The IASB has released a discussion paper with the preliminary views of the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) on a new accounting model for lessees. It has been a few years since a number of accounting standard setting bodies challenged conventional accounting in this area with concerns that the current method of accounting for leases provides the opportunity to structure certain financing arrangements in order to achieve a particular classification. The discussion paper proposes some radical changes that will result in all leases being accounted for in a similar manner to how we currently account for finance leases. The main impacts include the following: 

• All rights and obligations arising under lease contracts will be recognised at fair value on the statement of financial position of lessees and the distinction between finance and operating leases will be removed;
• Management will be required to make judgments about variables within lease arrangements, such as most likely term of the lease and expected payments to be made over the lease term, including items such as contingent rentals and residual value guarantees;
• The lease obligation will need to be re-measured in subsequent reporting periods if there is a change in the lease assumptions outlined above;
• Future operating lease commitments are purely a disclosure requirement currently and the new proposals could have an impact on the metrics used to evaluate the performance of a business such as net debt and EBITDA;
• The discussion paper does not provide any exclusion for non-core assets or short-term leases and although such items may not prove to have a material impact it will require calculations to be prepared and considered by your auditors.

The boards have not yet discussed how this new approach will be implemented on initial adoption or the effective date, and therefore the effect on existing lease arrangements is unknown.

QCA representatives recently met with members of the IASB to discuss the changes and highlight the additional cost to preparers that these changes could evoke. There has been a considerable amount of interest in this discussion paper, as it will have a significant impact across a broad range of sectors and industries.

The discussion paper is open for comment until 17 July 2009 with a final standard expected in 2011, and companies should familiarise themselves now with how the proposed model could impact them. To find out more about this, please visit the IASB’s Leases project webpage at: www.iasb.org/Current+Projects/IASB +Projects/Leases/Leases.htm

Sarah Cox is an Assistant Director of Financial Reporting Advisory at Ernst & Young LLP and member of the QCA’s Accounting Standards Committee. The views expressed in this article are her own and do not necessarily represent the views of Ernst & Young LLP.