Leases. Principles for Financial Reporting, ASB - Essay Example

Executive Summery: Leases (GRAP 13) Off-balance sheet arrangement have long been the main concern of all accounting regulators and the economic consequences related to these items have prompted these regulators around the globe to think of developing standards that increases transparency in the financial reporting. Operating leases are known to be one of the off-balance sheet obligations; therefore, the placement of lease accounting continues to be one of the priorities for Financial Accounting Standard Board (FASB) and the International Accounting standards Board (IASB). During March 2009, these boards issued paper referred to as Leases: “preliminary view” which clearly outlined the proposal for new global lease accounting standards. The proposed standards would need the replacement of all operating leases with the capital leasing thus, triggering a shift of billions of dollars to the balance sheet across North America which was estimated that 70% of the total lease value would be capitalized if it involves commercial real estate. Then the end result of these change of the magnitude will be vast shift rippling through all financial reporting, the processes and merits across all us and global industries. Introduction: In the current UK accounting standard, it is important to understand that for any accounting purpose leases are generally classified as being either financial or operating standards: First, the word lease simply means an agreement between two parties involving a hiring of asset. The lesser is a legal owner who lets out the asset to the lessee and then at the end of the lease, the asset is returned to the lesser; The only thing that the lessee will do, is to continually pay a lease rental to the lesser for using the assert. Under the SSAP 21, the term financial lease is defined as any lease contract that transfers substantially all the risk as well as the reward of ownership to the lessee, There is a reputable presumption that if, at the inception, the total percent value of a minimum lease payment amounts to at least 90% or even more of the value of the leased asset (Patterson, R., 2002). In order to rebut this presumption, the preparers of financial statement might consider looking for other indications about the risks as well the rewards, though rebuttal is usually expected only to happen in exceptional circumstances. On the other than, operating lease, is that type of lease where risk and reward of ownership of the assets remain with the lesser concerns regarding off-balance sheet nature for operating lease, different treatment of similar transaction as well as the whole approach have lead to many standards-setting bodies to treat leases consistently. Accounting treatment for leases: Accounting treatment for operating lease: It is generally very easy and straight forward for both the lesser and the lessee. Under operating lease, the lessee is the one who incurs the operating expenses, thus, lease rental payable are written off in the profit and loss account (Alexander, D., Britton, A., & Jorissen, A., 2005). This must to be disclosed in the notes to the account showing the amount charged in the year as well as those of payment which the firm is committed at the end of each year. The leaser continues to earn revenue out of renting out the asset and accordingly recognizes the amount of lease rental receivable as an income in the profit and loss account. Accounting treatment of financial lease by the lessee: When any lessee enters into a financial lease, then it gets access to the risk and rewards of the asset and therefore, the lessee reflects the substance by recognizing all assets leased in separate accounts which is also consistent with the ASB’s statement of principle which defines recognition criteria of assets. Then the lessee capitalizes the present value of all the minimum lease payments as fixed assets and the amount is recorded as a liability (Bircher, P, 2006). The PV of minimum lease payments are equated to cash price and the asset is depreciated over its useful life. Accounting treatment of financial lease by the lesser: Lessons are normally banks or any similar lending institutions. Once they enter into financial leases, then they are in substance of making a loan which will attract interest. Other than having legal title to the asset, the lesser does not recognize this as assets in the balance sheet since it does not have control and access to future economic benefits over the asset. Summary Statement of Principles or an accounting standard-setter’s conceptual framework describes all the accounting models which it uses as some of the conceptual underpinning for its work. For instance, the statement typically describes the standard-setters view on the following issues; Activities which must be reported on the financial statements, the aspects of those activities which should be highlighted (Middleton, D., 2004), Attributes that information needs to have incase there is need for inclusion in the financial statement and how the information should be included in the F. stat. The main purpose of the statement is to give conceptual input into the ASB’s work on the review and development of accounting standards, thus, the statement is not an accounting standard nor even contain any requirements on how financial statement are supposed to be prepared. Some of the principle in the statement plays a fundamental role in the existing standards, such principles are; FRS 5 ‘Reporting the substance of transaction’ draws on the statement of principle the definition of assets and liabilities, where as the FRS 2 ‘Accounting for subsidiary undertaking’ which reflects the overall statement discussion of activities that have to be included in the firms financial statement and all activities that must be excluded. Finally, the FRS 3’Reporeting financial performance’ shows the views on presentation of information about the performance of the entity (Elliott, B, & J. Elliott, 2004). Therefore the statement of principle have a major purpose in the standard-setting process, even though it is the only one of the key factors that ASB takes into account whenever setting this standards. Besides it, there are other factors such as cost-benefits, legal requirements, industry-specification issues, implementation of issues and the desirability of change evolution. The ASB’s statement of principles one of the most controversial framework, Considering the past years when the ASB published a draft statement introducing one of unpopular approach which was totally irrelevant for the vast majority of organizations producing accounts according to Middleton’s point of view. Some of the criticisms are: insufficient emphasis on the true and fair value view, it over emphasizes on current value rather than historical values, defining and measuring assets and liabilities is one of the problem exhibited by ASB framework, Balance sheet focus and statement of recognized gain and losses (STRGL) vs. matching, P & L and realization. Downplaying of the prudence concept since it is closely related to matching and realization principles, since there were more shortfalls in the ASB draft statement, there was a greater need for amendment to be done so as to rely on them to eliminate all the criticisms. Therefore the international accounting standard board (IASB) amended accounting frameworks so as to show a true and fair view of the financial statement of the reporting entities. Conclusion: On 13th of November 2003, ASB issued requirements on the amount of revenue recognized in form of an Application note to the FRS 5’Reporting the substance of transaction’ the note ids so much concerned with reporting turnover-top line of the profit and loss account. Thus, entities should report turnover, if only when they have performed in liaison with the underlying contractual agreement with their customers. The guideline goes beyond to include the measurement of turnover where there is significant risk about the customer’s ability to pay the amount due. Later in the year 2004, the International Accounting standards Board and the US Financial standard board come to an agreement to combine their separate research in one joint project so as to develop new accounting standards which were to eliminate the criticism exhibited in the ASB draft statement. ASB fully supported this effort (Baxter. W, 1999), for example, the application note was intended as one of the interim step to replace the underlying criticisms on issues like Revenue recognition (IAS 18). At present the IASB has tentatively opted to retain the objective of disagreement and coherent which would likely result into much more information on the face of statement of performance in particular. This separation of activities would also flow into the balance sheet as well as cash flow statement therefore giving a fair as well as a true view of the financial position of an entity. Other propose amendments are, it was deemed necessary while accounting for finance lease to use of cash investment method as opposed to net investment method for the finance lease according to IAS 17. This would clearly give a more weight on the fair value accounting thereby eliminating the chances of criticism of insufficiency on accounting statements as well as the overall financial report generated. Recommendation; The main recommendation by the committee’s exposure draft is to account for leases by the right use model. Under the approach, the lease would record the right to use an asset and consider to record future payments as a liability. The lesser is entitled to record the right to receive lease payments and the liability to lease use of the asset. Recent board meeting IASB and FASB discussed contractual agreements that allow the lease to purchase the asset from the lessee. In such a case, it is expected that the lessees would record the purchase option, if only it is reasonable that the lease has economic incentive to actually purchase the asset. In summery, the new proposed standards will alter the way lease are presented in the financial statement. Reference: Accounting Standards Board, (1999) Introduction to the Statement of principles for financial Reporting, ASB, pdf file Accounting Standards Board, (2003) Statement of principles for financial reporting, ASB Alexander, D. Britton, A., & Jorissen, A., (2005). International Financial Reporting and Analysis, Thomson Baxter, W. (1999) The ASB on principles: Accountancy and reporting standards, New York: Kogan page publisher Bence, D. & Fry N. (2004). Which way forward: Journal of Accountancy and reporting, Volume 35, no.4 Bircher, P. (2006) Problems with the Accounting Standards Board’s draft Statement of Principles, Financial Reporting Today and Emerging Issues, Accountancy Books Davies, M, & P, Davies, (1999). The ASB has got it wrong, Accountancy standards Intermediate Statistics. London: Rutledge Elliott, B. & Elliott, J. (2004) Conceptual Framework, Journal of Financial Accounting Fearnley, S. (1996).Why the ASB has lost its bearings, Journal of Accountancy Middleton, D. (2004). The purpose of company accounts’ chapter 1 and ‘General acceptance’ Chapter 6, in Unshackling accountants, IEA Patterson, R. (2003). What it’s all about Accounting, The accountancymagazine.com, London: Rutledge Read More