Comment Letter on Discussion Paper (DP) Preliminary Views on Leases

Verband der Industrie- und Dienstleistungskonzerne in der Schweiz Fédération des groupes industriels et de services en Suisse Federation of Industrial and Service Groups in Switzerland 16 July 2009 International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom Comment Letter on Discussion Paper (DP) Preliminary Views on Leases Dear Madam, dear Sir SwissHoldings, the Swiss Federation of Industrial and Services Groups in Switzerland, represents 49 Swiss groups, including most of the country s major industrial and commercial firms. We very much welcome the opportunity to comment on the above-mentioned Discussion Paper (DP). Our response below has been prepared in conjunction with our member companies. We outline some general comments below and answer the specific questions of the DP in the annexe. General Comments We welcome the publication of the DP on leasing and the work of the Boards to try to address the issues of lease accounting. We also agree that the current distinction between finance and operating leases lacks conceptual justification and is not always easy to apply but we consider that a new approach should not result in more complication for the preparers. As it stands, we have concerns about certain proposals of the DP. Despite what the Boards consider, we believe that it would be worthwhile to delay the project in order to tackle lessor accounting. We consider that this would avoid creating inconsistencies by capitalising all leases in the books of the lessees and to leave the distinction between operating and finance leases in those of lessors. With all leases being capitalised, IFRIC 4 on Determining whether an Arrangement contains a Lease will gain in importance. This interpretation should therefore be incorporated in the future standard on leasing and it should be made crystal clear that straight executory contracts should not be capitalised. While we agree with the removal of the distinction between operating and finance leases, we consider that short term rentals are more akin to executory contracts because of the reduced duration of access to the economic benefits embodied in these contracts. Finally we do not understand why the Boards have decided to require the lessees to reassess the incremental borrowing rate. As long as the lessor does not change the amount of the leasing annuities, we see no justification for a reassessment of the borrowing rate. This contradicts the measurement of financial liabilities in accordance with IAS 39. For the rest, we generally agree with the proposals of the discussion paper but, in the case of contingent rentals, we would favour the FASB proposals of the most likely rentals scenario. We consider that the IASB proposal based on probabilities would result in recognising an obligation for rentals that will never be paid. Postfach 402, 3000 Bern 7 Nägeligasse 13, 3011 Bern Tel. +41 (0)31 356 68 68 Fax +41 (0)31 352 32 55 sh@swissholdings.ch www.swissholdings.ch

SwissHoldings 2 We thank you for the opportunity to contribute to the due process and for taking into consideration our comments. Yours sincerely, SwissHoldings Federation of Industrial and Service Groups in Switzerland Dr. Gottlieb A. Keller Current Chair of SwissHoldings, (General Counsel Roche Holding AG) Dr. Peter Baumgartner Chair Executive Committee Annexe

SwissHoldings 3 Specific questions in invitation to comment Chapter 2: Scope of lease accounting standard Question 1 The Boards tentatively decided to base the scope of the proposed new lease accounting standard on the scope of the existing lease accounting standards. Do you agree with this proposed approach? If you disagree with the proposed approach, please describe how you would define the scope of the proposed new standard. We would agree in principle that the scope of the proposed new lease accounting standard be based on existing standards but we have reservations concerning the following points. First, we disagree that the scope be restricted to lessee accounting. Several entities are both lessors and lessees of equipment or use internal leases that should be eliminated on consolidation. Different treatments would thus create an imbalance in the accounts of these entities and would impair a fair presentation of their overall leasing transactions. Nevertheless we are pleased that the Boards have discussed some lessor issues in chapter 10 and we hope that the answers received from their constituents will help the Boards to issue lessor accounting requirements that are consistent with those of the lessee. Second, 2.10 (b) states that IFRIC 4 is "in most situations clear whether a lease contract is within the scope of existing standards". Since our member companies have gone through several cases of IFRIC 4 application, we consider that this interpretation will become more important as it may trigger the capitalisation of supply or service contracts as leases if they qualify under the interpretation, whereas, with the current IAS 17, the lease contracts are very frequently operating leases. We therefore recommend that the IASB maintains IFRIC 4 and incorporates it into the future standard on leasing in order to clearly distinguish between straight executory contracts and lease agreements. Additional clarification should be given on leases of intangible assets. The proposals could have a significant impact on pharmaceutical companies if the scope was extended to the right to use intellectual property, though the DP does not discuss this issue. Question 2 Should the proposed new standard exclude non-core asset leases or short-term leases? Please explain why. Please explain how you would define those leases to be excluded from the scope of the proposed new standard. We do not consider that the proposed lease standard should exclude non-core leases. As stated in 2.17 defining non-core leases may be difficult. Certain entities would consider non-core leases as those which are individually immaterial and which are not part of the production and distribution activities of an entity. We have difficulties in following this reasoning because even those so-called non core assets are part of the business processes of an entity and we consequently see no justification of scoping them out of a future leasing standard. In contrast, we consider that while the capitalisation should apply by default to all leases, rental agreements which are cancellable by both the lessor and the lessee with a short term notice

SwissHoldings 4 never exceeding one year should be scoped out. Even if these contracts also embody a right to use, their short term nature makes them more akin to an executory contract. Chapter 3: Approach to lessee accounting Question 3 Do you agree with the Boards analysis of the rights and obligations, and assets and liabilities arising in a simple lease contract? If you disagree, please explain why. We agree with the way the Boards have applied their asset and liability definitions to lease contracts. Question 4 The Boards tentatively decided to adopt an approach to lessee accounting that would require the lessee to recognise: (a) an asset representing its right to use the leased item for the lease term (the right of-use asset) b) a liability for its obligation to pay rentals. Appendix C describes some possible accounting approaches that were rejected by the Boards. Do you support the proposed approach? If you support an alternative approach, please describe the approach and explain why you support it. We support the right-of-use model applied by the Boards and we consider that it reflects the economics of the leasing transactions because the lessor enjoys the benefits of an asset and incurs an obligation to pay the lease payments during the term of the agreement. We do not agree with the whole asset approach explained in C2 ss. because, while lease agreements confer only the rights to use an asset during a specified period, the whole asset approach would result in inflating the entities' balance sheets with assets and liabilities that do not reflect resources and obligations that pertain to the lessees. Instead of creating comparability as the proponents of the approach assert, this would create confusion between leased and owned assets and their related liabilities. We also disagree with the executory contract approach explained in C6 ss because it contradicts the asset and liability definition of the Framework. Question 5 The Boards tentatively decided not to adopt a components approach to lease contracts. Instead, the Boards tentatively decided to adopt an approach whereby the lessee recognises: (a) (b) a single right-of-use asset that includes rights acquired under options a single obligation to pay rentals that includes obligations arising under contingent rental arrangements and residual value guarantees. Do you support this proposed approach? If not, why?

SwissHoldings 5 We agree with the Boards tentative decisions not to adopt a components approach to lease contracts because such an approach would create complexity for the preparers in separately measuring the rights and obligations conferred by the various options contained in leasing agreements as specified in 3.32 (a). We also agree that an obligation to return a leased asset at the end of a lease contract is not a liability as stated in 3.22 ss. but we do not agree with the last sentence of 3.23 that the lessee is holding an asset on behalf of the lessor. Instead we consider that the lessee is using the asset by virtue of the rights conferred by the lessor. Chapter 4: Initial measurement Question 6 Do you agree with the Boards tentative decision to measure the lessee s obligation to pay rentals at the present value of the lease payments discounted using the lessee s incremental borrowing rate? If you disagree, please explain why and describe how you would initially measure the lessee s obligation to pay rentals. We agree and consider that the use of the lessee's incremental borrowing rate to discount the lease payments when measuring the lessee's obligation is a pragmatic method that adequately depicts its obligation to pay the future lease payments. Question 7 Do you agree with the Boards tentative decision to initially measure the lessee s right-of-use asset at cost? If you disagree, please explain why and describe how you would initially measure the lessee s right-of-use asset. We agree for the same reasons as those explained in our answer to question 6 because at initial recognition the measurement of the asset and the liability are symmetrical. Chapter 5: Subsequent measurement Question 8 The Boards tentatively decided to adopt an amortised cost-based approach to subsequent measurement of both the obligation to pay rentals and the right-of-use asset. Do you agree with this proposed approach? If you disagree with the Boards proposed approach, please describe the approach to subsequent measurement you would favour and why. We agree that the obligation to pay rentals should be subsequently measured at amortised cost because such measurement is consistent with the measurement of financial liabilities in accordance with IAS 39. However we consider that the right-of-use asset should be depreciated on a straight line basis unless a different method better represents the pattern of consumption of the rights by the lessee.

SwissHoldings 6 Question 9 Should a new lease accounting standard permit a lessee to elect to measure its obligation to pay rentals at fair value? Please explain your reasons. We do not agree that a future lease standard should permit a lessee to measure its obligation to pay rental at fair value because this would be inconsistent with the measurement of financial liabilities as per IAS 39. This would also be impractical for preparers and hamper the comparability of lease obligations for the users. Question 10 Should the lessee be required to revise its obligation to pay rentals to reflect changes in its incremental borrowing rate? Please explain your reasons. If the Boards decide to require the obligation to pay rentals to be revised for changes in the incremental borrowing rate, should revision be made at each reporting date or only when there is a change in the estimated cash flows? Please explain your reasons. We do not agree with the yearly reassessment of the incremental borrowing rate and its consequential revision of the obligation to pay rentals. A lease obligation is akin to a financial liability and not to a non-financial liability per IAS 37. Therefore the reassessment of the incremental borrowing rate is inconsistent with the measurement of non-derivative financial liabilities per IAS 39, complex for the preparers and inconsistent with an amortised cost approach as stated in 5.23. Moreover, the reassessment of the incremental borrowing rate does not reflect the substance of the transaction because the lessor has fixed the amount of the annuities during the lease term. This implies that the lessee is borrowing at a fixed rate. Consequently the incremental borrowing rate should not be reassessed and we support the position of the FASB as stated in 5.24. Question 11 In developing their preliminary views the Boards decided to specify the required accounting for the obligation to pay rentals. An alternative approach would have been for the Boards to require lessees to account for the obligation to pay rentals in accordance with existing guidance for financial liabilities. Do you agree with the proposed approach taken by the Boards? If you disagree, please explain why. As we said in our answer to question 10 a lease obligation is akin to a financial liability but it does not mean that its measurement should be identical, in particular the fair value at initial measurement. It stems from the definition of fair value that, at initial recognition, the fair value of a financial liability is normally the cash consideration received. Since no cash consideration is exchanged at inception of a lease, requiring the determination of fair value would cause the use of estimates but, since the initial measurement of a lease obligation is already made in accordance with discounted cash flow techniques, we do not see the value of further complicating these estimates in order to try to approximate the fair value. Moreover we have said in our answer to question 10 that we do not agree with the reassessment of the lease obligation. Therefore we support the decision of the Boards not to require initial measurement at fair value. Question 12 Some Board members think that for some leases the decrease in value of the right-of-use asset should be described as rental expense rather than amortisation or depreciation in the income statement.

SwissHoldings 7 Would you support this approach? If so, for which leases? Please explain your reasons. We do not consider that treating the decrease in the value of the right of-use asset as rental expense as recommended by certain FASB members is correct. We consider that since the lease asset is a right its decrease in value is appropriately described as depreciation or amortisation, which is consistent with IAS 16 and IAS 38. Chapter 6: Leases with options Question 13 The Boards tentatively decided that the lessee should recognise an obligation to pay rentals for a specified lease term, i.e. in a 10-year lease with an option to extend for five years, the lessee must decide whether its liability is an obligation to pay 10 or 15 years of rentals. The Boards tentatively decided that the lease term should be the most likely lease term. Do you support the proposed approach? If you disagree with the proposed approach, please describe what alternative approach you would support and why. We would agree in principle with the recognition of a lease obligation for the most likely lease term based on the highest probability as described in the example 5 of 6.35. As specified in 6.34, we agree that the lease term should be determined on the basis of reasonable and supportable assumptions. Moreover, as stated in the example, the construction of lease improvements is a very strong evidence of the most likely lease term. Question 14 The Boards tentatively decided to require reassessment of the lease term at each reporting date on the basis of any new facts or circumstances. Changes in the obligation to pay rentals arising from a reassessment of the lease term should be recognised as an adjustment to the carrying amount of the right-of-use asset. Do you support the proposed approach? If you disagree with the proposed approach, please describe what alternative approach you would support and why. Would requiring reassessment of the lease term provide users of financial statements with more relevant information? Please explain why. We agree that the consequence of the use of the most likely lease term is that lease contracts should be reassessed on the basis of changes of the initial facts and circumstances at each balance sheet date. For example an entity may lease a machine to manufacture a new product. The lease term is five years, renewable tacitly for additional 5 year periods until 20 years. Since the entity's useful life for such a machine is 15 years, the most likely lease term is 15 years. However after 3 years it appears that the new product is not successful. Therefore the entity reassesses the lease term to 5 years because it is very likely that it will cancel the lease after 5 years. Question 15 The Boards tentatively concluded that purchase options should be accounted for in the same way as options to extend or terminate the lease. Do you agree with the proposed approach? If you disagree with the proposed approach, please describe what alternative approach you would support and why.

SwissHoldings 8 We consider that purchase options should also be considered in determining the lease term on the basis of the most likely scenario. There is no reason why they should be treated differently and we agree with the statement of 6.56 that a purchase option is the ultimate renewal option. Chapter 7: Contingent rentals and residual value guarantees Contingent rentals Question 16 The Boards propose that the lessee s obligation to pay rentals should include amounts payable under contingent rental arrangements. Do you support the proposed approach? If you disagree with the proposed approach, what alternative approach would you recommend and why? We would agree that the lessee's obligation to pay rentals should include amounts payable under contingent rental arrangements inasmuch as it is reasonably certain that the obligation would crystallise. Please also see our answer to question 17 below. Question 17 The IASB tentatively decided that the measurement of the lessee s obligation to pay rentals should include a probability-weighted estimate of contingent rentals payable. The FASB tentatively decided that a lessee should measure contingent rentals on the basis of the most likely rental payment. A lessee would determine the most likely amount by considering the range of possible outcomes. However, this measure would not necessarily equal the probabilityweighted sum of the possible outcomes. Which of these approaches to measuring the lessee s obligation to pay rentals do you support? Please explain your reasons. In our answer to question 13 we said that we favoured the recognition of obligations stemming from options to pay rentals for an extension of the lease term. Likewise we consider that contingent rentals should be accounted for in the measurement of the lease obligation on the basis of the most likely rental payments as recommended by the FASB in 7.21. The choice should be made on the basis of reasonable and supportable assumptions. We do not favour the probability approach of the IASB as described in 7.20. As stated in 7.16 we consider that the weight attributed to each option would be difficult to estimate and would result in an outcome that would never happen. This approach is inconsistent with the Boards own tentative conclusions on recognising obligations stemming from options to pay rentals for an extension of the lease term where a weighted average estimate was rejected for the reasons stated in 6.15. Question 18 The FASB tentatively decided that if lease rentals are contingent on changes in an index or rate, such as the consumer price index or the prime interest rate, the lessee should measure the obligation to pay rentals using the index or rate existing at the inception of the lease. Do you support the proposed approach? Please explain your reasons. We agree with the proposal to measure the lease payment obligation contingent on an index or on a change of it based on the index or rate existing at the inception of the lease. We consider

SwissHoldings 9 that this is consistent with the fact that the lease conditions are determined at the beginning of the lease term. Question 19 The Boards tentatively decided to require remeasurement of the lessee s obligation to pay rentals for changes in estimated contingent rental payments. Do you support the proposed approach? If not, please explain why. Since the initial remeasurement of a lease obligation that contains a contingent obligation results in an estimate, we agree that the obligation should be remeasured when there is a change in the previously estimated rental payments. Question 20 The Boards discussed two possible approaches to recognising all changes in the lessee s obligation to pay rentals arising from changes in estimated contingent rental payments: (a) (b) recognise any change in the liability in profit or loss recognise any change in the liability as an adjustment to the carrying amount of the rightof-use asset. Which of these two approaches do you support? Please explain your reasons. If you support neither approach, please describe any alternative approach you would prefer and why. We support alternative (a), i.e., the FASB's proposal of 7.31 to recognise the changes in the contingent rental payments in profit or loss. We consider that the change in the obligation to pay rentals should not be linked to the value of the right-to-use asset. We consider that the value of a non-financial asset should not be reassessed on the basis of the change of a financing obligation. Moreover we also support the argument of the consistency with the existing requirements whereby a change in an accounting estimate should affect profit or loss outlined in 7.27. Residual value guarantees Question 21 The Boards tentatively decided that the recognition and measurement requirements for contingent rentals and residual value guarantees should be the same. In particular, the Boards tentatively decided not to require residual value guarantees to be separated from the lease contract and accounted for as derivatives. Do you agree with the proposed approach? If not, what alternative approach would you recommend and why? We agree on the basis of our answer to question 5 where we said that we did not favour a component approach for lease accounting. Therefore we do not see any valid reason why a residual value guarantee should be separated from the lease contract and treated as an embedded derivative. Chapter 8: Presentation Question 22 Should the lessee s obligation to pay rentals be presented separately in the statement of financial position? Please explain your reasons.

10 SwissHoldings What additional information would separate presentation provide? As we said in our answer to question 10 a lease obligation is akin to a financial liability we therefore consider that it should be presented among financial liabilities on the face of the balance sheet (statement of financial position) but be the subject of a mandatory disclosure as a distinct class of financial liability. IFRS 7 should be modified accordingly. Question 23 This chapter describes three approaches to presentation of the right-of-use asset in the statement of financial position. How should the right-of-use asset be presented in the statement of financial position? Please explain your reasons. What additional disclosures (if any) do you think are necessary under each of the approaches? While leased assets have a distinct nature and represent a right to use, we would recommend that the Boards leave the option either to present them separately on the face of the balance sheet or to include them under tangible assets. If there are appropriate disclosures in the notes, we do not believe that such a proposal should hamper comparison. Chapter 9: Other lessee issues Question 24 Are there any lessee issues not described in this discussion paper that should be addressed in this project? Please describe those issues. We do not believe that there are any, apart from the issues of intra-group leases explained in our answer to question 29. Question 25 Do you think that a lessor s right to receive rentals under a lease meets the definition of an asset? Please explain your reasons. As said in our answer to question 1 we consider that lessor accounting should be part of a future standard on leasing. Excluding it under the proposal of the DP would mean that lessor accounting would continue to be governed by the existing standards, which may create inconsistencies. Therefore, since the Boards have decided that the lessee incurs an obligation to pay rentals that results in a liability, the lessor should consequently enjoy a right to receive rentals that results in an asset. Question 26 This chapter describes two possible approaches to lessor accounting under a right-of-use model: (a) (b) derecognition of the leased item by the lessor or recognition of a performance obligation by the lessor. Which of these two approaches do you support? Please explain your reasons. We favour alternative (a) that faithfully represents the economics of the transaction. As explained in 10.17 and in accordance with our answer to question 25, the lessor has granted a right-touse that represents an asset. It also retains an asset for the residual value.

11 SwissHoldings Question 27 Should the Boards explore when it would be appropriate for a lessor to recognise income at the inception of the lease? Please explain your reasons. We do not believe so. We agree with the conclusion of 10.25 that revenue out of the performance obligation should be recognised over the lease term. Such revenue would compensate the amortisation of the rights to receive rentals. However we would also agree that, in line with 10.26 and example 13, there could be situations where the lessor would recognise the sale immediately. Question 28 Should accounting for investment properties be included within the scope of any proposed new standard on lessor accounting? Please explain your reasons. This is not relevant to our members. However, investment properties could be relevant to lessees, for example, those lessees that lease land and/or buildings under a finance lease and are carried at fair value (or an operating lease which meets the definition of an investment property). The terms finance and operating lease will no longer exist in the new leasing standard so IAS 40 will need to be amended before a new leasing standard is finalised. Question 29 Are there any lessor accounting issues not described in this discussion paper that the boards should consider? Please describe those issues. We consider that the Boards should address the issue of intra-group leases and state that the right to receive rentals of the lessor should be eliminated against the obligation to pay rentals of the lessee for such intra-group lease transactions. 09-07-16-SH CL DP Leases