Accounting For Leases by Lessors. This report is a document that is outlining the critical evaluation of the proposed leasing standard which the IASB / FASB are trying to introduce.

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Accounting For Leases by Lessors

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Page

Introduction                                                                                              1

IASB 17                                                                                                    1

Balance Sheet effect                                                                                2

(Changing of investment ratio figure analysis)

Grant Thornton Research                                                                         3

International Implications (IAS16)                                                                         3

Sub Leasing (IAS 40)                                                                                               4 Contingent Asset / Liability (IAS 37)                                                                     4

Sale and Lease back Agreements (IASB17) (IAS 18)                                       5

Conclusion                                                                                                5

This report is a document that is outlining the critical evaluation of the proposed leasing standard which the IASB / FASB are trying to introduce. IASB stands for International Accounting Standards Board, and is the international accounting standard adhered by UK and European companies. FASB stands for Financial Accounting Standards Board and is used in the US as a generally accepted accounting principle (GAAP). After the Enron scandal a project has been set up to combine the FASB and IASB so that companies can have more clarity on how to account for certain transactions internationally but more importantly to have a single standard that is used across the board, therefore can be used interchangeably by different economies. At the moment UK companies who trade in the US adhere to a principle called SOX (Sarbanes Oxley) to comply with the US GAAP accounting rules. The Sarbanes-Oxley Act of 2002 is mandatory to ALL US or US affiliated organization. The Sarbanes-Oxley Act is arranged into eleven titles. As far as compliance is concerned, the most important sections within these are often considered to be 302, 401, 404, 409, 802 and 906. These are the over-arching rules that a public company accounting board have established by the act and was introduced amidst a host of publicity major  including the likes of Enron, which cost investors billions of dollars when the share prices of affected companies collapsed, shook public confidence in the nation's .(*1)

The report will outline the issues raised by the new lease standard and its effects on the preparers of accounts and the consequential effect on the final financial statements which stakeholders and potential investors use to determine the successful nature of the business. The report will focus on the retail sector, in particular the supermarkets as an example of the kinds of issues and debates arising. It will then conclude with the overall impression and practicality of the standard using the evidence mentioned in the report.

In the “Tesco and Sainsbury’s attack lease accounting proposals(*2)article there is a mistake, the article talks about lease contracts going on the balance sheet as a “asset or liability” when it should say “assets and liabilities”. This could be debated though in the case of a future liability, known as a contingent liability to the company, however the report will discuss this issue later. The proposal of the new lease standard states the lessee should apply a single accounting approach for all leases and would require a lessee to:

  • Initially recognize a liability to make lease payments and a right-of-use asset, both measured at the present value of the lease payments.
  • Subsequently measure the liability to make lease payments using the effective interest method.
  • Amortize the right-of-use asset on a systematic basis that reflects the pattern of consumption of the expected future economic benefits

(Financial accounting standard board 15.11.11) *3

This is known as the IASB17 leasing standard. The standard states that the asset leased would go into the lessee balance sheet as an asset at fair value or at the net present value (NPV) of leasing payments, whichever is lower. Fair value is the amount for which an asset could be exchanged for between knowledgeable and willing parties. The asset should firstly be depreciated at the same rate as other assets on the lessee’s balance sheet. Thereafter depreciated in a method that best mirrors the economic benefit gained in the future from using the asset.  The liability would be the lease repayments due in each financial period. This would mean that all leases would be treated in future as a financial lease. Currently the accounting treatment of leases depends on the kind of lease obtained. There are two kinds of leases A) Financial lease and B) Operating lease. As mentioned above financial lease involves the lessee stating the lease as an asset and liability in their balance sheet, however if you lease as an Operating lease then you would not have to declare a figure in your balance sheet. This current treatment is allowing managers to use creative accounting and manipulate their accounts so the business looks more profitable and hence more investable. The issue can be highlighted by an example,

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company A buys an asset for the use of its company. So it will have to state it as an asset in its balance sheet and then amortise it annually. But company B who are similar to company A chooses to lease the asset as an operating lease instead of buying the asset. Now although both companies could be off similar business strength and wealth their balance sheet would look different, and company B would look better to invest in due to the asset and the liabilities attached to the asset being of the balance sheet. Would this be fair? ...

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