The primary purpose of
financial statements is to provide useful decision-making
information to investors. Accurate, reliable and comparable
information helps investors allocate capital on an efficient basis,
which benefits all participants in capital markets.
For many companies, leases
represent an important source of financing. However, due to the
current accounting requirements for operating leases, many lease
obligations are only included in a company’s disclosures.
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This makes it difficult for
investors to compare different companies and the implications of
different leases, as well as to understand a company’s source of
leverage.
As rating agencies and other
financial analysts think that operating leases give rise to assets
and liabilities that should be recorded on the balance sheet, they
are forced to apply a ‘rule of thumb’ multiple to annual lease
payments in order to estimate the effects of these financial
obligations. These calculations are based on estimates and guesses
and this can result in the use of inaccurate information about a
company’s liabilities, gearing and earnings.
The International Accounting
Standard Board’s proposals address this issue by requiring both
lessees and lessors to apply the same accounting model – a
‘right-of-use’ model. Among other changes, this would result in
lessees recognising a liability to make lease payments and an asset
representing its right to use the underlying asset for all lease
contracts, thus providing more complete, accurate and useful
information to investors.
Our proposals are open for public comment until 15 December. We
are actively seeking broad participation in the consultation
process from all companies and industries.
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The main issue is that the International
Accounting Standard Board’s (IASB) proposals go beyond the simple
capitalisation of operating leases, although it is arguable whether
this in itself is a necessary improvement.
The new rules to capitalise
leases are anything but simple. They will involve complicated
measurements, probability-based estimates and frequent
reassessments, leading to fluctuating assets and liabilities that
may often exceed committed lease payments currently disclosed in
the notes.
Two lessees, with identical
leases, operating in similar economic circumstances, could have
very different accounts. Is this an improvement in comparability
and understandability of financial information? Standard setters
argue that this approach, an “uncertain overstatement” of assets
and liabilities, is preferable to a “certain
understatement”.
Even if that is true, it should
be weighted against the costs for lessees who will have to apply
the rules to tens of thousands of small-ticket leases and rentals
as well as to the few big-ticket contracts at the core of the
debate. As the proposals stand, it is unlikely they would meet such
a test.
It is also well known that the
IASB wants to remove lease classification. Yet lessors face
multiple models and a lack of clear principles on when to apply
them. As they stand, the lessor proposals simply do not reflect the
economics of leases.
There is also still no convincing argument as to why the
lessor approach is consistent with what is proposed for lessees
and, therefore, no coherent overall model. Much more will need to
be done before new lease accounting can be declared an
improvement.
