Lease accounting: proposals to be re-exposed
The IASB and FASB have announced that they will issue a formal re-exposure of the leasing proposals. The key changes to the original proposals include the application of a single ‘receivable and residual’ model by lessors and the exclusion of investment property measured at fair value from the scope of the proposed leasing standard.
The International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB) have confirmed that they expect to re-expose the leasing proposals by the end of 2011 whilst reaffirming their overall approach to the recognition by lessees of a lease obligation and the related right-of-use asset. The proposals have moved on quite significantly so this will be a welcome opportunity for interested parties to comment and we would urge both lessees and lessors to become involved in this important debate. Further information on the re-exposure process, including the comment period and the expected timetable is expected in September.
Although the Boards acknowledge that they still have further decisions/reassessments to make on a number of the original exposure draft’s (ED) proposals, they have agreed tentatively that:
- Lessors would apply a ‘receivable and residual’ model, which is a variant on the original ED’s de-recognition model and is discussed further below.
- Lessors may continue to account for investment properties measured at fair value using IAS 40 Investment properties. Such leases would be outside the scope of the new leases standard.
- The receivable and residual model would also not apply to short term leases (those with a maximum possible lease term of less than one year).
- Initial measurement of variable lease payments based on an index or rate would be based on the spot rate at that time (e.g., as if the current rate of inflation would persist throughout the lease term) and reassessed when those rates changed. Reassessment changes would be recognised in profit and loss when they relate to the current period and as an adjustment to the right-of-use asset when they relate to future periods.
- Foreign exchange gains and losses relating to a lease liability denominated in a foreign currency would be recognised in profit or loss.
- In a lessee’s cash flow statement, payments relating to the ‘principal’ component would be presented as financing. The interest component would be presented as an operating or financing component consistent with an entity’s accounting policy. Cash flows for short-term leases and variable lease payments not included in the lease liability would be included as operating cash flows.
What is the receivable and residual model?
In such a model, the lessor would first derecognise its original underlying asset and then recognise a lease receivable (representing its right to receive lease payments) and a residual asset (representing its right to the return of the underlying asset at the end of its lease term).
The lease receivable would be recognised on a consistent basis with a lessee’s lease liability. The initial carrying amount of the residual asset would be based on a fair value allocation of the underlying asset between the lease period and the residual period. An upfront profit could be recognised at lease inception, provided that profit is ‘reasonably assured’; we await guidance on how ‘reasonably assured’ would be determined. If no profit were recognised then the residual asset carrying value would be adjusted for the deferred profit. The lessor would then recognise interest income on the lease receivable and, in a change to the original ED proposals, recognise income on accretion of the residual asset. Whether this model would be both acceptable and practicable to apply will need to be assessed although we do note its consistency with the Boards’ approach to lessee accounting.
For further discussion and insight into the revised proposals, please refer to our latest Leases newsletter.
FRC confirms that true and fair concept remains fundamental
The FRC has reaffirmed the fundamental importance of the true and fair requirement under both UK GAAP and IFRS. It also confirms that objective professional judgement is required in order to provide a true and fair view; the preparation of accounts cannot simply be reduced to a mechanistic process.
In their July 2011 paper, the Accounting Standards Board (ASB) and the Auditing Practices Board (APB) of the Financial Reporting Council (FRC) reaffirmed the fundamental importance of the true and fair requirement under both UK GAAP and IFRS.
The FRC explains that whilst the whole essence of accounting standards, such as IFRS, is to reflect economic reality (substance) and provide a true and fair view, the preparation of accounts cannot be reduced to a mechanistic process, but that objective professional judgment is required, for example, in relation to:
- choosing the appropriate accounting policy (or most appropriate policy under UK GAAP) and selecting policies for items not specifically covered by accounting standards;
- making judgements aimed at giving a true and fair view, e.g., concerning prudent valuation (“fair values of financial assets are not aggressive”), and considering materiality;
- not using detailed accounting rules as an excuse for poor accounting;
- providing appropriate disclosures even if not specifically required by accounting standards and ensuring that significant information is not obscured by immaterial or irrelevant disclosures; and
- standing back and considering the financial statements objectively: do they give a true and fair view?
The FRC also notes that the true and fair override does not apply simply because the answer under the relevant standard might be claimed not to accord with “common sense”, or because one disagrees with the standard. It acknowledges that instances of the override do occur but only in “extremely rare circumstances” and that in the past almost all true and fair overrides under UK GAAP were of law rather than a standard.
The FRC's paper is available here.
News in Brief
FRC defends comply-or-explain approach to corporate governance reporting
In its recent response to the EC Green Paper on the EU corporate governance framework, the FRC has defended the comply-or-explain approach to corporate governance reporting. It believes that the flexibility this approach offers is positive for economic activity and warns against replacing it or watering it down with arrangements that might stifle entrepreneurialism and economic growth.
The FRC’s response sets out to dispel the apparent misconception that comply or explain is self-regulation but does agree with the view expressed in the EC’s Green Paper that it should be made to work more effectively.
Amendment to FRS 29 Financial instruments: disclosures issued
In order to ensure convergence with IFRS 7 Financial instruments: disclosures, the ASB has issued amendments identical to those to IFRS 7 issued by the IASB in October 2010.
The amendment adds disclosure requirements in relation to transfers of financial assets. The new disclosures aim at enabling users to evaluate an entity’s risk exposure arising from the transfer of financial assets, as well as any resulting impact on the financial position.
The amendment applies for annual periods beginning on or after 1 July 2011.
IASB to re-expose revenue recognition proposals
The IASB’s latest work plan (July 2011) shows that the revenue recognition proposals are to be re-exposed before the end of the year. It also shows that the proposals for financial instrument impairment and insurance contracts may also be re-exposed in the near future.
IFRS newsletters and other publications
KPMG in the UK publishes Financial Reporting Matters, a short newsletter to alert you to key changes in UK and International Financial Reporting Standards and UK Company Law. It is available for download here. Alternatively, you may subscribe by sending an email to Financial Reporting Matters.
KPMG IFRG Limited has published the following since the June/July 2011 Update, which are available on its Web site at http://www.kpmgifrg.com/:
IFRS Practice Issues for Banks: Loan Acquisition Accounting (August 2011)
IFRS Illustrative Condensed Interim Financial Statements: First time adopters (July 2011)
First Impressions: Employee Benefits (July 2011)
IFRS Disclosure Checklist (July 2011)
IFRS Illustrative Financial Statements: Banks (June 2011)
KPMG IFRG Limited also publishes In the Headlines, which provide information in relation to new exposure drafts and standards issued by the IASB, as well as any other relevant developments affecting current and future IFRS reporters, including summaries of IASB meetings on a monthly basis.
In the Headlines Issue 23 – June 2011 IASB meetings
In the Headlines Issue 24 – Release of ninth edition of International Valuation Standards
In the Headlines Issue 25 – Public consultation on IASB agenda for next three years
In the Headlines Issue 26 – Should IFRS 9’s effective date be pushed back?
In the Headlines Issue 27 – July 2011 IASB meetings
In the Headlines Issue 28 – Consolidation exception for qualifying investment entities