uunk henk

This article is intended to alert you, not to give you a comfortable feeling. Most people do not like to get an uncomfortable feeling and skip reading articles like this one.

So what is the driver for you reading any further?

For technical testers of new standards, like EFRAG, (the European Financial Reporting Advisory Group), or institutional bodies like the ARC, (the Accounting Regulatory Committee), providing an opinion to the European Commission on proposals adopting IFRS’s, this article aims to establish a platform for discussion and contemplation.

For others, it allows prospective views about why certain developments are against the European public good. I consider the implementation of IFRS 16, Leases, one such wrong development.

Look before you leap

Two main lines of thought have developed over time, that have entered into the accounting profession too:

(a) if it is not forbidden, then it is allowed; and

(b) if rules need to be improved, amendments are a proper way of doing so.

Bearing in mind the outcome of Brexit and the 2016 American elections for president, this can be viewed as typically Anglo-Saxon thinking. And like the Brits have decided against Continental Europe, Continental Europe may decide against Anglo-Saxon mind framing.

Why adopt accounting rules with a particular Anglo-Saxon undercurrent? Why implement 20th century thoughts into new regulations that are out of sync with 21st century developments?

Just to tease: what is the relevance of the English language in 27-state Europe where only the Irish and Maltese populations speaking English?

More generally: is Continental Europe better off with anglo-saxon law and order or its own continental footing?

Recently, in the Netherlands, the assurance (audit) profession was highly criticised by the Netherlands Authority for the Financial Markets (AFM), monitoring the assurance profession. Complaints were that auditors had become too close to their auditees, were not transparent in writing down what activities they had employed (or why not), which considerations they had made and which actions they had undertaken, combined with lacking documentation of internal supervision of managers and partners. After just over a year, a remediation plan has come into force, led by NBA, The Royal Netherlands Institute of Chartered Accountants.

The first step in remedying the (perception of) lost trust is the move towards improved credibility of staff at all levels, and a mindset of awareness and integrity and … it may be correct, but it is not right … act accordingly.

Ironically, the current chair of the IASB (International Accounting Standards Board) earlier happened to be chair of AFM, the Dutch auditors’ supervisor and criticaster, and he now has taken responsibility for replacing the criticised IAS 17 with a new standard for Leases, which may be correct, but is not right … at all.

Practical expedients

The wording of IFRS 16 was adjusted time and again with all kind of exemptions to appease the public consent and make the new standard more acceptable. The exemptions are give-aways called practical expedients of which a number have to do with the transition from old IAS 17 to new IFRS 16.

The practical expedients, it was believed, would only have a temporary effect. Take the expedient that no comparative figures have to be stated in one of the options allowed for transition. In IFRS terms, this has never been done before and is unheard of, yet very practical. But practical expedients set borders, thus creating two sides of a line and therefore are prone to discussions and criticism.

Grandfathering the unknown

One such an effect comes from the practical expedient to ‘grandfather’ all leases at initial application.

Companies deciding to applying the practical expedient to grandfather leases, have to apply this policy to all leases: it applies to all former IAS 17 leases and all contracts now containing a lease in accordance with IFRIC 4. A lease now is a lease then.

It also applies to all contracts currently identified as not containing a lease: no lease now is no lease then.

This is an accounting policy decision, thus high in the organisation. Management needs to be fully aware of its effects, which it only can be, when timely proper investigations are performed. In order, however, to choose the most beneficial or practical outcome, this means that impacts on P&L, Balance sheet and Equity have to be calculated not later than Q3 2017; less than a year to go.

Meanwhile, through the outcome of a general questionnaire, EFRAG is grasping for arguments whether or not the new standard is fit for a positive endorsement advice to the European Commission.

The EU plans to endorse end Q1 2017, whereas companies by then still have no clue as to what the impact for them will be. Analysts really may question the soundness of their own position while pushing for improvements of lease reporting, using IFRS 16.

Inflating balance sheets with thin air

Is the above all too descriptive and vague? Then here is a scary, but very likely example:

Two companies are deploying, as purchasers, power purchase agreements which are regarded to be operating leases under IAS 17:

One company opts for grandfathering leases and therewith is relieved from retroactive assessment of all of its decisions whether a contract was or contains a lease. Else, the problem to the company would be that the IFRS 16 assessment has to relate to all transactions still current, not just all current leases.

By making a choice for grandfathering, it pulls the power purchase agreement on balance sheet.

Company two has not chosen for grandfathering and therefore the same transaction is dismissed of being a lease under IFRS 16, thus will not become on balance sheet.

The difference is not just two different balance sheet totals. The difference is that one company choosing to grandfather leases is inflating its balance sheet very transparently: it fills its balance sheet with “thin air” compared to the other company that timely arranged to assess all transactions. Consider that power purchase agreements easily can range for up to 25 years, thus having a long-lasting effect on either company.

Grandfathering is a real Eldorado for balance sheet fetishists. And it is all included in the new IFRS standard that was started to fight abuse and lack of transparency in current IAS 17. Some improvement!

Risk and Compliance

In my earlier articles, I pointed at “anomaleases” like services-as-a-lease and effects from sale and operating lease back transactions. This article, once more, reveals weaknesses, leading to incomparability between companies.

One sees a tendency, at large accounting firms and their customers, to focus on the technical aspects of implementing the new standard according to the rules: timeliness and correctness in implementation prevailing.

When management is not alert on rightness, or even accepts, for practical purposes as presented, an outcome of an inflated balance sheet, nobody is to blame but IASB itself. Is that correct, but not right, either?

Perhaps, the European Commission might yet declare the new standard to be too manipulative, hence refuse its application in the EU to the benefit of the European public good.

In my view, that would be a right step.

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).