Guide to leases

Practical guide to IFRS

19 September 2010

Leasing – overhauling lease accounting
Latest instalment: a joint IASB/FASB exposure draft

At a glance
 The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) released an exposure draft on 17 August 2010 that will significantly change lease accounting and is expected to impact almost allentities. The exposure draft proposes a new model for lessee accounting under which a lessee's rights and obligations under all leases, existing and new, would be recognised on the balance sheet. The boards are proposing a dual model for lessors, under which a lessor would need to apply either a performance obligation approach or a derecognition approach, depending on whether the lessor retains exposureto significant risks and benefits associated with the underlying leased item. The proposal would require lessees and lessors to estimate the lease term and contingent payments at the beginning of the lease and re-assess the estimates throughout the lease term; this entails more effort and judgement than under existing standards. The boards expect to issue a final standard in 2011. The effectivedate has not yet been determined but could be as early as 2014. The boards are consulting separately on potential adoption dates for this and other major convergence projects nearing completion. Management should begin to plan now for its potential impact due to the proposed standard’s business implications, including contract negotiations and the impact on key metrics, systems and processes.

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Practical guide to IFRS – leasing

19 September 2010

The main details
1. As part of their global convergence process, the boards' objective of a new leasing standard is to provide information in the financial statements about the amounts, timing and uncertainly of cash flows arising from lease contracts. The proposals will significantly change leaseaccounting. For lessees, the balance sheet will be grossed up to report a leased asset and lease obligation. In addition, straight-line rent expense will generally be replaced by amortisation of the leased asset and interest expense on the lease obligation on an effective interest basis. Hence, total expense will be front-loaded compared to the current practice. PwC observation: Research completed by PwCand the Rotterdam School of Management has quantified the impact of the proposals on financial ratios reported by 3,000 entities worldwide. The expected impact of the proposed changes to lease accounting is that interest-bearing debt and leverage will increase, but so will earnings before interest, tax, depreciation and amortisation (EBITDA). The increases will be substantial for certain entities.For more detail, see from paragraph 65 below. 2. The proposals require both lessees and lessors to reassess estimates of the lease term and cash flows as facts and circumstances change. As a result, significantly more effort will be required to account for leases initially and on an on-going basis. Greater investment by preparers in systems and processes may also be needed to support theaccounting. Because virtually all entities enter into lease arrangements, the new model will have a pervasive impact. Management should therefore continue to follow the project and plan for implementation. PwC observation: Management will need to undertake an in-depth review of the proposed changes in order to assess the impact on financial performance ratios (including debt covenants), taxation andcompliance with the proposed standard. The changes will require more information to be gathered and more judgements to be made on an annual basis. They will affect financial ratios and metrics, ‘lease-buy’ decisions, taxes, accounting processes and controls, and IT and lease accounting systems. Lessees may need to consider re-negotiating or restructuring existing and future leases. Business and legal...