With the new International Financial Reporting Standard (IFRS) 16 Leases published, the International Accounting Standards Board (IASB) is fully committed - yet also exposed - to bring this standard into practice.
Observers are keen to analyse which last minute changes have occurred compared to the review draft that was circulated previously. One may have thought its content would closely match the previous deliberations of the IASB Board.
One of the last minute changes that seem to have occurred and must have been very deliberate is the use of the word depreciation rather than amortisation in respect of the right-of-use asset.
Non-native English speakers may think that the words have identical meanings. In practise, however, the connotation of amortisation is to loans and intangibles assets whereas depreciation refers to (tangible) fixed assets.
The impact of using the word depreciation in the final text is immense: a leased asset already was suggested to only relate to a tangible asset and so, it looks very logical (paragraph 31) to apply IAS 16 depreciation requirements: strictly linear depreciation.
However, the original IASB’s intent was to amortise the right-of-use asset on either:
• a straight-line basis; or
• another systematic basis if that basis is more representative of the pattern in which the lessee expects to consume the right-of-use asset’s future economic benefits.
The published standard eliminates the second option of amortisation/depreciation and therewith seems in fundamental breach with earlier deliberations; even when it was preferred to using the linear depreciation as prescribed by IAS 16.
Exposed to criticism
By publishing the standard as it is, the IASB is very much exposed to criticism as to the decent reporting about leased assets. This conclusion is not just based on the use of a word like ‘depreciation’. It, too, goes back to earlier critical comments, by EFRAG, the European Financial Reporting Advisory Group, and others, among which most (international) leasing associations, that the IASB should exercise more fieldwork before final deliberations by the board, let alone publication, would take place.
With insufficient fieldwork performed, the IASB Board has allowed itself to be exposed to costly misinterpretations: putting the current operating leased assets on balance sheet is not at all similar to reporting about the financing of assets as is the primary goal of a current finance lease.
By assuming identical application for accounting, the true nature of operating leases is ignored. More-over, lacking proper field work, a practical element like the timing of lease payments has remained unobserved.
Timing of lease payments
Operating leases, for the vast majority, stipulate that in order to benefit from using the asset, the reward to the lessor (consideration) has to be paid in advance of the applicable lease period. This is an important difference to amortising a loan (finance lease) where ordinarily payment is made at the end of the lease period (in arrears).
Speaking about transparency and consistency - the board has failed an elementary understanding of what an operating lease is. A first conclusion is that, if fieldwork had been performed earlier, it would have provided arguments for simpler and more consistent reporting about leases transactions. That’s more than just a chance missed.
Next problems: materiality and discount rates
Disclosure initiatives are one of the IASB’s current projects still under way, dealing, amongst others, with materiality and discount rates.
Considering that the outcome of applying discounted values in reporting depends on its starting assumptions, effecting materiality considerations (and the board just had a first educational session about discount rates in its January 2016 meeting) it very much looks like the IFRS 16 Leases standard has been released far too soon - yet another area not explored timely.
And don’t argue that the process already took almost 10 years! That would only signal even more explicitly that the board has neglected signs for proper and timely fieldwork.
Henk Uunk held the position of manager financial accounting and reporting at ING Lease Holding from 2004 to 2014. He is chairman of the accounting committee of the Dutch Leasing Association (NVL) and a member of Leaseurope’s accounting and taxation committee since 1992. Uunk is a contributor to the Dutch Accounting Standards Board working group on leases and acts as a consultant to the Dutch Car Leasing Association (VNA).