European Association of Co-operative Banks Groupement Européen des Banques Coopératives Europäische Vereinigung der Genossenschaftsbanken

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1 European Association of Co-operative Banks Groupement Européen des Banques Coopératives Europäische Vereinigung der Genossenschaftsbanken Mr Hans Hoogervorst, Chairman International Accounting Standards Board 30, Cannon Street London EC4M 6XH United Kingdom Brussels, 10 September 2013 ED/2013/6 - Leases Dear Mr Hoogervorst, the members of the EACB are pleased to comment on certain aspects of the Exposure Draft Leases and thank you for the possibility to express our concern. We welcome the IASB s work on leases. However, in our opinion, the right of use model is unworkable in practice. We therefore suggest that the IASB that maintains IAS17 (risks and rewards approach) with improved disclosures that will allow users of accounts the flexibility they need to assess lessee accounts depending on their different needs. The new proposals do not provide for better quality information than today s accounting. It is unlikely that users will find lessee accounts more transparent under the new proposals. However, we are concerned about the costs and complexity associated with the new proposals compared to today where the accounting for leases is simple. We do not agree with the IASB s assessment that benefits of the proposals would outweigh the costs. Indeed, the requirements of the Exposure Draft will certainly need strong accounting systems and reporting processes developments in order to collect and calculate the information required to comply with the proposed model specially for the lessee. It should be noted that the costs will likely be proportionality greater for entities having a large number of leases of low value. On the other hand we believe that lease contracts are accounted appropriately under the current standard. Moreover, the new treatment of leases would seriously affect the calculation of prudential ratios (as it will increase capital requirements), as a result of an accounting, but not an economic, change. This aspect is also important for the calculation of the leverage ratio. While this is a point that needs to be addressed to the Basel Committee, it seems appropriate for the Boards to consider regulatory implications in their cost/benefit and impact analyses. The voice of local and retail banks, 50 million members, 160 million customers EACB AISBL Secretariat Rue de l Industrie B-1040 Brussels Tel: (+32 2) Fax (+32 2) Enterprise lobbying register secretariat@eurocoopbanks.coop

2 Our detailed comments are provided in the annex to this letter. We hope you find these comments useful and would be pleased to provide any further information you may require. Yours sincerely, Hervé Guider General Manager Volker Heegemann Head of Legal Department 2

3 Question 1 identifying a lease This revised Exposure Draft defines a lease as a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. An entity would determine whether a contract contains a lease by assessing whether : (a) fulfilment of the contract depends on the use of an identified asset; and (b) the contract conveys the right to control the use of the identified asset for a period of time in exchange for consideration. A contract conveys the right to control the use of an asset if the customer has the ability to direct the use and receive the benefits from use of the identified asset. Do you agree with the definition of a lease and the proposed requirements in paragraphs 6 19 for how an entity would determine whether a contract contains a lease? Why or why not? If not, how would you define a lease? Please supply specific fact patterns, if any, to which you think the proposed definition of a lease is difficult to apply or leads to a conclusion that does not reflect the economics of the transaction. We believe that there should be no difference in the scope of leases between the current IAS 17 and ED standard for our business. We think that both a lessee and a lessor should separate each lease component from non-lease components of a contract. We consider that the proposal presented in the Exposure Draft could be a solution to allocate agreement consideration. Nevertheless, we fear that this distinction between service contracts and lease contracts will have an important negative impact for lessees managing a large number of small-value contracts which will have to face important additional costs and complexity. The simplified method for short term leases does not seem to provide a real simplification because lease contracts which meet the 12-month requirements defined in this Exposure Draft are rare because of including the maximum possible lease term in the assessment of the contract maturity. Question 2: lessee accounting Do you agree that the recognition, measurement and presentation of expenses and cash flows arising from a lease should differ for different leases, depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset? Why or why not? If not, what alternative approach would you propose and why? The right-of-use model presumes that all leases consist in the financing of the purchase of an asset but this is untrue because in many cases the lessee look for the simple use of the asset (for instance for vehicles). Vehicle leases are currently classified as operating leases and according to the ED they will be classified as Type A. The operational impact will be significant. However, the goal of the client is not to finance the acquisition of a car but is to use the vehicle over a period of 3 to 4 years and the lessor will retrieve the vehicle at the end of the contract and sell it. We believe that the classification of contracts should not depend on the nature of the property but the objective of companies (lessees and lessors). 3

4 The lessee and the lessor accounting models are not symmetrical. Under the model Type B leases, the lessee would recognise a financial liability for its obligation to make lease payments but the lessor would not recognise a corresponding financial asset for its right to receive lease payments. According to the project, a Type B contract is accounted for as a right of use in the assets of the lessee but also in the assets of the lessor eg twice a time. In the proposed approach, the amortisation in each period is a balancing figure to achieve a straight-line expense in profit and loss, as it is determined as the difference between the periodic lease cost and the periodic unwinding of the discount on the lease liability. The subsequent measurement of the right-of-use asset is not consistent with other non-financial assets measured on a cost basis. Furthermore the presentation of a straight line expense is in a single line (operating expense) in the profit and loss statement. This method corresponds to the impact of operating lease in the profit and loss statement. The determination of the amortisation as a difference is overly complex. For leases that are currently not on the balance sheet, the requirement to test right-ofuse assets for impairment could accelerate expense recognition (if an impairment occurs with IAS 36). The accounting treatment of Type B leads to account for a liability. We criticize that the lessee would recognise a lease liability but no interest cost on the liability would be presented distorting the lessee financial ratios. Now in addition to what are a lessee s finance leases also for operating leases there assets will be accounted for. This results in an increase of debt and that creates volatility in the balance sheet or the income in accordance with subsequent remeasurements required by the ED. Also reassessments requires more judgements at the end of each reporting period. We consider that we would bear major costs to implement the proposed model, for each new contract (collecting more information in order to compute the right of use and the lease liability and judgments for a new contract), for the requirements of reassessment (at least at the end of the reporting period and at any time if there is a change in the lease term or in the factors used to determine whether the lessee has a significant economic incentive to exercise an option to purchase the asset or to renew the lease) and for the portfolio of leases at the date of transition. While the concept of capitalising all contracts that fall under the definition of a lease has been retained, the change is that most property lessees (Type B leases) would recognise a straight line lease expense in their P&Ls, whereas most equipment and vehicles lessees (Type A leases) would have a front loaded P&L, as set out in the initial ED. This change comes as a concession to property lessees, since their leases are not financial transactions. The fact that they still have to be capitalised on the balance sheet seems however to be contradictory with this approach. Question 3: lessor accounting Do you agree that a lessor should apply a different accounting approach to different leases, depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset? Why or why not? If not, what alternative approach would you propose and why? The implementation of Type A contract is both expensive and complex for the determination of residual asset or the accounting for initial benefit when fair value is different from book value at the inception of the contract. 4

5 In the first place we do not understand why objects (residual assets) carry any interest at all. At lease inception, the gross residual asset should be measured as the present value of the amount the lessor expects to derive from the underlying asset following the end of the lease term, discounted using the rate the lessor charges the lessee (for example the rate implicit in the lease). This requirement involves judgements and we are concerned that these judgements would be based on very long term assessments. If the contract contains a call for a minor residual value at the end of contractual time, our understanding is that it will be accounted for at this value. The main impacts of the ED shall be for contracts with significant residual value. The reassessment of the lease receivable entails volatility over balance sheet and income depending on the type of the factor. The reassessment requires to take into account one s own judgment to estimate the circumstances and the factors at each reporting period or at any time if there is a change in the lease term for instance. Question 4: classification of leases Do you agree that the principle on the lessee s expected consumption of the economic benefits embedded in the underlying asset should be applied using the requirements set out in paragraphs 28 34, which differ depending on whether the underlying asset is property? Why or why not? If not, what alternative approach would you propose and why? We believe that the accounting of leases should adequately reflect the difference in economic substance of the leases. Therefore, we consider that an operating lease and a financial lease are not similar transactions and thus have to be accounted for differently as stated in the current standard IAS 17. We do not believe that the classification proposed by the IASB (Type A and B) corresponds to the preparers business model. We do not agree with the distinction based on the nature of the underlying asset. This distinction is not a principle. The property lease is currently accounted for a finance lease but can be classified as a Type B contract according to the ED. However, paragraph 31 states that "the lease is classified as a type A if a lessee has significant economic incentive to exercise an option to purchase the underlying Asset". It follows that it will eventually classified as Type A. This complexity in the decision tree leads to conclude that classification should not depend on the nature of the property. We agree to classify leases in two categories but not the categories named Type A or Type B leases. We are in favour of maintaining criteria defined in the current standard IAS 17 to classify leases, criteria based on the risks and rewards principle. The current distinction between finance leases and operating leases has the merit of being well established and well understood. Many leases of assets other than property (cars and office equipment) considered operating leases today would likely be classified as Type A leases under the proposal. Classification as a Type A lease would result in accelerated expense recognition. We do not agree to limit the use of Type B contract for qualified property assets. For instance transport equipment should in principle be integrated into this category B as the lessee pays for the use of the asset and is not intended to gradually acquire the asset. - We observe that the definition of Type A or B categories is based on non-symmetrical criteria and using the judgment of each one. Moreover, depending on whether the underlying asset is property or not, the way the criteria are formulated differs ( major 5

6 part / substantially all for property versus more than insignificant for other assets) with no conceptual justification. We note that, for property, the criterion to retain is the remaining economic life of the asset whereas for other assets this is the total economic life of the asset with no conceptual or pragmatic justification. Therefore, evaluating whether a non-property lease meets either of the criteria for the exception would likely be subjective and require careful judgement. This may lead to bright line tests or uncertainties and this may impede comparability. Comparing the lease term of leases of assets other than property to the total economic life of the underlying asset (and not the remaining economic life) may result in leases of certain older non-property assets being classified as Type B leases. We prefer the remaining economic life as a reference. By treating equipment and property leases differently, the Boards have re-introduced classification into the new standard. This is difficult to reconcile with the premises of the right of use model which implies that all leases should be treated in the same way. We suggest that A significant issue for banks as either lessee or lessor is that if a sale and leaseback transaction is not treated as a sale but as a financing transaction, then it would be accounted for in accordance with the financial standards : a liability for the lessee (options treated as embedded derivatives) and a receivable for the lessor (measured at cost or more likely at fair value in IFRS 9) with variability in P/L account. Because lessees would recognise all leases on the balance sheet (except for certain short-term leases), sale and leaseback transactions would no longer be a source of offbalance sheet financing and the consequence is that this business will no longer occur. Question 5: lease term Do you agree with the proposals on lease term, including the reassessment of the lease term if there is a change in relevant factors? Why or why not? If not, how do you propose that a lessee and a lessor should determine the lease term and why? We agree with the proposals on the lease term (see paragraph 25). The new proposal to determine the lease term as the non-cancellable period of the lease is much better than estimating the probability of occurrence for each possible term (see the previous exposure draft). We believe the threshold of significant economic incentive to be similar to reasonably certain under current IAS 17. We recommend maintaining the current concept of 'reasonably certain' which is familiar to all stakeholders. The consequence is the importance of judgment in the assessment of the lease term for the lessee. We suggest to add some clarifications for leases with automatic renewal how they can benefit from the simplified method for short term leases. Question 6: variable lease payments Do you agree with the proposals on the measurement of variable lease payments, including reassessment if there is a change in an index or a rate used to determine lease payments? Why or why not? If not, how do you propose that a lessee and a lessor should account for variable lease payments and why? 6

7 We are concerned about the concept in-substance fixed payments. This concept is not defined and there is no principle provided to identify these payments in the Exposure- Draft or in the basis of conclusions ( 153). We consider that the principle should be conceptually (not only by Illustrative Examples) defined, and we do not believe that is currently the case. The ED indicates that in the initial measurement of the residual asset, the present value of expected variable lease payments is included when those payments are reflected in determining the rate that the lessor charges the lessee. This requirement is quite complex. Question 7: transition Paragraphs C2 C22 state that a lessee and a lessor would recognise and measure leases at the beginning of the earliest period presented using either a modified retrospective approach or a full retrospective approach. Do you agree with those proposals? Why or why not? If not, what transition requirements do you propose and why? Are there any additional transition issues the boards should consider? If yes, what are they and why? The cost of the transition is important for contracts classified currently as operating leases in lessee s accounts. We believe that the ED has an impact on every payment plan and amortization schedule for existing lease contracts. In addition, payment plans and amortization schedules for RoUs and corresponding liabilities have to be created. Out of this reason we believe the board should also consider the grandfathering for all existing lease contracts terminated before the end of the period in which the new standard is applied for the first-time. We suggest a simplified retrospective treatment for type B contracts for which no impact on equity is to be recorded for the change in accounting method. For the lessor, the cost of implementation focuses on the change of operating lease contracts to the Type A contracts with the accounting of a lease receivable and residual asset. The cost can also be reduced with a simplified method to only account for the residual assets for new contracts. An entity should not be required to apply the requirements described in the Exposure Draft, if the lease term has ended before the end of the period in which the new standard is applied for the first-time. For finance leases existing at the date of initial application, lessees and lessors would be permitted to use the existing carrying amounts of lease-related assets and liabilities as the initial measurements under the proposal. We consider that the date of application depends on Revenue recognition and at least two complete years between the expected publication and the effective date of application is needed for implementing the new Leases standard. Question 8: disclosure Paragraphs and set out the disclosure requirements for a lessee and a lessor. Those proposals include maturity analyses of undiscounted lease payments reconciliations of amounts recognised in the statement of financial position; and narrative disclosures about leases (including information about variable lease payments and 7

8 options). Do you agree with those proposals? Why or why not? If not, what changes do you propose and why? We criticize the expansion of disclosure requirements for lessees and lessors. We believe that the balancing of right-of-use-assets should provide sufficient information. If this is not the case we suggest that in the first place the proposals should be changed until higher transparency is reached. We suggest that the list of disclosure requirements (paragraphs and paragraphs ) should be presented as a suggestion of items that preparers have to disclose if they judge that information could be relevant or material for the users. We do not agree with the proposed quantitative disclosures for separate reconciliations of the opening and closing balances of Type A and Type B right-of-use assets by asset class and lease liabilities. It would be less costly to have a global information. We are not in favour of giving a maturity analysis of the lease liability balance at the reporting date for all contracts (cost of obtaining information). Question 12: changes to IAS 40 The IASB is proposing amendments to other IFRSs as a result of the proposals in this revised Exposure Draft, including amendments to IAS 40 Investment Property. The amendments to IAS 40 propose that a right-of-use asset arising from a lease of property would be within the scope of IAS 40 if the leased property meets the definition of investment property. This would represent a change from the current scope of IAS 40, which permits, but does not require, property held under an operating lease to be accounted for as investment property using the fair value model in IAS 40 if it meets the definition of investment property. Do you agree that a right-of-use asset should be within the scope of IAS 40 if the leased property meets the definition of investment property? If not, what alternative would you propose and why? The subsequent changes to IAS 40 will lead to lots of additional effort for the preparers that from our point of view is not justified. Under the draft the existing election for entities that hold investment property under operating leases is to elect on a property-by-property basis whether to recognize those interests as investment property would be replaced by a requirement to classify all such interests as investment property. This will require the entity to measure the property interest at fair value, either for the financial statements or disclosure in accordance with the general requirements of IAS 40. We question the value of the information disclosed for property that is not owned by the reporting entity. We favour a leasing specific election within IAS 40 for leased property that is leased out. It should allow valuation of the ROU either at cost or at fair value and should abstain from disclosing the fair value in the notes. Additional comment on the classification of right of use (ROU) assets in the financial statements and the impact on regulatory capital: The accounting description and characterization of the lessee s ROU assets and the lessors residual value assets in the ED is unclear. Treatment of leases as intangible 8

9 assets would greatly affect the calculation of risk-weighted assets, with regulatory deduction from capital; such an effect would be unwarranted as a result of an accounting, but not an economic, change. This issue is important not just for the basic Basel III capital determination, but also for purposes of the leverage ratio. Recognition on the balance sheet would lead to an increase of the denominator in the leverage ratio calculation that would be inappropriate on anything other than a net basis. A substantial distortion of the leverage ratio could push the leverage ratio from a backstop measure to a binding capital constraint for affected firms. While this is a point that needs to be addressed to the Basel Committee, it is appropriate for the Boards to consider regulatory implications in their cost/benefit and impact analyses