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August 16, 2011updated 12 Apr 2017 4:12pm

Lease accounting – getting ready

Norton Roses Judy Harrison explains why its important for lessees and financiers to act in anticipation of the proposed changes to the lease accounting standard The International Accounting Standards Board and the Financial Accounting Standards Board have been consulting for a number of years to try and agree a revised international leasing standard

By Judy Harrison

Norton Rose’s Judy Harrison explains why it’s important for lessees and financiers to act in anticipation of the proposed changes to the lease accounting standard

A new exposure draft has been announced as part of the on-going consultation into lease accounting. The International Accounting Standards Board and the Financial Accounting Standards Board have been consulting for a number of years to try and agree a revised international leasing standard. It is likely that this will lead to changes in UK accounting practice. More than 800 responses were received regarding the initial exposure draft, and in response, the Boards are considering some substantial changes to their proposals. 

Finance Act 2011 introduced legislation aimed at ensuring that UK businesses that account for lease transactions continue to be taxed in the same way as they are at present following any change to the accounting standards. Readers will recall that we wrote about these provisions when they were still in draft form in the April 2011 issue.  The new legislation has recently been enacted. 

It is worth noting that the new lease accounting standard will increase the compliance cost of UK resident companies. The Finance Act 2011 rules will require UK resident companies to prepare two sets of accounts – the first set will be prepared using whatever accounting standard is in force and from time to time will be required to calculate accounting profits, the second set which will be prepared using accounting standards in force on 1 January 2011 will be required to calculate taxable profits. In the April 2011 issue, we hoped that an alternative long-term solution would be found.  No such solution has yet been announced.

It is anticipated that the revised exposure draft will:

-Propose removing the distinction between finance and operating leases for lessees

This is a return to earlier proposals made by the IASB and FASB. It is expected that lessees will recognise an asset which represents the right to use each asset and a liability for its obligation to make future lease payments for the asset. This asset and liability will amortise over time. It is understood that the effect of this is to generate a front loaded profit for lessees.

– Consult upon the introduction of a single accounting model for lessors

This is a significant change from the previous exposure draft which suggested two different accounting models. It is tentatively proposed that lessors should apply a “receivable and residual” accounting model where the lessor recognises its right to receive lease payments and the value of its residual interest in the asset.

It is expected that certain leases of investment property and short-term leases will be excluded from this change.

It is also thought that the second exposure draft will consult upon a revised definition of lease.

The new exposure draft is expected during the final quarter of 2011. This will inevitably delay publication of the revised leasing accounting standard.

Despite the delay, companies should be preparing for changes to the rules. It is not anticipated that the new accounting standard will grandfather existing leases. As a result, lessees should be reviewing the effect of the changes on their loan covenants. These covenants often restrict a company’s borrowings based upon the amounts shown in a company’s accounts.  As proposed, the new standard seems likely to increase the liabilities shown in an operating lessee’s accounts. Lessees should be liaising with their financiers in anticipation of the proposed changes.

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