leases, measure the right-of-use asset at the same amount as the lease liability. Record to retained earnings any difference between the liabilities and the right-of-use assets at transition. When lease payments are uneven over the lease term, a lessee would adjust the right-of-use asset by the amount of any recognised prepaid or accrued lease payments. Lessors The lease was accounted for as Finance lease Operating lease Operating or finance Transition No adjustments to carrying amounts. Recognise a receivable, measured at the present value of the remaining lease payments, discounted using the rate charged in the lease determined at the date of commencement of the lease, subject to any adjustments required to reflect impairment. Recognise a residual asset consistent with the initial measurement of the residual asset under the receivable and residual approach, using information available at the beginning of the earliest comparative period presented. Derecognise the underlying asset. When lease payments are uneven over the lease term, adjust the cost basis in the underlying asset that is derecognised presented by the amount of any recognised prepaid or accrued lease payments.

31 LEASES - THE 2013 EXPOSURE DRAFT 31 The 2013 ED also includes a number of proposed reliefs that could be taken advantage of on transition: Lessors and lessees would not be required to evaluate initial direct costs for contracts that began before the effective date Hindsight could be used in comparative reporting periods, including the determination of whether or not a contract is or contains a lease. If an entity elected to use any of the reliefs, disclosure would be required. Although transition disclosures would be required to be consistent with those required by IAS 8, disclosure would not be required of the effect of the change on income from continuing operations, net income, any other affected financial statement line items or any affected earnings per share amounts for the current and any prior periods. However, all of the disclosures required by IAS 8 could be included if an entity wished to do so.

32 32 LEASES - THE 2013 EXPOSURE DRAFT COMPARISON OF THE IASB AND FASB PROPOSALS The leases project is a joint IASB and FASB project, and the requirements in the 2013 ED are almost identical to those proposed by the IASB. The following are the main differences between the IASB s and FASB s proposals: 1. Revaluations a. IFRS allows revaluation of the right-of-use asset (and related disclosure requirements). 2. Statement of cash flows a. US GAAP requires interest to be classified as cash flows from operating activities. b. IFRS allows interest to be classified as either cash flows from operating, investing, or financing leases (so long as it is presented consistently year on year). 3. Disclosure a. US GAAP requires disclosure of a maturity analysis of non-lease components. b. US GAAP does not require disclosure of a reconciliation of the opening and closing balances of the right-of-use asset. 4. Non-public entities a. US GAAP permits a policy election to use a risk-free rate to discount the liability. b. US GAAP permits an exemption from the liability balance reconciliation disclosure. c. The IASB will consider whether and, if so, how to incorporate this requirement into its IFRS for Small and Medium-sized Entities at a later date.

33 LEASES - THE 2013 EXPOSURE DRAFT 33

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