David Woodroffe examines some possible consequences of the standard-setters’ Exposure Draft recommendations.
For some time now, we’ve been discussing viewpoints on the lack of support for many of the changes in the Exposure Draft jointly issued by the International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB).
However, we’ve also pointed out that the requirement for lessees to capitalise leases, which today only require footnote disclosure, appeared to be generally acceptable. If those changes are enacted, what impact will it have on leasing and how might lessors react?
According to a 2012 survey of CEOs, volume seems to be the number one concern.
Since the requirement to capitalise most equipment leases on the books of lessees appears to be the most likely survivor within this Exposure Draft, it is now appropriate to look at how this will impact leasing volume and how lessors may respond to preserve that volume.
If lessees are required to capitalize leases along the lines of the last Exposure Draft, the vast majority of leases written would be classified as Type A leases.
This means lessees would have to set up both a ‘right to use asset’ and a lease liability to reflect their interest in the equipment and their obligation to pay.
Asset and liability
Two different methods of amortisation and accrual will be required to account for the asset and the liability, the combination of which will account for the lessee’s expense.
In addition to the multiple formulas required, information about renewal and purchase options will have to be recorded to substantiate judgments as to how these leases are recorded on the lessee’s books.
The complexities of these requirements will most likely have a negative impact on volume, and lessors will be forced
to respond in an attempt to preserve that volume.
One of the ways lessors can respond, especially for companies that do a substantial amount of leasing, is to suggest to lessees that they implement software to handle their accounting.
Even before the accounting changes, some lessees were already exploring that option. These accounting requirements will only increase the need.
Many customers may instead look for more direct assistance from their lessor. Some lessors may see this as an opportunity to gain a competitive advantage, by providing the information the lessee requires to handle their accounting.
They may even include this detail on invoices, so that the lessee can make the appropriate entries at the time each instalment is recorded.
Of course, this would require substantial disclaimers and consideration of how it might affect the contract from a tax and legal perspective.
It seems certain that competitive pressure will require lessors to be more transparent with their customers.
Lessors will have to consider if their current systems enable them to support these additional market demands.
Finally, some of the responses to the Exposure Draft have suggested an exemption for small dollar transactions, but what if that doesn’t happen?
If a company has to capitalise every small-ticket office equipment lease it enters into, what will that do to the convenience leasing segment?
One of the things we might see is a move to try and create a service contract instead of an equipment lease.
The revised Exposure Draft defines a lease as "a contract that conveys the right to use an asset for a period of time in exchange for consideration".
An entity would determine if a contract contains a lease by assessing whether or not:
1. Fulfilment of the contract depends on the use of an identified asset.
2. The contract conveys the right to control the use of the identified asset for a period of time in exchange for consideration.
So if a company doesn’t want the contract to be a lease, the fulfilment must not depend on the use of an identified asset and must not convey the right of the user to control the use of an identified asset.
Not all lessors will be willing or able to make this shift. Giving up the unconditional obligation on the part of the lessee in exchange for the warranties and guarantees of the vendor/supplier adds a level of risk that may be unacceptable for many.
The service contract will also require the lessor to bundle different components with the instalment portion and be able to remit portions of the payment to third parties. Lessors would have to determine if their current systems could support this additional administration and at what cost.
Although there has been substantial discussion over the past few years about how lessee and lessor accounting would be handled if these proposed changes are enacted, there has been very little discussion about how these changes might affect volume.
Lessors will need to take steps to ensure that they are prepared for the possible scenarios that could play out, and position themselves to turn this into a competitive advantage.
David Woodroffe is product director, asset finance at SunGard