Key Features of Accounting Standard Board - Essay Example

?IAS 17 “Leases” Lease accounting is generally considered as the one which depends upon the agreements between the parties regarding the use of a particular asset. International Accounting Standard Board (IASB) has outlined the accounting treatment in case of leased assets for both the lessor and the lessee under International Accounting Standard 17 (IAS 17) “Leases”. This article mainly discusses three important elements regarding IAS 17 such that the first section describes the accounting treatment provided in the standard along with an illustrated example. Next section highlights the development of IAS 17 since its inception. Last section of this article critically examines the loopholes in the existing accounting standard followed by a conclusion which summarizes the article. Key Features of IAS 17 This accounting standard is quite comprehensive in its nature such that it encompasses different aspects of leases in a very detailed manner. This section briefly analyzes 1) Scope of IAS 17, 2) Classification of Leases, 3) Accounting by Lessor, 4) Accounting by Lessee, 5) Disclosure Requirements for Lessor and, 6) Disclosure Requirements for Lessee. 1. Scope of IAS 17 The applicability of IAS 17 rests with all the leased assets except the following assets: Natural regenerative resources including oil, gas and other minerals Licensing agreements in respect of videos, manuscript, copyrights, brands, films, games etc. Investment property valued on fair value basis by lessee under IAS 40 Investment property considered as operating lease by the lessor under IAS40 Biological assets considered as finance lease by the lessee under IAS 41 Biological assets considered as operating lease by the lessor under IAS 41 2. Classification of Lease Leases are generally classified into either finance lease or operating lease. The major distinguishing factor between a finance lease and an operating lease is the transfer of substantial risk and rewards even if the ownership is not transferred. It is important to note that the classification must be made before the commencement of the lease. The major criteria for the finance lease is as followed: At the expiry of the lease term, the ownership title is transferred to the lessee. At the inception of the lease the lessee has been provided the option to purchase the leased asset a price lower than the fair value of the asset, and there is likelihood that the option would probably be exercised by the lessee. Leased asset is provided to the lessee for a major part the useful life of the leased asset. The present value of the minimum lease payments (MLP) should be approximately equal to the fair value of the leased asset at the inception of the lease. The leased assets can be used by the lessee without any significant modification in the asset due to its specialized nature. 3. Accounting by the Lessor The following accounting treatment is provided under IAS 17 for the recognition of the leased assets by the lessor: There are three major recognition criteria should be used by the lessor in respect of accounting for lease. The criteria are highlighted as under: Finance lease should be recorded by the lessor in the balance as a receivable. The amount of the receivable should be approximately equal to the net investment made in the lease by the lessor. For finance lease, the income earned from the leased asset by the lessor should be presented as a constant rate of return of the outstanding amount of the lease by lessor. For the case of operating lease, those leased assets should be recognized in the balance sheet according to the nature of the leased asset. The income earned in respect of the operating lease should be recognized on straight line basis over the lease term of the leased asset or on the basis of any other suitable and systematic criteria. 4. Accounting by the Lessee The following accounting treatment is provided under IAS 17 for the recognition of the leased assets by the lessor: In respect of the finance lease, the lessee is obligated to recognize a leased asset as an asset as well as a liability in the balance sheet. The amount of the lease should be lower of MLP and fair value of the asset. Finance lease payments should be apportioned in terms of finance charge and the amount liability that outstanding. Depreciation should be recognized on the leased asset under the consistent policy of the company in respect of owned assets. For operating lease, the lessee is required to expense out the lease payments over straight line basis or on the basis of any other suitable and systematic criteria. 5. Disclosure Requirements for Lessor The following list encompasses the disclosures to be made by the lessor in respect of both finance and operating lease whichever is applicable: Reconciliation of the present value of MLP and the Gross Investment in the Lease The presentation of Gross Investment in Lease and receivables in respect of present value of MLP for next year year 2 till 5 in combination more than 5 years Finance Income (Unearned) Unguaranteed Residual Value (UGRV) Allowance for doubtful MLP receivables Description of important lease arrangement 6. Disclosure Requirements for Lessee The following list encompasses the disclosures to be made by the lessee in respect of both finance and operating lease whichever is applicable: Reconciliation of the total MLP and its corresponding present value The presentation of total MLP and its corresponding present value for: next year year 2 till 5 in combination more than 5 years Contingent Rent should be disclosed as an expense Description of important lease arrangement Future minimum sublease income in totality 7. Illustrative Example of IAS 17 The following excerpts are taken from the financial statements of British Airways which is lessee of some of the leased assets. Here are the two tables which encompasses the liabilities recognized and disclosed by British Airways. Group   Company ? million 2010 2009   2010 2009 a  Current Bank and other loans* 139 69 126 57 Finance leases** 129 103 140 115 Hire purchase arrangements 288 517   288 517 At 31 March 556 689   554 689 b  Non-current Bank and other loans* 1,345 779 1,062 582 Finance leases** 2,077 1,979 2,246 2,156 Hire purchase arrangements 24 316 24 316 Loans from subsidiaries       366 279 At 31 March 3,446 3,074   3,698 3,333   Group   Company ? million 2010 2009   2010 2009 Future minimum payments due: Within one year 468 687 489 707 After more than one year but within five years 909 1,163 1,002 1,252 In five years or more 1,618 1,672   1,732 1,811 2,995 3,522 3,223 3,770 Less: Finance charges 477 607   525 666 Present value of minimum lease payments 2,518 2,915   2,698 3,104 The present value of minimum lease payments is analysed as follows: Within one year 417 620 428 632 After more than one year but within five years 27 926 15 981 In five years or more 2,074 1,369   2,255 1,491 At 31 March 2,518 2,915   2,698 3,104 Rationale and Development of Existing IAS 17 Historically, there was a great dilemma found among the accountants as to what should be the appropriate way of accounting for leases as many questions came in front regarding the adequate treatment of leases. The accountants were indifferent as to whether they should present the leased asset as a receivable or as per its nature in the balance sheet of the lessor. Similar confusions were raised for the treatment leased asset in the financial statements of lessee whether lessee should show it as its assets or not. These are the different sorts of issues that were raised by the accountants before almost 30 years. In 1980, an Exposure Draft was issued by IASB named as “Exposure Draft E19, Accounting for Leasing”. In late 1982, IAS 17 was then issued by IASB giving more considerations to some issues that were not considered earlier in exposure draft. After 10 years, the reformatted version of IAS 17 of 1982 was presented by IASB. The existing IAS “Leases” was issued in 1997 repealing the old standard. The existing IAS 17 has been revised twice by IASB in 2003 and then in 2009. Criticism on IAS 17 Critics present their opinion in respect of IAS 17 as there are many areas which have been either ignored or left upon the users as per their own judgement. The reason given by the IASB for that matter is that they want companies to use their own professional judgement in dealing with the leased assets as they are better aware of the leased arrangements. If IASB provides more rigorous criteria for leased assets, then it would make the standard more rigid to be adopted by the companies and the chances of their departure from the standard might be increased. However, still there are too many deficiencies which are highlighted below: The existing IAS provides a very simple treatment in case of operating lease such that it is not allowed to represent the leased asset under operating lease as part of the assets of the lessee’s balance sheet. However, in reality it is observed that the lessees keep using the leased asset even for a large period of time such that they use the major part of the economic life of the asset, however, they do not recognize it as their asset under the existing standard. The criteria for finance lease have some loopholes such that the standard has not provided exact cut off points. For instance, the criteria describe that that “major” part of the economic life of the asset should be used by lessee. Question arises as what exactly is the “major” part, is it 3 years? 5 years? 10 years? or even more than that? The standard remains silent on this point. Another pitfall that can be realized in the same criteria for the finance lease is of the approximation of present value of MLP and the fair value of the leased asset. Here firstly, it is quite difficult to identify the fair value of the leased asset, not even that, present value of MLP is also subject to assumption. Therefore, both of these fair values and present value of MLP seems to be subjective in nature and their equal approximation is yet another assumption based criteria. References Deloitte, 2012, Summaries of International Financial Reporting Standards, IAS17 Leases, [Online] Available at :< http://www.iasplus.com/en/standards/standard15> [Accessed on 15th April 2012]. International Accounting Standards Board, 2008, International Financial Reporting Standards (IFRSs®) 2008: Including International Accounting Standards (IASs®) and Interpretations as approved at 1 January 2008, “The consolidated text of International Financial Reporting Standards as approved on 1 January 2008”. London, International Accounting Standards Board. KPMG, 2012, The Future of Lease Accounting, [Online] Available from:[Accessed on 15th April 2012]. British Airways, 2010, 2009/10 Annual Report and Accounts, [Online] Available from:[Accessed on 15th April 2012]. Thomson One Banker database, 2012, [Online] Available from:[Accessed on 15th April 2012]. Read More