Mr Hans Hoogervorst Chairman of the International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom 13 September 2013 540 Dear Mr Hoogervorst Re.: IASB Exposure Draft 2013/6 Leases The IDW appreciates the opportunity to comment on the Exposure Draft Leases. General remarks We have serious concerns about many proposals in the Exposure Draft. In particular, we disagree with the proposed dual model in respect of lease classification, lessee accounting and lessor accounting. Proposing two approaches is not only inconsistent with the Board s initial objective of introducing a single lease accounting model, it also impairs the comparability of financial statements, offers structuring opportunities and makes accounting for leases complex and costly. In the Board s view, the existing guidance in IAS 17 is fundamentally flawed since the existence of two different accounting models for leases (the finance lease model and the operating lease model) would lead to similar transactions being accounted for differently. We believe that the same reservation can be expressed in relation to the proposed dual model. Moreover, several specific proposals of the Exposure Draft contain inconsistencies and would add complexity to current lease accounting for both lessees and lessors.
page 2/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases All in all we doubt whether the benefits of the proposals warrant the increased costs and administrative burden that would arise from implementing and applying a new model that includes so many shortcomings. In our view, a new approach to lease accounting can only be justified if the IASB is able to demonstrate that users consider the proposals as a substantial improvement to existing requirements and are not compelled to make adjustments to reported figures any more. Otherwise, it would be more cost-beneficial to make only targeted improvements to IAS 17. We would like to comment on certain matters as set out below.
page 3/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases Question 1: Identifying a lease This revised Exposure Draft defines a lease as a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. An entity would determine whether a contract contains a lease by assessing whether: (a) (b) fulfilment of the contract depends on the use of an identified asset; and the contract conveys the right to control the use of the identified asset for a period of time in exchange for consideration. A contract conveys the right to control the use of an asset if the customer has the ability to direct the use and receive the benefits from use of the identified asset. 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. In general, we agree with the proposed definition of a lease. The IASB has concluded that leases create rights and obligations that are different to those arising from service contracts. This is because the lessee obtains and controls the right-of-use asset at the time the underlying asset is delivered to the lessee. When the lessor delivers the underlying asset for use by the lessee, the lessor has fulfilled its obligation to transfer the right to use that asset to the lessee. Accordingly, the lessee has an unconditional obligation to pay for that right of use. In contrast, in a typical service contract, the customer does not obtain an asset that it controls at commencement of the contract. Instead, the customer obtains the service only at the time that the service is performed. The vendor has remaining obligations until it has provided the services to its customer. Consequently, the customer typically has an unconditional obligation to pay only for the services provided to date (paragraphs BC20 et seqq.). We do not believe the (economic) difference between an unconditional right-ofuse asset arising from a lease contract and similar rights arising from executory contracts that are currently not recognised in the statement of financial position is as clear-cut as the Board assumes. Were the right-of-use model implemented for lease contracts (i.e. leases are on-balance sheet ) whilst executory con-
page 4/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases tracts with similar characteristics (especially service contracts) remained offbalance sheet, the new bright-line would offer structuring opportunities. The IASB should provide additional guidance to clearly distinguish between leases and service contracts. Even more important, it should clarify the issue of leases vs. executory contracts at a more fundamental level as part of the Conceptual Framework project. The Board proposes to change the guidance pertaining to the right to control the use of an asset to make it more consistent with the concept of control applied in other requirements and projects (i.e. consolidation and revenue recognition). As a consequence, it decided to change the current requirements of IFRIC 4 and to require a customer to have not only the right to obtain substantially all of the economic benefits from use of an asset during the lease term (benefits) but also the ability to direct the use of that asset (power). Hence, to have the right to control the use of an asset, a customer must have decision-making rights over the use of the asset that give that customer the ability to influence the economic benefits derived from the use of the asset (paragraph BC105(d)). While we agree that the proposal increases internal consistency within IFRS, the guidance on the application of the new concept is unsatisfactory: Assessing power based on the fact patterns in the Illustrative Examples 5A and 5B seems straightforward. In other cases, the assessment will be more complex, for example, when parties to a contract each have decision-making rights that give them the unilateral ability to direct different aspects of the use of the asset. Additional examples on such facts patterns would be helpful. Finally, we have the impression that the guidance relating to the term power in IFRS 10 is not fully consistent with the proposals in the Exposure Draft on the ability to direct the use: According to paragraph B51 of IFRS 10, being involved in the design of an investee alone is not sufficient to give an investor control. Paragraph 15 of the Exposure Draft states that a customer may be involved in designing the asset for its use or in determining the terms and conditions of the contract, so that the decisions about the use of the asset that most significantly affect the economic benefits to be derived from use are predetermined. In those cases, the customer has the ability to direct the use of the asset throughout the term of the contract. The IASB should avoid such an inconsistency.
page 5/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases Question 2: Lessee accounting 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 embedded in the underlying asset? Why or why not? If not, what alternative approach would you propose and why? The IDW does not see any conceptual justification for a different accounting treatment dependant on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. In all cases the lessee acquires a right-of-use asset and incurs an obligation to make lease payments. Thus, we do not support a dual model for lessee accounting, especially lease expense recognition. The IASB should select one approach and apply it to all leases. We oppose the proposed model for Type B leases for the following reasons: In order to generate a straight-line expense profile, the periodic amortisation of the right-of-use asset would have to be determined as a balancing figure, calculated as the difference between the periodic lease cost and the periodic unwinding of the discount on the lease liability. The amortisation would increase over the lease term. There is no conceptual basis for such a pattern of increasing amortisation, because such allocation would not reflect the diminution in value. Moreover, a lessee would not measure right-of-use assets arising from Type B leases consistently with other non-financial assets that are measured on a cost basis. Since the lease liabilities for all types of leases are based on the present value of cash flows, there is no conceptual basis for not separately recognising related financing costs for Type B leases. In effect, the right-of-use asset and the lease liability would be treated as one unit of account (only) for subsequent measurement. This approach would require major system changes because amortisation of the right-of-use asset must be calculated as the complement of the unwinding of the discount on the lease liability. The development of the IASB s project on lease accounting to date has made it clear that it is impossible to develop proposals to which all stakeholders agree. Hence, we support the board members who expressed a preference to have a single lessee accounting model that would require a lessee to amortise the right-of-use asset consistently with other non-financial assets and measure the lease liability consistently with other similar financial liabilities. Such a coherent
page 6/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases accounting model would reduce complexity by removing the need for a lease classification test and for systems capable of dealing with two lessee accounting approaches. Regarding the drawbacks of the dual model for lease classification we refer to our answer to question 4. Question 3: Lessor accounting 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? The IDW does not support a dual model for lessor accounting. Again, the IASB should select one approach and apply it to all leases. We have identified the following shortcomings in the two models: Type A leases: In general, the proposed lessor accounting for Type A leases is very complicated and seems over-engineered. Much of the complexity arises from the accounting for the residual asset. The basis for the initial measurement of the residual asset would be different from the measurement basis typically applied to other non-financial assets measured at cost. For example, the initial measurement of the residual asset would include the present value of expected variable lease payments, if the lessor reflects an expectation of variable lease payments in determining the rate the lessor charges the lessee and those payments are not included in the lease receivable. It is quite surprising that a non-financial asset would include a right to receive payments. In addition, the lessor s accounting treatment of these variable lease payments would be inconsistent with that of the lessee. The proposed unwinding of the discount on the gross residual asset can hardly be justified from a conceptual point of view as it effectively constitutes interest income arising on a non-financial asset. No other non-financial assets are accounted for in this way under IFRS. In addition, the lessor does not perform any revenue-generating activity in relation to the residual asset during the lease term. Testing the residual asset for impairment would be challenging in practice.
page 7/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases Type B leases: The proposed lessor accounting for Type B leases is inconsistent with the proposals for lessee accounting and with the IASB s initial objective of recognising all assets and liabilities that arise from lease contracts. Although the lessee would recognise a financial liability for its obligation to make lease payments, the lessor would not recognise a financial asset. We consider it inappropriate that only one party to a contract recognise a financial instrument. To apply the right-of-use model consistently, a lessor should recognise a receivable for all those leases for which a lessee recognises a lease liability. We support the alternative view of Messrs Kalavacherla and Zhang that, regardless of the type of lease and the business model of the lessor, the right to receive lease payments is a financial asset and should be reflected in the lessor s financial statements. This is because the risks associated with this financial asset are different from those of the underlying asset, and information about those different risks is critically important to users (paragraph AV4). For Type B leases, the lessor would not account for the loss of its right to control the use of the underlying asset (during the lease term) and would continue to recognise that asset. Hence, the right to control the use of the underlying asset (during the lease term) would be recognised in the statement of financial position of both the lessee (as a separate right-of-use asset) and the lessor (as part of the underlying asset). On balance, we believe that the inconsistencies of the proposed lessor accounting for Type B leases are so severe that the IASB should abandon this approach completely. In our view, a single approach should be based solely upon a modified lessor accounting for Type A leases. Regarding the drawbacks of the dual model for lease classification we refer to our answer to question 4. Question 4: Classification of leases 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?
page 8/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases The IDW does not agree with a dual model for lease classification. A dual model contradicts an important objective of the project, which is to create a single lease accounting model. As mentioned above, we do not see any conceptual justification for a different classification of leases depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. Irrespective of the extent of consumption, the lessee acquires a right-of-use asset and incurs an obligation to make lease payments, while the lessor acquires a right to receive lease payments and has a residual asset. The proposed approach purports to be based on a principle, i.e. the level of the lessee s consumption of economic benefits embedded in the underlying asset. According to this principle, the classification would depend on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset (paragraph BC42 et seqq.). Nevertheless, pursuant to the proposals in paragraphs 29 et seq., leases would be classified largely on the basis of the nature of the underlying asset (property vs. assets other than property) in combination with some rules-based exceptions. The result can be at odds with the aforementioned consumption principle: For example, as proposed, property is only considered Type A if the lease term is for the major part of the remaining economic life of the underlying asset or if the present value of the lease payments accounts for 'substantially all' of the fair value of the underlying asset. Consequently, the classification of many property leases as Type A would require that the lessee consumes almost all / most of the economic benefits embedded in the underlying asset rather than more than an insignificant portion of the economic benefits. The Board s rationale (in paragraphs BC55 et seq.) is not convincing because, for example, the land element does not always represent the predominant proportion of the fair value of the property, and the service potential of a building does not generally decline more rapidly nearing the end of its life rather than in the early years of its life. Moreover, economically similar arrangements i.e. having similar lease terms and lease payments might be accounted for differently under the proposals depending on whether the underlying asset is property or an asset other than property. This will be the case where the lease term is for more than an insignificant part of the economic life of the underlying asset, but not for a major part of the economic life,
page 9/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases the present value of the lease payments is more than insignificant relative to the fair value of the underlying asset, but does not account for substantially all of the fair value. In addition, Messrs Kalavacherla and Zhang rightly point out that it is arbitrary and unnecessarily complex to have different criteria for assessing the lease term when classifying leases, namely relative to the remaining economic life of the underlying asset in the case of property but relative to the total economic life of the underlying asset in the case of assets other than property (paragraph AV5). The proposed model for lease classification includes several judgemental thresholds. Again, we share the operational concerns of Messrs Kalavacherla and Zhang in questioning how an entity would assess what insignificant, substantially all and major part mean without additional guidance (paragraph AV5). Furthermore, the proposed thresholds would allow for structuring. Question 5: Lease term 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? Given the fact that the Board assumes that applying the concept of significant economic incentive would provide a threshold that is similar to the concept of reasonably certain in existing IFRS (paragraph BC140), it might be preferable to stick to the concept of reasonably certain, because this is generally understood and works well in practice (as acknowledged by the IASB). In general, the IDW agrees with the proposals on the reassessment of the lease term if there is a change in relevant factors (contract-based, asset-based, market-based and entity-based factors). Nevertheless, we doubt whether it is appropriate to prescribe that a change in market-based factors (such as market rates to lease a comparable asset) shall not, in isolation, trigger reassessment (paragraph 27(a)). While we ackowledge that the Board is thereby attempting to consider practical concerns about the possibility of frequent changes to the lease term as market prices increase or decrease, it will be difficult in practice to separate one factor, since many factors are interlinked (as explained in paragraph BC142). In this regard, there is no difference between an original assessment and a reassessment.
page 10/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases Question 6: Variable lease payments 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? From a theoretical point of view, lease payments should not be treated differently solely because the amounts to be paid are uncertain or variable. Including all variable lease payments would be preferable, since it precludes a conceptually inappropriate measurement of assets and liabilities. However, in practice the cost and complexity of measuring all variable lease payments outweigh the benefit. Moreover, in many cases it is difficult to estimate variable lease payments reliably. The IASB s proposals thus represent a compromise between theory and practice. Nevertheless, we would like to point out some drawbacks of the proposed compromise: The proposals on the measurement of variable lease payments on the one hand and residual value guarantees on the other are inconsistent because a lessee is required to estimate amounts expected to be payable under a residual value guarantee, which is a form of variable lease payment, but is not required to do so for other variable lease payments that are contingent on performance or use. The proposals on the measurement of variable lease payments are also inconsistent with the forthcoming standard on Revenue from Contracts with Customers. Lessor accounting for variable lease payments in case of Type A leases is burdensome (see our answer to question 3). The IASB is proposing to include variable lease payments that are in-substance fixed lease payments in the measurement of lease assets and lease liabilities because those payments are unavoidable and, thus, economically are indistinguishable from fixed lease payments. In this context, the Board concluded that providing a principle and some examples would be sufficient (paragraph BC153). However, we believe that the examples given in paragraph IE10 are not helpful as they do not address the real cases of doubt. For example, if the lessee has to pay a certain percentage of the lessee s sales generated from the underlying asset, it remains unclear how to determine the level of past sales that
page 11/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases would be an appropriate basis for determining in-substance fixed lease payments. Question 7: Transition 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? While the IDW agrees that entities should have the option to apply all the proposals retrospectively, we suggest the IASB consider further transition relief with regard to the modified retrospective approach. This would reduce the burden and costs associated with the implementation of the proposals. For instance, the Exposure Draft proposes that entities would be required to recognise and measure leases that exist at the beginning of the earliest comparative period presented, adjust equity at the beginning of the earliest comparative period presented, and adjust the other comparative amounts disclosed for each prior period presented (paragraphs C3 et seq.). In our view, the IASB should allow the date of initial application to be the start of reporting period in which entities first apply the new lease standard without adjusting comparative amounts. Currently, the Board proposes that (in case of Type A leases) lessors shall recognise a lease receivable measured at the present value of the remaining lease payments, discounted using the rate the lessor charges the lessee determined at the commencement date (paragraph C13(b)). In particular, lessors with long-term leases may have difficulties in determining the rate charged to the lessee as of the commencement date. Additional relief seems necessary in this area. Both the full retrospective approach and the modified retrospective approach would be much simpler to apply if the dual model concerning lease classification, lessee accounting and lessor accounting were abandoned.
page 12/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases Question 8: Disclosure Paragraphs 58 67 and 98 109 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? In general, it seems contradictory for the IASB to propose to implement a completely new accounting concept and to increase the disclosure requirements at the same time. This suggests that the Board does not believe in its own recognition and measurement proposals. In our view, the proposed disclosures are excessive and would pose a significant burden on preparers. The requirements could be reduced significantly if the Board decides not to introduce a dual model in respect of lease classification, lessee accounting and lessor accounting. Some of the proposed requirements have the potential to result in boilerplate disclosures (e.g. information about the nature of the leases pursuant to paragraphs 60(a) and 100(a)). We are very disappointed that the IASB has still not changed its mind set by making disclosures less voluminous and more meaningful. Hence, we would like to remind the Board of its plan to deliver tangible improvements to disclosures in financial reporting. The Board proposes that lessees should disclose a maturity analysis of the lease liability, showing, at a minimum, the amounts due on an annual basis for each of the first five years after the reporting date, plus a lump sum for the remaining years. Those maturity analyses are similar to the maturity analyses currently required by US GAAP. In contrast, paragraph B11 of IFRS 7 allows entities to use judgement to determine the appropriate number of time bands when preparing the maturity analyses required by IFRS 7. In the IASB s view, the comparability of maturity analyses for leases (between different jurisdictions) is more important than the comparability of disclosures about lease liabilities and other financial liabilities. We disagree with the IASB, as we believe that accounting provisions in a single jurisdiction should not lead to internal inconsistencies within IFRSs. Maturity analyses under IFRS should be based on similar principles in order to assist users of financial statements in understanding and evaluating the nature and extent of liquidity risks.
page 13/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases Question 12 (IASB-only): Consequential amendments to IAS 40 The IASB is proposing amendments to other IFRSs as a result of the proposals in this revised Exposure Draft, including amendments to IAS 40 Investment Property. The amendments to IAS 40 propose that a right-of-use asset arising from a lease of property would be within the scope of IAS 40 if the leased property meets the definition of investment property. This would represent a change from the current scope of IAS 40, which permits, but does not require, property held under an operating lease to be accounted for as investment property using the fair value model in IAS 40 if it meets the definition of investment property. 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? 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. The elimination of the option would result in greater consistency in accounting for investment property. Other remarks: Scope Paragraph 4 includes subleases in the scope of the Exposure Draft. Hence, subleases should be measured on the same basis as any other leases. In practice, this could result in asymmetry between the way in which an intermediate lessor accounts for a headlease and a sublease in respect of the same underlying asset (even if the terms of both leases are similar), especially when the headlease and the sublease are classified as Type B leases. In this case, the intermediate lessor would recognise a financial Iiability for its obligation to pay rentals to the headlessor, but would not recognise a financial asset for its right to receive rentals from the sublessee. Paragraphs 4 and 5 would not permit lessors, nor require lessees, to apply the lease accounting proposals to leases of intangible assets. In particular, paragraph 5 would allow lessees to apply the proposals to leases of (all) intangible assets by applying IAS 8 (paragraph BC83). However, the proposed consequential amendments to paragraph 6 of IAS 38 state that rights held by an entity under licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights are within the scope of IAS 38. These consequential amendments do not provide for the above-
page 14/14 IDW CL to Mr Hans Hoogervorst on IASB ED/2013/6 Leases mentioned option to apply the new IFRS Leases. The IASB should avoid such an inconsistency. Sale and leaseback transactions The proposed guidance on the right to control the use of the underlying asset in paragraphs 12 et seqq. conflicts with paragraph 112 on sale and leaseback transactions. According to the latter, the transferor would be considered to have the ability to direct the use of and obtain substantially all of the remaining benefits from the asset, if either of the following occurs: the lease term is for the major part of the remaining economic life of the asset; or the present value of the lease payments accounts for substantially all of the fair value of the asset. Thus, the control criterion would be described by conditions which are used in IAS 17 to classify leases on the basis of risks and rewards. In our view, it is inappropriate to mix the control concept with the risks and rewards concept. We would be pleased to answer any questions that you may have or discuss any aspect of this letter. Yours sincerely Norbert Breker Technical Director Accounting and Auditing Uwe Fieseler Director International Accounting