ANNEXE ANSWERS TO SPECIFIC QUESTIONS 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: Fulfilment of the contract depends on the use of an identified asset; and 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. The proposed definition of a lease is similar to that in IAS 17 and is likely to be equivalent in most practical situations. However, in some arrangements such as supplier comanufacturing arrangements, both the customer and the supplier may have involvement in or ability to make significant decisions before the contract commencement (in negotiating the operating agreement) and during the agreement on how the asset is operated. The ED does not provide guidance on how to consider arrangements that include significant decisions that are jointly agreed to by the customer and supplier prior to lease commencement and consideration for other significant decisions made jointly during the lease term. In addition, the ED does not specifically exclude transactions that automatically transfer title of the asset to the customer at the end of the lease term nor does it state whether these contract provisions would transfer control of the asset to the customer. We recommend the board clarify whether these transactions are in the proposal s scope or these transactions are substantively different from a lease with a bargain purchase option. We do not agree with the conclusion in BC 118 that distinguishing between leases and sales of assets is less critical: given the proposed presentation and disclosure requirements, the distinction remains quite important. 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?
2. We are not in favour of having two treatments. In our view, one of the main advantages of the leasing project was the reduction of complexity by eliminating the distinction between operating and finance leases. This dual approach negates a large part of the benefits we expected to come from the elimination of this distinction. Nevertheless, we understand that there is an argument that the underlying economics of different types of leases do vary. If the Board remains convinced that these differences must be reflected by having two types of leases, then we consider that significant additional simplification is needed (see below our response to Q4). 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? We believe that the correct approach is to mirror the lessee accounting treatment wherever possible. However, the lessor s view of the lessee s significant economic incentives to exercise a renewal or termination option is a very subjective judgment that will lead lessors to arrive at different answers for leases with similar terms. We consider that requiring lessors to make judgments about the economic incentives of lessees is not practical. We urge the Board to require the lessor to make a judgement about the reasonably certain outcome (with due consideration of the economic incentives of lessee, to the extent that these are known to the lessor). Also, in our view the initial measurement of the residual asset should represent the present value of the expected residual value at the end of the lease, which is the method used in the current finance lease accounting under IAS 17 as specified in the gross investment in the lease definition. We expect that applying paragraphs 72 to 75 will be quite complicated. 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? The ED uses a combination of the nature of the underlying asset (which we consider rulebased) and the portion of economic benefits of the underlying asset expected to be consumed by the leasee over the lease term (in our view this is principle-based) and to distinguish between the two lease types. We consider that it is too complicated to classify the lease based upon the nature of the underlying asset except in cases where the presumption can be rebutted. We would recommend that the classification of the lease type should be based only on the consumption of economic benefits by the leasee over the lease term relative to the total economic benefits embodied in the asset (i.e. considering its total useful life). This would remove a rule-based classification with two very different presumptions and contradictory outcomes. We are not
convinced by the arguments in BC 124 that a lease of a building with a short remaining useful life is analogous to purchase. For example, we do not think that a tenant who leases a storefront for an extremely short period should be forced to evaluate whether the building is new or near the end of its life. We think that eliminating this aspect of the classification will lead to superior conclusions of the economics of the transaction than the ED proposed requirements. Another example of the inconsistent conclusions which we are concerned about is presented below: Under the ED a two year lease of a railcar would be insignificant to the total economic life of the railcar, even if the railcar was 38 years in service and near the end of its useful life. The lease of the railcar could be deemed a lease that consumes an insignificant portion of the asset under the ED, and hence a type B lease. Conversely, a two year lease of a building that was also 38 years old and near the end of its useful life could be classified as a lease consuming a significant portion of the economic benefits of the leased asset (a type A lease) because the lease term would be compared to the remaining economic life of the building under the classification proposed by the ED. If the Board considers it necessary to retain the nature of the underlying asset as a key criteria in the classification of the lease, we agree with AV6 that leases of buildings should be separated from leases of land. We consider that paragraphs 33 and 34 require additional guidance on the definition of property and the judgement required when an arrangement includes multiple assets. For example, a 40 year lease of building and the underlying land would be considered a lease that consumes the significant economic benefits of the building (and hence a type A lease) whereas the lease of the land alone for 40 years would not be a major part of the land s remaining economic life (and the lease would consequentially be classified as a type B lease). The same land is assessed and classified differently in the two scenarios. Also, it is not clear that the Board intended for certain structures that are attached to land, or buried under land, to be considered property or non-property assets under the proposal. An additional possible consequence of the ED proposed model for type B right-of-use assets would be the possible increase in impairments for this category of assets. This is due to the pattern of asset amortisation in which amortisation is low at the start of the lease and increases each period over the life of the contract, with a resulting increase in average net asset value over the life of the lease. We consider that this is a consequence of using an amortisation pattern that does not reflect the consumption of the benefits in the right-of-use asset. If the Board considers that the type B lease is fundamentally different to the financing of an asset purchase then a simplified approach would be to amortise the interest element on a straightline basis, rather than using an effective interest rate method. This would allow the asset to be amortised on a straight line basis also. A more radical idea would be to present the undiscounted values of the liability and asset, thereby eliminating all notions of financing from type B leases. Whilst we do not necessarily advocate this latter approach, we consider it illustrates the inconsistencies inherent in the accounting for type B leases. The proposed exemption for leases with a maximum possible contractual lease term (including any options to extend) of 12 months or less is designed to reduce cost and complexity under the proposal. In our view, this will not provide significant relief as many short term leases contain renewal options. We consider that renewal options should not be considered in evaluating the applicability of the short term lease exemption if their exercise is not reasonably certain (or if there is no significant economic incentive to exercise the renewal). 3.
4. In cases where large volumes assets, such as automobiles, trucks, copiers, computers, etc. are leased it will be challenging to maintain the detailed accounting records due to the sheer number of these agreements. We think the Board should provide guidance for recognition and valuation of groupings of similar leased assets with similar useful lives that would limit the total number of leases to be administered under the ED. These low value items represent significant reporting challenges for companies with decentralized global operations. Finally, we consider that the naming of these leases Type A and Type B displays a lack of representational faithfulness and transparency. If the final standard retains two types of leases, we would recommend that they be named something more meaningful, for example consumption leases and access leases respectively, which would indicate the economic nature of the arrangement. 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 generally agree with the concept of the lease term consisting of the non-cancellable period of the lease and the periods covered by an option to extend the lease or terminate the lease if certain criteria are met. However, we oppose the criteria for both extension and termination options being included in the lease term defined as a significant economic incentive and we would encourage the inclusion of the current IAS 17 language of reasonably certain in the standard as this concept is well understood in practice. The presence of significant economic incentives might be an indicator that renewal or termination options are reasonably certain to be exercised. This requirement is even more relevant for lessors, who do not have visibility in to the lessee s economic incentives (see our comments on Question 3 above). Paragraph 27 requires an entity to reassess the lease term if there is a change in factors as described in paragraph B6. Paragraph B6 could be read that an entity needs to do such an assessment based on each change in relevant factors, possibly leading resulting for the lessee to have further or no longer a significant economic incentive. A change in market-based factors such as market prices alone would not trigger a reassessment of the lease term; however the change in a market price for an asset could be interpreted to influence the significant economic incentive to exercise an option. The Board s intent to limit the analysis required for market based factors as indicated in paragraph 27(a) may not provide as much relief as intended. We urge the Board to avoid burdensome and onerous tests while limiting clearly the reassessment to situations of substantial changes. 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? We agree with the proposals.
5. 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? In general, the transitional proposals and the requirements therein appear reasonable subject to a suitable transition date which would allow preparers to accumulate the information that will be required by the new standard. However, it is not clear in the ED whether arrangements previously treated as operating leases would be accounted for in the transition period by using the information as of the lease commencement date or another date (e.g., beginning of the earliest period presented in the financial statements). Different outcomes may be reached in the analysis of the agreements concerning the exception criteria based upon which dates are utilised and we recommend that the Board clarify this issue. Also, paragraph C11(b) will require additional on-going effort to segregate leases classified as finance leases under IAS 17 from those commencing after the new IFRS would become effective. This could require them to be excluded from any systematic processes for reassessment which might be developed. Differentiated treatment like this should be a policy choice, not a mandatory requirement to allow preparers to assess the benefits of the proposed relief relative to the consequential costs of special treatment of old leases for several years after transition to the new standard. Question 8: disclosure Paragraphs 58 67 and 98 109 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 options). Do you agree with those proposals? Why or why not? If not, what changes do you propose and why? We consider that the disclosures related to leases should be aligned on the disclosures required currently to property plant & equipment and financial liabilities. They should not exceed the requirements already existing for fixed assets and financial liabilities recognized in the balance sheet. While the ED does not request comments on the presentation requirements for lessees (paragraphs 54-57), we are concerned that as currently drafted, paragraph 56 would be interpreted as requiring new lines to be added to the face of the statement of profit or loss and would therefore conflict with IAS 1.99. It seems clear from BC196 and particularly BC197 that this is not what the Board had in mind, but think this is not clear in the drafting. This apprehension is reinforced by some of the concerns expressed by Mr Linsmeier in AV11(b). We consider that in most cases such disclosures should be in the notes to the financial statements and that paragraph 56 should be redrafted to eliminate this possible confusion. In our view paragraph 42(b) already expresses the concept of the single lease expense for type B leases,
and could be enhanced or referred to in a redrafted paragraph 56. The presentation requirements for lessors in paragraph 90 should be used as a possible basis for the redrafting. 6. Question 12 (IASB-only): Consequential amendments 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? We have no comments on this question.