We are all familiar with the current requirements for classifying leases as either finance leases or operating leases. Whilst leases are a major form of finance for many entities, the current accounting models have been criticised for the ‘off-balance’ sheet accounting of operating leases which can be quite similar in nature to their on-balance sheet counterpart, yet treated differently due the notional assignment of risks and benefits to the lessor in the arrangement. Conceptually, it is argued that the economic benefits controlled under an operating lease deserve to be recognised as assets (with accompanying liability) just as they are with a finance lease.

The new approach to lease accounting which advocates a ‘right-of-use’ model would see assets and liabilities arising under all forms of lease arrangement (other than the scoping out of biological and intangible assets, exploration leases, and some investment properties) recognised to the statement of financial position of the lessee.

The asset recognised in the statement of financial position would represent the entity’s ‘right of use’ of the asset and a liability would be recognised for the obligation to make lease payments to the lessor. Conversely, the lessor would recognise a receivable for rights to receive lease payments with a corresponding performance obligation liability. Alternatively, where substantial risks and benefits associated with the underlying asset have been transferred to the lessee, the asset is derecognised by the lessor but an asset representing the lessor’s right to the residual assets at the end of the lease term is recognised.

There is also a change in the method of determining the relevant lease term where it is proposed that it be ascertained based on an estimation of the probability of occurrence for each possible term, taking into account the effect of any options to extend or terminate the lease. Under the existing standard, options for renewal are only taken into account where, at inception of the lease, it is reasonably certain that the lessee will exercise the option.

The liability to be recognised by the lessee shall be determined as the present value of the lease payments payable during the lease term on the basis of expected outcome. In this regard, the calculation shall include an estimate of future contingent rentals payable, residual value guarantees and term option penalties. This represents a change from the existing standard where minimum lease payments excluded contingent rentals and residual guarantee payments unless reasonably certain.

These changes represents a substantial shift in the way that leases are accounted for and may have drastic impacts on the net asset structures of many entities that engage in substantial leasing activities. A final standard is anticipated by the second quarter of 2011.


Contact

Rob Mackay
T +61 3 8635 1800
rmackay@moorestephens.com.au

www.moorestephens.com.au