New leases standard – lessor accounting

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 covered the main aspects of lessee accounting in a series of articles. It’ll only take this one post though to cover the other side of the transaction, the implications for lessors. That’s both because there are far more lessees than there are lessors, and because, well, there aren’t so many implications. Actually, you’d be forgiven for momentarily thinking, as you reach that portion of the standard, that there must be a printing error – it’s jarring to be thrown back from the new world of IFRS 16 into the old terminology and concepts of IAS 17. By which I mean that lessor accounting still reflects a difference between finance and operating leases, with the accounting implications playing out as they do in the current model.

This reflects, as the IASB puts it, “that the costs associated with making changes to lessor accounting would be difficult to justify at this time because most stakeholders (including users of financial statements) were of the view that lessor accounting in IAS 17 is not ‘broken’.” In its exposure drafts, the board did propose changes to the lessor model, mainly on the premise that “developing consistent and symmetrical accounting for lessees and lessors would be beneficial.” But at the end of the day, it concluded among other things that: “most users of financial statements do not currently adjust lessors’ financial statements for the effects of leases—indicating that the lessor accounting model in IAS 17 already provides users of financial statements with the information that they need. In addition, investors generally analyze the financial statements of individual entities (and not a lessee and lessor of the same underlying asset). Accordingly, it is not essential that the lessee and lessor accounting models are symmetrical.” (One member of the IASB dissented from the new standard on this basis, finding it “conceptually inconsistent” and noting: “two transactions that are economically the same could be structured in a way that results in those transactions being accounted for differently under the dual lessor accounting model.”)

Still, this doesn’t mean that all lessors will be wholly unscathed by the change. For one thing, the core definition of a lease is now different, along with the guidance on identifying a lease. We wrote here about issues arising in determining whether a contract conveys the right to control the use of an identified asset for a period of time; some of the factors noted there might lead to different basic determinations about the nature of a particular contract. The standard also includes new material on lease modifications and on subleases. Regarding the latter, an intermediate lessor usually classifies the sublease by reference to the right-of-use asset arising from the head lease, rather than by reference to the underlying asset. However, if the head lease is a short-term lease accounted for as discussed here, then the sublease is an operating lease.

Not surprisingly, disclosure requirements for lessors have also been expanded. In particular, IFRS 16 now requires disclosing information to help users to assess “how the lessor manages the risk associated with any rights it retains in underlying assets. In particular, a lessor shall disclose its risk management strategy for the rights it retains in underlying assets, including any means by which the lessor reduces that risk. Such means may include, for example, buy-back agreements, residual value guarantees or variable lease payments for use in excess of specified limits.” The IASB explains: “the main concern associated with lessor disclosure in IAS 17 was the lack of information about a lessor’s exposure to credit risk (associated with the lease payments receivable from the lessee) and asset risk (associated with the lessor’s residual interest in the underlying asset). Particularly for leases classified as operating leases, lessors could retain significant residual asset risk and little, if any, information was generally available about that exposure to risk in the financial statements.” The standard also requires disclosing “a qualitative and quantitative explanation of the significant changes in the carrying amount of the net investment in finance leases”.

I’m certainly a believer in the “ain’t broke if it don’t fix it” approach to accounting, and in emphasizing practicality over conceptual purity. Still, as I said at the start, the lack of symmetry in the IFRS 16 approach to lessees versus lessors does make for a rather bumpy read, and the dissenting member surely has a point in thinking that a “right-of-use asset” and corresponding liability on the lessee’s part might usually be expected to coincide with a (so to speak) “agreement-not-to-use” asset on the lessor’s. It probably doesn’t matter too much in the specific context of lease accounting, but I wonder if the IASB will ever have cause to regret so prominently acknowledging that the world needn’t always be in any kind of balance…

The opinions expressed are solely those of the author.

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