Discover the world SEPTEMBER 13, International Accounting Standards Board First Floor 30 Cannon Street London, United Kingdom EC4M 6XH

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1 SEPTEMBER 13, 2013 International Accounting Standards Board First Floor 30 Cannon Street London, United Kingdom EC4M 6XH Re: Exposure Draft ED/2013/06 Leases Dear Board Members, The Liquor Control Board of Ontario ( LCBO ) is pleased to have the opportunity to comment on IASB s Revised Exposure Draft ( ED ) ED/2013/06 on leases. We also would like to thank the IASB for giving LCBO the opportunity to present at the IASB outreach working groups on the Leases exposure Drafts over the past few years in Toronto. Background on LCBO The LCBO is a $5 billion agency of the Ontario Provincial Government. We operate principally as a retail organization with well over 650 stores across Ontario, (approximately 400 are leased), specializing in the responsible retailing of beverage alcohol. We are also one of the world s largest single purchasers of beverage alcohol. We have been preparing our consolidated financial statements in accordance with IFRS/IAS since 2011 and therefore have a substantial interest in the standard setting process and how outcomes will develop. Overview of the Revised Exposure Draft on Leases As outlined in our response letter dated December 15 th, 2010 to the original 2010 Leases Exposure Draft (ED), we conceptually agree with the IASB s position that entities should apply a right of-use model to

2 account for leases. However, we have significant concerns over the practicality of applying the ED in its current form. Our main concerns are as follows: We believe it will be helpful to include further guidance on how to determine if a lease term is considered as a significant portion of the asset s economic life when classifying leases between Type A and Type B We are disappointed with the level of extensive disclosures which are required to be included in the notes of the financial statement, and we do not believe they will provide more meaningful information to users We disagree with the proposal to include lease renewal options within the measurement of right-of-use assets if there is a significant economic incentive for the lessee to extend the lease based on the assessment of contract, asset, market and entity factors. Overall, we support the proposals but in certain instances as outlined in the appendix to this letter, we believe more clarity is required in order to communicate the intentions of the IASB comprehensively. Our position is that the revised ED does not take into account the full costs of implementation and ongoing compliance. As a result, the achievement of the desired objectives may remain elusive. Should you have any questions or concerns please do not hesitate to contact either Nicola Wong, Accounting Policy Manager (nicola.wong@lcbo.com, phone ) or Carol Lyons, Controller (carol.lyons@lcbo.com, phone ). Thank you for allowing us the opportunity to respond to this proposal. Sincerely yours, Carol Lyons Controller, LCBO

3 Appendix Lease classification Under the revised ED, there are no bright lines to determine how a lease term is considered as significant / insignificant relative to the underlying asset s total economic life when classifying leases as Type A or Type B. The application would require significant judgment, we therefore believe that the revised ED does not provide a practical approach to measure the right-of-use assets and lease liability. This lack of clarity may result in undesirable diversity in the application of the guidance, which would diminish the comparability in financial reporting. We therefore request more guidance on how to determine significant portion of economic life. Furthermore, there is little conceptual merit behind segregating the population of leased assets between property and non-property, then Type A and Type B. We therefore request that the IASB clarify the rationale behind making such segregation. Lease term While we agree with non-cancelable period as the lease term, we do not agree with the definition of a lease term, which would include the non-cancelable period plus optional periods for which there is a significant economic incentive for the lessee to extend the lease based on the assessment of contract, asset, market and entity factors. We have considerable concerns with regards to the entity s ability to reliably estimate and measure the possible significant economic incentive for a lease to be extended. In practice, particularly in real estate transactions, lessees are not economically tied to renew an option at the end of a lease term, but have an option to exercise the right of first refusal. In most real estate transactions, lessees are given the choice, to exercise an option based on the market price and are not given any economic incentives by the lessors to exercise an option in the form of (1) a penalty to not renew or (2) a lessors incentive to renew. We propose that the lease term under the revised ED should be defined the same way the lease term is defined under the current IAS 17 standard, i.e., non-cancelable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the option. This will allow entities to better reflect the present obligation of the lease term and is much more practical for entities to determine. Overall, we do not believe that lease liabilities based on payments that may not occur based on management s

4 assumptions about the distant future should be included as a right-of-use asset or obligation on the balance sheet. Executory costs Under the current standard, IAS 17.4 explicitly excludes executory costs from the calculation of the minimum lease payments. The revised ED makes no explicit mention of excluding these costs, which may result in them being included in the initial measurement of the right-of-use asset and the corresponding liability. This is inconsistent with the definition of an asset under the Conceptual Framework as such costs are not resources controlled by the entity as a result of past events. We propose that minimum lease payments under the revised ED are defined the same way they are under the current IAS 17 standard, i.e., the payments over the lease term that the lessee is or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor. This will ensure the right-of-use asset and corresponding liability are recognized and measured in accordance with the definitions laid out in the Conceptual Framework. Reassessment of lease liability We conceptually agree that under the revised ED entities should be required to reassess the right-of-use assets and lease liabilities after inception of the lease. However, given that under the revised ED, entities will need to make significant assumptions in determining the lease term and discount rate, the reassessment process will prove to create significant practical and operational issues whereby entities will be required to incur significant costs to perform the reassessments, especially in cases where the lease payments include escalation clauses based on an index. We believe these costs will greatly outweigh any benefits, and could result in extreme variability and inconsistency from year to year. New Systems and processes/ Proposed effective date We currently lack a sophisticated system that could efficiently perform all the necessary calculations to comply with the revised ED. Most of the current lease arrangements are managed with Excel or Access based spreadsheets. As a result, we are concerned that entities will be required to incur significant costs to develop or purchase a specialized lease accounting software system. Our research shows that software programs available in the market designed to comply with the revised ED are very limited. Given these circumstances, it is unreasonable to tie the final Lease standard effective date to align with the proposed Revenue standard s effective date, January 1, We propose that the early adoption date should be at least 3 years after the final Lease standard is published, which, based on current information, would be later than This will allow preparers to have a more feasible timeline for

5 implementing new systems, training resources for ongoing maintenance of the new system, including defining new business processes and controls to comply with the Final leases standard. Data collection and ongoing data management We operate principally as a retail organization with hundreds of leased properties across Ontario. Under the revised ED, we will need to review hundreds of leases and require careful judgment in many key areas of evaluation introduced in the revised ED. We will need to compile and track many data elements to perform an analysis for each of our lease agreements, including: Non-cancellable term of the lease Renewal options Commencement date End date of non-cancelable term of the lease Expected end date of the lease Lease payments over the lease term and any incremental charges such as CPI Discount factor Non-lease components (CAM, property tax, etc) Contingent rent (If applicable) Leasehold improvements related to the lease and its expected useful life Any penalties associated with the lease Management intent to renew a lease term We are concerned about the fact that the costs, resources and complexities involved in complying with the revised ED will extend well beyond just the Accounting department, but also affecting Legal, Real Estate, Financial Planning & Analysis, IT and Retail.

6 Discount factor We conceptually agree that the discount rate should be reviewed from time to time if there is a change in the lease term, renewal option or significant economic incentives. However it would be very time consuming to determine the implicit rate of the lease or the property yield for each of the leases. Furthermore, because the LCBO does not hold any debt, there would be considerable difficulty in determining our incremental rate of borrowing. We therefore propose that the interest rates of high quality corporate bonds of similar duration comparing to the liabilities should be used as the discount factor. Financial Statement presentation/disclosure We have significant concerns that the revised ED could have considerable impact on key financial metrics such as SG&A expenses. The revised ED would result in a gross up of the balance sheet, which could cause measurable deterioration in return on assets compared to current accounting. Other operational and financial ratios may also be impacted. Based on our initial assessment of contract, asset, market and entity factors, we determined there are several properties for which there may be an economic incentive to exercise all possible renewal options. When including all possible renewal periods in the determination of these lease terms, we noted the calculated lease terms may reasonably be considered to exceed a major part of the remaining economic lives of their respective assets. We then sample tested 2 property leases under the Type A method, and discovered that the timing of expense recognition would accelerate and impact both SG&A and interest expenses. Rather than the current straight line basis and Type B method, entities would recognize an upfront amortization, as well as additional interest expenses. This could result in extreme variability and inconsistency from year to year. We do agree that the new disclosure requirements will provide greater transparency for financial reporting. However, we also believe that the costs outweigh the benefits for the users. Entities would be required to consume extensive resources in order to prepare for the disclosures in order to comply with the proposed requirements.