Leasing – has the case for change been made?
18 October 2013
You’ll recall that in May this year, after more than two years of re-deliberations, the IASB and FASB issued a revised exposure draft (ED) on lease accounting. The ED aimed to address many of the criticisms of the 2010 exposure draft, including abandoning the concept of a single income statement model (you can find a summary of the proposals in Straightaway 118 – IASB/FASB publish revised exposure draft on leases. However the diverse initial feedback seems to suggest that the proposals may not deliver what many are looking for. If that’s true, has the case for change been made?
Before we consider that question, let’s consider users’ views of the proposals.
We know users are interested in information to assess the cash flows, returns and capital structure and a company’s ability to meet financial commitments.
The IASB recently summarised the feedback from investors and analysts on the proposals. It is fair to say that views were mixed. Credit analysts generally support the changes to the balance sheet because they focus on assessing credit risk and so better information about leverage is important. Equity analysts are concerned about the balance sheet because they focus on operating performance and would prefer to know about the ‘whole asset’ (that is, how much would be capitalised if the asset was purchased rather than leased). This information gives them a comparable asset base (or capital employed) on which to evaluate performance across different companies.
Most, but not all, agree that there are economic differences between most real estate leases and equipment leases. They understand the rationale behind the dual expense recognition approach. However the majority of retail, restaurant and hotel analysts view a lease liability as debt-like rather than operating and would likely make an adjustment for real estate leases to split the expense between depreciation and interest expense.
Views were equally mixed on the cash flow statement. While the majority of credit analysts support treating equipment leases as financing, other analysts would prefer to see all lease cash outflows as part of operating activities. Even though the lease liabilities might be seen as debt-like, the actual cash flows are payments for assets used for operations.
So where does this leave us? Is there really a case for change? There was clear support for enhanced disclosures, so one option is for the Board to consider making no change to existing recognition and measurement requirements and simply improve note disclosures. My personal preference is to change the balance sheet as proposed but stick with the finance/operating lease income statement classification of IAS 17. To me, the proposed income statement classification doesn’t seem to give sufficiently enhanced information to justify the cost of change.
What are your thoughts?