RSM Reporting september 2013

7/27/2019 RSM Reporting september 2013

1/13

Welcome rom the Editor

Marco Mongiello

How would it eel i, on the rst day back ater a summer break, you were given the news

that two denitive standards on accounting or leases and accounting insurance contracts

had been issued? For many o us the relie would be that the end o these two sagas

would give space to some other interesting issues. For the rest o us, it would mean diving

into the excitement o implementing these long due standards. But this newsletter is not

ction, so we can only try to help our readers navigate the uncertainty o these standards

by shedding light and soliciting debate. This is what Joelle Moughannis Hot Topics in

Accounting and Gil Rosenstock and Shlomi Shuvs articles do. The rst has a ocus on the

accounting or leasing current status, the second addresses one o the implications o

leasing contracts in the context o the valuation o investment properties.

This newsletter also explores the boundaries o accounting and reporting and their

developments in less chartered territories. To this end, the guest contributor, Karen

Sanderson, shares with us her experience and opinions rom the very prominent point

o view o her senior position at HM Treasury in the UK and her leading role in the

development o the Whole o Government Accounts (WGA). Few countries have ventured

into this initiative and others will ollow suit by adopting the WGA approach or public

accounts. This opens tremendous opportunities or investors, analysts, politicians and

economists to make more sense o the actual situation and o the perormance o the

public sector, and or our proession to have a louder voice in helping the public sector

decision makers.

Expect more on this and, wishully, less on the endeavours o amending existing

standards!

Enjoy your reading.

Dr Marco Mongiello [email protected]

In this issue:

Section 1: Accounting and reporting

this quarter

Updates from the IASBand EFRAG

Section 2: The point o view o ...

... Karen Sanderson onthe Whole of Government

Accounts - a new frontierof accounting

... Shlomi Shuv & GilRosenstock on investmentproperty - issues inpractice

Section 3: Hot Topics in Accountingby Joelle Moughanni

Welcome to the seventeenthedition o RSM Reporting thenewsletter rom RSM coveringtechnical developments in globalaccounting and reporting.

Issue 12

RSM Reporting

September 2013

Issue 17

Connect to RSM IFRS experts and connect with success


2/13

22

June 2013

The IASB published a revised Exposure Drat

o proposals or the accounting or InsuranceContracts aiming to provide a consistent

basis or accounting or insurance contracts

and to make it easier or users o nancial

statements to understand how insurance

contracts aect an entitys nancial position,

nancial perormance and cash fows. The

ocus is on enhanced presentation and

measurement o insurance contracts and

minimum articial accounting volatility.

The IASB published narrow-scope amendments

to IAS 39 Financial Instruments: Recognition

and Measurement - Novation o Derivativesand Continuation o Hedge Accounting, aimed

at allowing hedge accounting to continue

in a situation where a derivative, which has

been designated as a hedging instrument,

is novated to eect clearing with a central

counterparty as a result o laws or regulation.

Similar relie will be included in IFRS 9

Financial Instruments.

July 2013

IASB and FASB have stepped up their jointeorts to reach a nal consensus on

accounting or leases.

IASB has stepped up its eort to advance the

development o the accounting or insurance

contracts.

August 2013

No activity took place.

IASB | or urther news and updates please visitwww.irs.org

July 2013EFRAG commented on the IASB exposure drat

on leases that constituents do not seem tohave a good understanding o the objectives

o the project and what economic phenomena

the IASB intended to depict in the primary

nancial statements. EFRAG agrees with the

IASB that more leases should be brought onto

balance sheets o entities and that application

o the right-o-use model to a right population

will prove to be useul or users o nancial

statements.

EFRAG supports the IASBs proposal o the

credit deterioration approach or expected

credit losses in nancial instruments. However,

it recommends that the IASB reconsiders how

the model could be implemented in such a

way that entities are able to leverage their

existing practices and hence limit the costs

and increase reliability o their estimates and

reviews the level o proposed disclosures in

order to balance appropriately the cost or

preparers and benets or users.

EFRAG has endorsed and supports the

adoption o the Amendments to IAS 39

Novation o Derivatives and Continuation o

Hedge Accounting proposed by IASB.

EFRAG has endorsed and supports the

adoption o the Amendments to IAS 36

Impairment o Assets proposed by IASB.

EFRAG invites comments on its letter on the

IASBs revised exposure drat on accounting

or insurance contracts.

August 2013

Nothing to report.

June 2013

EFRAG contributed to the debate on the

Conceptual Framework, ocusing in particularon the threshold or recognition o assets and

liabilities.

EFRAG has been actively seeking and soliciting

proposals and eedback on accounting or

insurance contracts rom the industry.

EFRAG has voted in avour o the adoption o

the amendments to IFRS 10 and 12 and IAS 27:

Investment Entities.

EFRAG | or urther news and updates please visitwww.erag.org

1 | Accounting & reporting this quarter

IASB EFRAG

RSM Reporting | Issue 16 | September 2013RSM Reporting | Issue 17 | September 2013


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44

2 | Point o view

Ian Mackintosh1

on the global nancial crisis and a change at the top: a crucial time

or the IASB

Ian Mackintosh

on Global nancial crisis and a change at the top: a crucial time or

the IASB

Ian Mackintosh

on Global nancial crisis and a change at the top: a crucial time or

the IASB

RSM Reporting | Issue 17 | September 2013

Editors interview

The words attributed to Karen Sanderson express her own

opinion and do not constitute ofcial communication o HM

Treasury.

It is oten reported that the IFRS ramework is gaining more

and more momentum globally because more countries

require or allow its adoption or companies that meet certain

conditions.

However, there is another dimension to the expansion o the

IFRS ramework, which is less publicised; its adoption by public

sector entities.

Adopting International Financial Reporting Standards in the

public sector brings big challenges and big opportunities or

any government and regional authorities that decide to move

into this space. The entrance o the public sector in the realm

o international accounting is also an important turning point

or the accounting proession globally. This is happening

with the partial adoption o the International Public Sector

Accounting Standards (IPSAS), by a number o countries and

public sector bodies worldwide over the last decade, and with

the partial adoption o the IFRS by ewer countries in more

recent years.

In this context, I had the privilege to talk with the Deputy

Director to the Whole o Government Accounts (WGA) at HM

Treasury in the UK, Karen Sanderson, about the visionary

project o reporting the entire domain o the UK public sector

as i it was one large group o companies using IFRS.

Karen Sanderson:

The WGA is seen by proessional bodies (e.g. Institute o

Chartered Accountants in England and Wales) and by the

government as a valuable document that helps to bring abouttransparency. The public sector has reported using sets o

accounts which are essentially ragmented. Even though

some users nd entity accounts useul because they are

interested in the delivery o specic ront line services, this

ragmentation prevents users rom seeing the big picture o

the public sector. The national accounts, which are produced

by the Oce o National Statistics using economics-based

measures o activity, are written in a language that is less

amiliar to users and so may be more dicult to understand

and compare with the accounts produced by the private

sector entities. The WGA, instead, is written in the much more

common language o IFRS and brings the nancial position

and perormance o the UK public sector together in one

place. For example, beore we published the WGA there was

speculation about what government liabilities were, because

some liabilities recognised under IFRS were not captured

in national accounts measures. What we have done is bring

certainty; users o the accounts do not have to wonder

whether there is some skeleton in the cupboard. We prepare

the accounts based on IFRS as every other listed company

does and go through similar rigour.

We use the EU adopted IFRS and interpret them or adapt

them as necessary to refect the public sector context. We

have a statutory Financial Reporting Advisory Board thatreports to the Parliament, which provides advice to the

Treasury and other standard setters in the public sector

on how to comply with the IFRS ramework and whether

interpretations or adaptations are acceptable. In the same

way as private sector companies, there is a proper process

or setting accounting standards and we cannot make up the

rules as we go.

Guest Contributor - Karen Sanderson

... on the Whole o Government Accounts a new rontier o accounting


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55

From the technical point o view there are at least two

major challenges in this initiative: the frst is creating

the procedures that are needed to consolidate the sheer

number and variety o entities. You currently include around

3,000 bodies, rom small local authorities to the National

Health Service and the Bank o England. Is this bigger and

more varied than any private sector company you can think

o?

In terms o consolidation procedures, the approach we adopt

is probably dierent rom the approach o a private sector

group. We take the audited accounts o the individual entities

and consolidate them. Private groups tend to audit the group

rst and the subsidiaries aterwards. Because we do it the

other way around, we rely heavily on what is in the accountso the local entities.

Also, as opposed to private sector groups, we do not have

detailed monthly intercompany accounting procedures.

The WGA is an annual exercise. Although we are currently

looking at ways to improve the elimination o counterparty

transactions by perhaps introducing additional processes

during the year, it is dicult or WGA to operate in the same

way as the private sector. We do ask or inormation about

transactions that involved other public sector bodies to be

reported, but still we are let with signicant numbers o

transactions that do not match. For example, there are grants

that are made between the central government and local

governments that can be dicult to identiy. When a grant

given to a local authority has not been spent at the year end,

it is likely to be reported in the entitys balance sheet, and

may not be properly captured or WGA purposes, so we end

up with a mismatching item. Although the net impact is small,

the impact on individual lines is potentially bigger. We see the

challenge and we are getting better at it!

The second challenge is perhaps represented by the

applicability o the concept o control?

We do not see WGA as a set o group accounts; the Treasuryis not the parent. We see it as a set o consolidated nancial

statements or the UK public sector. There is no command

centre because the public sector has been developed over

time under numerous pieces o legislation.

As a consequence, we have applied a slightly dierent concept

o control, and have taken a dierent view to applying the

IFRS in ull. The Act that requires the WGA to be produced

allows the Treasury to decide which entities to consolidate.

We have taken a view about how to dene the boundary o

the WGA consolidation; we have chosen to base the WGA on

those entities that are classied as part o the public sector

by the Oce or National Statistics (ONS). In this way we

ensure that the scope o the WGA is similar to the scope that

is being used in the national accounts measures. This gives

better comparability and use o the inormation. The way that

ONS classies bodies to the public sector is, in turn, based

on guidance provided by Eurostat, and part o that guidance

in based on control. The denition o control in the Eurostat

guidance and IFRS has a strong overlap, but is not exactly thesame. So, the concept o control is present in the WGA but is

also slightly dierent than control in the IFRS ramework.

One other reason or using the ONS classication is that

the boundaries o our consolidation are independently

determined, and we cannot be accused o udging them.

Admittedly changes are happening at the moment, as in

the rst year we did not catch all the entities that should be

consolidated. So, between year one and year two, or example,

we added the Bank o England. These changes are part o

getting started and will continue over the coming years, but

the aim is that we should get to a point where the boundaries

should be airly static and allow or comparability and trend

analysis.

What is the rationale or embarking on such a huge task or

a government?

Fiscal transparency is at the heart o the WGA. The UK has

been leading the way. The International Monetary Fund

talks about correlations between scal health and scal

transparency: the more scally transparent a country is,

the better its scal health. By using IFRS and being audited

independently, WGA gives the readers the hard acts, and

the government cannot udge its position. We are telling thestory as it really is and or people to make decisions. This

includes people within the government and people outside o

the government e.g. the rating agencies which are checking,

among other things, i the sovereign debt is sustainable.

This is equivalent to the managers and the investors use o

accounting inormation in the private sector.

I all members o the European Union (EU) used this

accounting approach we would experience less uncertainty

about the stability o the member states. In act, the European

Commission is looking at whether harmonised accounting

standards should be introduced or member states, to createmore consistent reporting among them.



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66

Rating agencies have taken some interest in our WGA; the

very act that ministers have the WGA is a plus point in

managing the governments nances. Although there are

people who would argue that cash accounting is ne, it is

a act that cash accounting does not give the reader as

complete a picture as accrual based accounting gives: accrual

accounting enables decision makers to see the eects o their

and others decisions on uture nances.

The risk in publishing WGA is that by measuring important

items like the debt in dierent ways to those that are used

by the Government or scal management, and the numbers

are dierent, people start to question whats going on. In

act, nothing has changed! It is not that the liabilities were

not there, they have been measured in a dierent way. Theinormation contained in WGA can help Ministers see the

tough decisions that need to be made.

Other countries produce consolidated nancial statements,

even though very ew consolidate the whole o the public

sector. For example, Estonia has progressed really well with

this, and that in part may be because they have been able to

adopt accrual based accounting almost rom a blank sheet o

paper. They have also been able to learn lessons rom other

countries, and Estonia too is now producing the consolidated

accounts or the whole public sector.

Other stakeholders?

The WGA is o use or the private sector in a twoold sense:

as taxpayers, companies are interested in the shape o the

government nances and the challenges that it is acing. As

providers o services, companies may use the WGA to spot

opportunities to propose ideas o ways or improving how

we deliver government services more eciently and more

cheaply.

On this note, though, we do not have a huge interaction

with our user base. Thereore, we are nding ways to

communicating with users and ask them whether they douse the accounts and what they use them or, and whether

there is other inormation they would nd more helpul.

We have launched a piece o work called simpliying and

streamlining annual reports and accounts. This includes a

public consultation document aimed at users and preparers,

to try and understand who is using the accounts and or what

purpose. We are conscious that the IFRS language is the

language o investors, and that taxpayers may require other

or additional inormation that is more important. At the same

time we do want to stay true to the concepts in IFRS.

So, what we are witnessing is the birth o a new type o public

accounts, which brings more transparency to the fnancial

situation and perormance o the public sector, making it

easier or us to judge the governments stewardship o a

countrys fnances. When a government body sells an asset

at a loss, this emerges in the WGA, which is concerned with

the public sector as a separate entity rom the private sector.

The same transaction would disappear in the current national

accounts, which are concerned with the entire economy o a

country.

What makes this historical turn in accounting and politics even

more amazing, is that our guest contributor, Karen Sanderson,

is leading this initiative with a smaller team than manyprivate sector groups: a lesson o efciency rom those who

look ater the taxpayers money to those who look ater the

shareholders money?

Karen Sanderson

Deputy Director, Government Financial Reporting

HM Treasury

Karen leads nancial reporting policy or central

government, acting as the standard setter or central

government departments, leads on the production o

whole o government accounts, and the reporting o public

expenditure in the orm o public expenditure statistics

and to meet the requirements o Supply legislation. She

qualied as a Chartered Certied Account, on an accredited

programme with the ormer British Railways Board. On

privatisation o the rail industry she joined Railtrack beore

moving to the private sector, where she joined Tetley

GB Ltd. With her heart in the delivery o public services,

she subsequently moved back to the public sector, rstly

with the Strategic Rail Authority, beore moving to the

Department or Transport and then joining HM Treasury in

2008.

She serves as a member o the Financial Reporting Advisory

Board, which advises on accounting standards in the public

sector.



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2 | Point o view

On 31 October 2012 the amendments to IFRS 10 or

investment entities (Investment Entities Amendments

to IFRS 10, IFRS 12 and IAS 27) were published and will

be eective rom 1 January 2014 (with early adoption

permitted). These amendments provide an exemptionor consolidation as required in IFRS 10 Consolidated

Financial Statements. Instead o consolidating the

controlled investments (i.e. subsidiaries), investment

entities have to measure all o their investments at air

value through prot or loss.

IAS40 Investment Property provides or the accounting

treatment o investment property and the related

disclosure requirements.

It is paramount or a correct application o the Standard

that the right model is adopted or the measurement o

the investment property value. In light o the nature o

investment property, the air value model is, in our view,

more relevant or measurement purposes than the cost

model. In our view, the Standard itsel seems to privilege

the air value model when it states that it is highly unlikely

that a change rom the air value model to the cost model

will result in a more relevant presentation. Furthermore,

the Standard requires that even where the cost model is

applied, the air value must be disclosed in the notes.

Under the air value model, investment property is

measured at air value, with changes in air value

recognised in prot or loss. According to this approach,measurement o investment property using the cost

method similarly, or example, to inventories would

undermine relevance in the long term (as opposed to

inventories, where this irrelevance is eliminated in the

short term). However, or mainly practical reasons, in

light o reporting entities' amiliarity with the cost model

and to allow time or countries with less-developed

property markets and valuation proessions to mature, the

Standard permits the use o the cost model.

The air value model raises many questions in practice,

two o which are dealt with in the ollowing paragraphs.

The rst issue deals with actors specic to the reporting

entity whereas the second issue deals with actors specic

to the asset being valued.

1. Factors specifc to the reporting entity: air value versus

value in use

The air value o investment properties should disregard

actors specic to the reporting entity. In this sense

air value diers rom value in use as dened in IAS 36

Impairment o Assets. While value in use refects the

reporting entity's estimates, including the eects o

entity-specic actors, air value refects all participants

interests in the market. Thereore, in estimating the

air value o an investment property, an entity shall not

include additional value created by a property portolio

containing properties in dierent locations, synergy

between investment property and other assets held by

a reporting entity, statutory rights or restrictions which

are specic only to the present owner, and tax benets or

liabilities specic only to the present owner.

On the other hand, air value shall be calculated according

to the optimal use (highest and best use) o the

property, and not necessarily according to its present

use. For example, assume that land with a gol course can

be easily converted into a parking lot, which would yieldhigher income. While the value in use o the land refects

its current use (as a gol course), the air value o the

land should refect its optimal use (a parking lot). This

means that air value is the highest possible value o the

property evidenced by market data, taking into account

each possible use - both nancially easible and legally

permissible - that is suciently justied and expected.

Shlomi Shuv and Gil Rosenstock

... on investment property issues in practice



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2. Factors specifc to the asset being valued: accounting or

prepaid or accrued operating lease income

In principle, the air value measurement should take

into account actors specic to the asset being valued.

This has consequences in the case o operating leasing

incentives.

Occasionally, when a reporting entity leases an

investment property under an operating lease, it may

provide the lessee with various incentives, such as a

rent-ree or reduced-rent period. SIC-15 Operating Leases

- Incentives states that the lessor should recognise thecost o the incentives as a reduction o rental income

over the lease term (usually according to the straight-line

method). However, or investment property measured

at air value, the incentives provided to the lessee might

already be included in the measurement o the income-

producing property's air value (in particular, where a

similar incentive would be granted by any other market

participant).

For example, the air value measurement o investment

property takes into account actors such as the specic

location o the asset, its age and its physical condition.

Similarly, air value measurement takes into account

contractual rent cash fows in uture periods, whether at,

below or above market rent as o the measurement date.

However, the Standard states that in determining the

carrying amount o investment property under the air

value model, an entity does not double-count assets

or liabilities that are recognised as separate assets

or liabilities. Thereore, where the air value has been

determined based on the net rentals, since the lessor

recognises a separate asset or the lease incentive as

accrued operating lease income, the carrying amount o

the investment property should be decreased, so as toavoid double counting.

In conclusion, when valuing an investment property: (i) the

model to adopt is the air value, which must be used or

the ace o the accounts or in the note, (ii) actors specic

to the owner o the property should be disregarded, but

(iii) actors specic to the property should be considered.

This is illustrated in the example, where leasing incentives

are accounted or.

In another example, assume that a company owns

investment property (a rentable warehouse) whose

carrying amount is CU 10 million. The carrying amount

o the property is comprised o land (CU 8 million) and

the warehouse built on that land (CU 2 million). A valuer

reaches the ollowing conclusion: the air value o the

warehouse (current use) is CU 10.5 million (comprised o

land value - CU 8.5 million and the value o the building

- CU 2 million). On the other hand, the value o the land

according to an alternative, optimal use (oce building) is

CU 12 million (but, in this case, the building would have to

be demolished - air value o zero).

Even i the company's management does not intend to

change the current use o the property, the air value

o the property should be CU 12 million. This is because

the objective o a air value measurement is to refect

the price that would be received to sell an asset in an

orderly transaction between market participants. In other

words, in this case it is sae to assume that a potential

buyer (a market participant) would disregard the specic

intentions o the reporting entity, but rather use the

asset based on its highest and best use. Thereore, the

air value measurement should refect this act, while the

exceptional intentions o the reporting entity in respect

o the uture use o the asset should be refected in the

results o subsequent reporting periods.



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Example - accrued operating lease income or lease

incentive [to be ramed separately i possible]

On January 1, 2013, a company signs a 10-year operating

lease with a lessee. Under the agreement, annual rent

amounts to CU 100,000 per year, to be paid beginning

rom the third year onwards (i.e. the rst two years are

rent-ree). Rent is paid at the beginning o each year. The

air value o the investment property on January 1, 2013

is CU 1,000,000, which refects a rate o return o 8% =

(100,000 X 8/10) / 1,000,000.

Furthermore, the investment property's air value onDecember 31, 2013 is CU 1,050,000. It should be assumed

that the property's air value takes into account the rent-

ree period. As the accrued operating lease income is

recognised in a separate asset (other receivables) in the

statement o nancial position at December 31, 2013 or

CU 80,000, the carrying amount or investment property

is CU 970,000 (ie 1,050,000 80,000).

In act, in 2013 no rent is paid or the property. However,

in accordance with the provisions o SIC-15, the company

is required to average the total rent over the lease term.

Accordingly, the company shall recognise rent in the

amount o CU 80,000 (= 100,000 X 8/10). Furthermore,

the company presents the incentive granted to the

lessee as a separate asset, so the company reduces the

investment property's air value in order to avoid double

counting.

Accordingly, the journal entries recorded in 2013

will read (in CU):

In this case, loss rom changes in the air value o the

investment property amounts to CU 30,000. This is

because, assuming no changes occurred in all other terms,

conditions and circumstances during 2013, the pure air

value (without regard to the double-counting issue) should

have been CU 1,080,000. In other words, on December 31,

2013, a willing buyer would have paid CU 1,080,000 or

the property, taking into account the act that the above-

market rent o CU 80,000 will be contractually received

in the uture or services supplied in the past (rent during

2013). Consequently, an actual air value o CU 1,050,000

means that 2013 suered a decrease in air value o CU

30,000.

The air value o the property (CU 1,050,000) is actually

split in the statement o nancial position between the

two assets: investment property or CU 970,000 and lease

incentive (other receivables) o CU 80,000.

________________________________________

This article includes a sample o Chapter Twenty Investment Property o an

IFRS Manual written by Mr Shlomi Shuv, an IFRS expert in Israel.

Dr Other receivables -

incentives 100,000 X

8/10 =

80,000

Dr Changes in air value

o investment property

30,000

Cr Rental income

80,000

Cr Investment property

(1,050,000-1,000,000)

80,000

30,000

Gil Rosenstock, CPA, IFRS Consultant

Head o Proessional Practice

RSM Shi, Hazenratz & Co., Israel

T +972 (3) 791 9111

E [email protected]

Shlomi Shuv, CPA, IFRS Consultant

Vice Dean at the School o Business (IDC)

Herzliya, Israel

T +972 (9) 952 7655

E [email protected]



9/13

1010

Entities around the world enter into leases as a means

o gaining access to assets, o obtaining nance, and o

reducing their exposure to the risks o asset ownership. Theexisting accounting models under both IFRS and US GAAP

have been criticised or oten providing a misleading picture

about leverage and the assets that the lessee uses in its

operations. As a result, many users o nancial statements

adjust the amounts presented in a lessees statement o

nancial position to refect the assets and liabilities arising

rom operating leases, even though such adjustments can

be incomplete or inaccurate due to missing inormation.

Moreover, existing dierences in the accounting or nance

and operating leases have encouraged some companies to

structure some transactions as operating leases to achieve

o-balance-sheet accounting.

As part o their global convergence process, the IASB and

FASB (the Boards) have been working jointly since 2007

to create a single, converged, global leasing standard. The

proposals in the revised exposure drat published on 16 May

2013 (with comment period ending on 13 September 2013)

were developed by the Boards ater considering responses to

their Discussion Paper (issued in March 2009) and their initial

exposure drat issued in August 2010 (the 2010 ED). However,

given that two o the IASBs ourteen voting members and

three o the seven FASB members voted against issuing the

new ED (the dual accounting model being the main reason),

the new proposals are likely to generate more debate anduncertainty about how the Boards will proceed.

It is in this context that the ollowing questions and answers

provide a practical overview o the key re-exposed proposals

or this long-existing project.

1. In a nutshell, what is the IASB proposing in its new

exposure drat (the ED)?

Overall, all leases would be brought on balance sheet unless

they are short-term (i.e. less than 12 months) or not leases at

all. The ED includes new guidance to distinguish a lease rom

a service contract, meaning that the accounting or some

arrangements currently treated as leases might change.

I the ED lessor model looks quite similar to the current IAS

17 model (except or some nuances in recognising revenue

and discounting the residual asset), signicant changes

concern lessee accounting, in particular or operating leases

o more than 12 months (lessee accounting or nance

leases would remain unchanged). In act, a lessee would be

required to recognise assets and liabilities or all leases (o

more than 12 months) on a discounted basis, with a prot or

loss impact dependent on the nature o the underlying asset.

Consequently, the statement o nancial position, income

statement and statement o cash fows would change or the

majority o leases o equipment or vehicles, whereas or the

majority o leases o property, only the statement o nancial

position would change.

2. Are there any changes to the proposed defnition o a

lease?

The IAS 17 denition o a lease (i.e. the right to use an assetor a period o time in exchange or consideration) and the

criteria in IFRIC 4 Determining whether an Arrangement

contains a Lease (i.e. based on rights to control the use o

specied assets) are retained in the ED (similar to the 2010

ED). However, changes to the application guidance o the

denition, in particular relating to the concept o control

within the denition i.e. a contract contains a lease when

the lessee obtains the right to control the use o an identied

asset or a period o time - are expected to narrow the

population o contracts to which the proposals apply; in

particular, service contracts that, under current requirements

and the previous proposals, may have been considered to beleases would be excluded (e.g. some take-or-pay contracts ).

3 | Hot topics in accounting

Joelle Moughanni

... The newly proposed leases model in tenquestions-and-answers



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3. Are the measurement complexities o the 2010 ED

reduced in the new proposals?

Yes, arguably. In particular, measurement o lease assets and

liabilities would include:

Variable lease payments, only i those are in-substance

xed payments or linked to an index or a rate (as opposed

to including all expected variable lease payments in the

2010 ED).

Lease payments payable in optional renewal periods,

only i the lessee has a signicant economic incentive

to exercise the option (as opposed to including suchpayments on a more likely than not basis).

In act, the EDs proposals or variable lease payments are

closer to current practice under IAS 17 than was the 2010 ED.

In addition, entities could elect not to apply the proposed

accounting models to short-term leases, i.e. leases with a

maximum term (including renewal options) o up to 12 months;

the existing operating lease accounting model could apply

instead. Thus, lease length and renewal options might become

key considerations in contract terms and business practices;

or example, entities might be tempted with entering into very

short leases to take advantage o the continued o-balance-

sheet treatment o short-term leases.

4. How dierent is the proposed lease classifcation rom

current practice?

The proposed lease classication tests are undamentally

dierent rom the current risks and rewards approach in IAS

17. Under the ED, leases would be classied at commencement

date (without subsequent reassessment), by both lessees and

lessors, as either Type A or Type B depending on the nature

o the underlying asset and on the extent o the lessees

consumption o the underlying asset.

Leases o property (i.e. land and/or building) would be

classied as Type B leases unless the lease term is or the

major part o the underlying assets remaining economic lie

or the present value o the lease payments is substantially all

o the air value o the underlying asset.

Leases other than property would be classied as Type A

leases unless the lease term is or an insignicant part o

the total economic lie o the underlying asset or the present

value o the lease payments is insignicant relative to the

air value o the underlying asset. There are no bright-line

quantitative thresholds on what constitutes an insignicant

part o the total economic lie or an insignicant amount o

the air value o the underlying asset.

However, in all cases, i the lessee has a signicant economic

incentive to exercise an option within the lease to purchase

the underlying asset, then the lease is classied as a Type A

lease.

The accounting models or each type o lease are discussed in

Q&A 6 or lessees and Q&A 7 or lessors.

5. What is the rationale behind this introduced dual

approach?

In response to many comments on the 2010 proposals, the

ED accounts or most equipment leases dierently rom most

property leases in order to refect the diering economics

o the wide variety o lease contracts. The principle or

determining which approach to apply is based on the amount

o consumption o the underlying asset, refecting the

dierence between a lease or which the lessee pays or the

part o the underlying asset that it consumes during the lease

term, and a lease or which the lessee merely pays or use.

Typically, a lessee consumes a part o any equipment that it

leases (e.g. aircrats, ships, cars and trucks), because such

equipment and vehicles are depreciating assets, whose value

not only declines over their economic lives but generally

declines aster in the early years o their lives than in the later

years. In such leases, the lessor prices the lease to recover the

value o the part o the asset consumed as well as obtaining a

return on its investment in the asset.

In other leases, the lessee merely uses the underlying asset

without consuming more than an insignicant part o it. This

is typically the case or most leases o real estate property.

Property typically has a relatively long lie, and a large

proportion o the lease payments or some property leases

relates to the land element inherent in those leases. Land

has an indenite lie and the value o the land would not be

expected to be consumed by a lessee. In such leases, the

lessor prices the lease to obtain a return on its investment

in the underlying asset (without requiring recovery o the

investment itsel).



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The ED simplies this concept by making rebuttable

presumptions requiring entities to classiy a lease largely on

the basis o the nature o the underlying asset and account

or it accordingly.

6. How does the newly proposed lessee accounting model

compare to the one in the 2010 ED?

The core requirement or a lessee to recognise a right-o-use

(ROU) asset (representing the right to use the underlying

asset) and a lease liability (representing the obligation to

make lease payments) is conrmed, although simplied as

recognition o assets and liabilities would not be required or

leases with a maximum term o 12 months or less.

The more signicant change is at the income statement

level: whereas a lessee would have amortised the ROU asset

over the lease term (typically on a straight-line basis) and

recognised separately interest on the lease liability under

the 2010 ED, the new ED proposes a dual approach to the

recognition and presentation o lease expenses and cash fows

based on classication o the lease (see Q&A 4).

For a Type A lease, the ROU asset would be amortised using

a systematic method with the related expense presented as

amortisation expense. In addition, interest expense on the

lease liability would be recognised using the eective interest

method. Under this method, the interest expense would

generally decrease over time whilst amortisation o the ROU

asset is likely to either remain constant (under a straight-line

method) or decrease over time (under a diminishing balance

method). Accordingly, the total expense resulting rom the

lease arrangement would be ront-loaded. This pattern o

expense recognition is consistent with the treatment o

nance leases under current lease accounting.

For a Type B lease, a lessee would recognise a single lease

expense that combines the unwinding o the discount on

the lease liability with the amortisation o the ROU asset,calculated so that the remaining cost o the lease would be

allocated on a straightline basis over the remaining lease

term. Thus, the ROU asset in a Type B lease is not amortised

on a straight line basis; it is instead a balancing gure arising

rom the dierence between the amount paid, the lease

expense and the amortisation o the liability.

7. How does the newly proposed lessor accounting model

compare to the one in the 2010 ED?

The 2010 ED proposed two dierent lessor accounting models,

based on whether the lessor retained or transerred to the

lessee the signicant risks or benets associated with the

underlying asset. The ED proposes a dual model or lessors

based on lease classication (see Q&A 4).

A lessor in a Type A lease would derecognise the underlying

asset and recognise a lease receivable (representing the

right to receive lease payments and measured at the present

value o the payments) and a residual asset (representing the

lessors claim to the residual value o the leased asset at the

end o the lease term and measured at the present value o

the estimated residual value at the end o the term plus the

present value o any expected variable payments). The lessor

would recognise prot at lease commencement on the portion

o the underlying asset that is considered to be sold to the

lessee. Interest income on both the receivable and the residual

asset would be recognised over the lease term using the rate

the lessor charges the lessee in the lease contract.

In a Type B lease, the lessor would simply continue to

recognise the underlying asset and recognise lease payments

as income (similar to current operating lease accounting

under IAS 17). The initial proposals o recognising a lease

receivable and a liability or the obligation to permit the

lessee to use the asset received very little support and thusabandoned.

8. What to expect or eective date and transition?

The ED does not propose an eective date or the new

standard and does not speciy whether early adoption would

be permitted. However, it seems unlikely that entities would be

required to adopt the new lease requirements beore annual

periods beginning on or ater 1 January 2017.

Under the ED, entities could choose between a ull

retrospective or modied retrospective transition. Under both

approaches, entities would recognise lease-related assetsand liabilities as o the beginning o the earliest comparative

period presented. The modied retrospective approach would

allow entities to use certain shortcut calculations to initially

measure lease-related assets and liabilities and hindsight

to determine the lease term or whether a lease exists at all.

No leases would be grandathered under either transition

approach. In any case, transition is likely to be onerous.



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9. How would the new proposals improve the quality and

comparability o fnancial reporting?

For all leases with a lease term o more than 12 months,

assets and liabilities would be reported in the lessees

statement o nancial position, thus providing a more aithul

representation o the nancial position o the lessee and,

together with enhanced disclosures, greater transparency

about the lessees leverage. The proposals require lease assets

and liabilities to be measured on a discounted basis. This

inormation is useul to users o nancial statements because

it provides inormation about uture cash outfows arising

rom leases, which is comparable with inormation provided

about other nancial liabilities that are reported on an entitys

balance sheet and measured on a discounted basis.

The main concern rom users o nancial statements about

current lessor accounting is the lack o transparency about

the residual values o assets that are subject to operating

leases. Those users are interested in understanding the

assumptions that lessors make about signicant residual

values. Those who analyse the nancial statements o

equipment and vehicle lessors also told the Boards that it

would be benecial to distinguish credit risk (associated with

receivables rom lessees) rom asset risk (associated with

residual interests in underlying assets). The proposals would

assist in providing that inormation or most equipment and

vehicle leases by requiring a lessor to account or its residual

interest in underlying assets separately rom its receivables

rom lessees. The lessor would also be required to provide

inormation about how it manages its exposure to that

residual interest.

10. What key impacts are expected rom such undamental

changes to lease accounting?

The impacts would be elt across sectors. Entities that lease

high-value assets (e.g. airlines and other transport companies)

would see large increases in reported liabilities. Companies

with large volumes o lower-value leases could ace high

implementation costs as they identiy all leases and extract

the data required to apply the new accounting models.

Key nancial metrics would be aected by the recognition o

new assets and liabilities and by changes in the prole and

presentation o lease income and expense. There could also

be impacts on compliance with debt covenants, employee

compensation arrangements, tax balances, and the entitys

ability to pay dividends. Banks would also be concerned about

the eect on regulatory capital.

The proposals introduce new estimates and judgemental

thresholds that would aect the identication, classication

and measurement o lease transactions.

Also, in order to minimise the impact o the proposals, some

entities might seek to reconsider business practices andstructure lease transactions in dierent ways. The current

ocus on whether a lease is an operating lease (o-balance-

sheet) or a nance lease (on-balance-sheet) would be

irrelevant. Instead, companies might ocus more on whether

a contract is a service arrangement (o-balance-sheet) or a

lease (on-balance-sheet).

Systems and process changes may be required to capture

the data necessary to comply with the new requirements,

including creating an inventory o all leases on transition.

In conclusion, implementing these proposals would be a real

challenge or many entities, as they would need to identiyall their leases, extract key data, make new estimates and

judgements, and implement new or updated systems to

perorm the required calculations.

Since it is dicult at this stage to assess the ull impact o the

proposals, the Boards are holding joint round table meetings

(in September and October 2013) and undertaking outreach

activities to obtain additional eedback that will be considered

when they nalise the Standard.

Joelle Moughanni

Technical ConsultantRSM Executive Ofce

T +44 (0)207 601 1089

E [email protected]



13/13

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RSM International Association, 2013

Editor

Dr Marco Mongiello ACA

Director MSc Management and MSc Innovation, Entrepreneurship & Management

Principal Teaching Fellow in Accounting

Imperial College London Business School

T: +44 (0)20 7594 9686E:[email protected]

Middle East

Chandra SekaranT: +965 2245 2680E: [email protected]

Arica

Simon FisherT: +254 20 4451747/8/9E:[email protected]

RSM Global Executive Ofce UK

Ellen CostaT: +44 (0)20 7601 1080E: [email protected]

Global Contacts

Americas

Richard StuartT: +1 203 905 5027E: [email protected]

Europe

C.M. (Kees) RoozenT: +31 (0)30 24 28 505E: [email protected]

Asia Pacifc

Jane MeadeT: +61 2 8226 9518E: [email protected]

Documents

RSM Reporting september 2013