New leases standard – the big scope exemption

As we discussed here, the IASB has issued IFRS 16 Leases, effective for annual reporting periods beginning on or after January 1, 2019.

We’ve already discussed some of the issues attaching to the first step in the new standard’s lease accounting model, to identify at inception of a contract whether that contract is a lease, or contains a lease. But before launching into that, I should really have covered the standard’s big scope exemption. Here it is:

  • A lessee may elect not to apply the requirements…to:
  • (a) short-term leases; and
  • (b) leases for which the underlying asset is of low value…
  • If a lessee elects not to apply the requirements…to either short-term leases or leases for which the underlying asset is of low value, the lessee shall recognize the lease payments associated with those leases as an expense on either a straight-line basis over the lease term or another systematic basis. The lessee shall apply another systematic basis if that basis is more representative of the pattern of the lessee’s benefit….
  • The election for short-term leases shall be made by class of underlying asset to which the right of use relates. A class of underlying asset is a grouping of underlying assets of a similar nature and use in an entity’s operations. The election for leases for which the underlying asset is of low value can be made on a lease-by-lease basis.

It’s fairly self-evident what that all amounts to, and this of course is the standard’s big concession, sacrificing a certain amount of conceptual purity and consistency for the sake of a more persuasive cost-benefit calculation. Here’s some of the IASB’s underlying thinking on short-term leases:

  • “The IASB considered simplifying the measurement requirements for short-term leases. Specifically, it considered exempting lessees from the requirement to discount the payments used to measure the assets and liabilities arising from short-term leases. Many stakeholders, however, thought that this exemption would provide insufficient cost relief for lessees because it would still require an entity to track a possibly large volume of leases of a low value.
  • The IASB concluded that, even with simplified measurement requirements, the benefits of requiring a lessee to recognize right-of-use assets and lease liabilities for short-term leases would not outweigh the associated costs…”

And for leases of low-value items:

  • “…many lessees expressed concerns about the costs of applying the requirements of IFRS 16 to leases that are large in number but low in value. They suggested that such an exercise would require a significant amount of effort with potentially little effect on reported information.
  • In the light of these concerns, the IASB decided to provide a recognition exemption for leases of low-value assets…..
  • In developing the exemption, the IASB attempted to provide substantive relief to preparers while retaining the benefits of the requirements in IFRS 16 for users of financial statements. The IASB intended the exemption to apply to leases for which the underlying asset, when new, is of low value (such as leases of tablet and personal computers, small items of office furniture and telephones). At the time of reaching decisions about the exemption in 2015, the IASB had in mind leases of underlying assets with a value, when new, in the order of magnitude of US$5,000 or less. A lease will not qualify for the exemption if the nature of the underlying asset is such that, when new, its value is typically not low. The IASB also decided that the outcome of the assessment of whether an underlying asset is of low value should not be affected by the size, nature, or circumstances of the lessee—ie the exemption is based on the value, when new, of the asset being leased; it is not based on the size or nature of the entity that leases the asset.
  • The IASB conducted fieldwork to assess the effect that low-value asset lease would have if the right-of-use assets and lease liabilities were recognized in the financial statements of lessees. On the basis of this fieldwork, the IASB observed that, in most cases, assets and liabilities arising from leases within the scope of the exemption would not be material, even in aggregate. The IASB considered whether these findings demonstrated that the exemption would be of limited benefit to lessees because most leases that would be within its scope might instead be excluded from the recognition requirements of IFRS 16 by applying the concept of materiality in the Conceptual Framework and in IAS 1. However, in the light of feedback received from preparers of financial statements, the IASB concluded that the exemption would provide substantial cost relief to many lessees (and, in particular, smaller entities) by removing the burden of justifying that such leases would not be material in the aggregate.”

If a lessee accounts for short-term leases in this way, and a lease modification or a change in the lease term occurs, the lessee considers the lease to be a new lease, and assesses matters again.

The IASB acknowledges that this scope exemption creates a risk of structuring opportunities (although it thinks the standard has largely anticipated and guarded against these), and as I said, this is obviously based in pragmatism more than conceptual purity. But it’s hard to imagine the world as a whole being happier with the standard if the exemption wasn’t there…

The opinions expressed are solely those of the author

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