Problems Arising from International Accounting Standard17 Leases - Essay Example

Leasing is a debt financing approach used by companies across various sectors of the economy (IFRS Foundation, 2013c). It refers to an arrangement whereby the lessor delivers the right to use an asset for a prescribed period in exchange for a payment or series of payments. In a globalized economy leasing activities are increasing in magnitude as businesses strive to improve competitiveness through cost reduction and improved quality of products and services (IFRS Foundation, 2013a). Therefore, changes in accounting standards for leasing will influence the overall preparation of financial statements.

Leasing is of great significance to the business entities. “It is a means of gaining access to assets, obtaining finance, and of reducing an entity’s exposure to the risk of asset ownership” (IFRS Foundation, 2013a, p.5). Initially, the prevailing accounting model for leases required the lessors and lessees to recognize and categorize leases either as finance leases or operating lease. Also, it required them to maintain a separate account for leases. The financing lease used to finance equipment for most of its useful life and lessee would take ownership of the equipment after the lease period.

On the other hand, operating lease financed equipment for a period less than its useful life and lessee returned the leased equipment to the lessor without any obligation of transfer of ownership. However, the model failed to fulfill the needs of users because it did not recognize assets and liabilities relating to operating leases. This led to the adoption of IAS 117 Leases (IFRS Foundation, 2013a).The application of IAS 17, Leases requires the lessee to establish items and maintain track of all right-to-use assets.

It requires comprehensive sub-ledgers and creates the need for the establishment of discrete “property, plant and equipment sub-ledgers for the right-to-use assets” (IFRS Foundation, 2013a, p. 5). In addition, the lessee has to establish a scheme to ascertain each lease as a component of the right-to-use asset category. However, the International Accounting Standards 17 (IAS 17), leases do not distinguish between operating and financing leases. It classifies all leases under the conception of “right-to-use asset” which denotes the capability to use realized assets over the lease duration (IFRS Foundation, 2013c).

The approach will have an effect on both lessor and lessee. The use of IAS 17 will incorporate property, plant, and equipment with bank loans and right-to-use assets. Consequently, the increase in property, plant, and equipment will affect the calculation of return-on-asset and other ratios such as income statement ratio and debt ratios (IFRS Foundation, 2013b). Considering leasing is worldwide business the differences in accounting standards can result in substantial issues of non-comparability of entities.

Furthermore, it is a complex model hence difficult to implement.