Procedural differences: -
Proposed standard says rather than classifying the lease as finance and operating they will treat all the leases in the same accounting manner. The presences of the two different accounting models help the lessee to manipulate the system and account them differently. So directly saying lessee has an opportunity for structuring. Thus the lessee would recognize the leased item as per preliminary views mentioned in the paragraph 3.26 of the discussion paper.
· Right-to-use the asset
· Obligation to pay the rental.
- in the proposed standard as there are some problem mentioned in the paragraph 3.32, so board decided not to adopt the components approach for the complex leases, what is well described in the paragraph 3.29
Philosophical differences: -
Simple lease: -we agrees with the board decision on the adoption of the rights and obligation approach. The paragraph 3.28 of the discussion paper and IASB framework represent the rights and obligation should be shown on the face of the balance sheet rather than in the notes, which takes direct attention of the users helpful in their decision making purposes. The instances mentioned in the discussion paper well define the situation.
- as explained in the phrase above of the simple lease that rights and obligation should be on the face of the balance sheet. We agree with the discussion in the Sir Tweedie article that we agree with unitary approach specified in the paragraph 3.33 due to the problem rose in the paragraph 3.32 and it is the most practicable approach. Decomposition of the financial instrument into the components is inconsistent with the IAS 39
Initial measurement: -
Measuring the Obligation to pay rental: - this chapter in the proposed standard describes the board's initial measurement of the lessee right-to-use the asset and obligation to pay the rental. Obligation to pay the rental meets the definition of the financial liability in IAS 32 and IAS 39 measured at initially at fair value (but excludes lease liability from its scope)
- the board tentatively decided to initial measure the lessee obligation to pay the rental at the present value of the lease payment, discounted back using the lessees incremental borrowing rate as mentioned in the paragraph 4.15 rather than measuring it at the fair value. No matter fair value represent the current market condition and its more comparable from the users prospective but in some lease contracts it is not possible to determine it.4.6 (a,b)
- in the existing standard board is putting more emphasis to use the implicit rate when it is determinable, if not then use lessee incremental borrowing rate to determine the present value of the lease payment. But in the proposed standard board is saying not to use the implicit rate, directly use incremental borrowing rate, as implicit rate is not possible to determine as reason specified in the paragraph 4.13 and 4.16. As mentioned in the paragraph 4.17 existing rate is more complex for prepares to apply and might reduce the comparability for the users. As the view given in the Sir Tweedie article.
Discussion: - as per comments given on the Questions posted in the discussion paper, every firm giving their different views.
Discussion in the IASB meeting on 15th September shows
That the respondents says where implicit rate is not possible to determine then use the new techniques incremental borrowing rate but if it is possible to determine it then use the implicit rate to calculate the present value of the lease payment, as per comment made by the Deloitte group, they believe implicit rate is more relevant and reliable as it is the rate of return of every transaction. On the other side they are saying incremental rate of return is based on the hypothetical transaction. At the end they are support in the same argument that when it is not possible to determine the implicit rate then use incremental borrowing rate.
Subsequent measurement: -
The paragraph 25 of the existing standard says minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rents shall be charged as expenses in the periods in which they are incurred
There is not really such a difference between existing and proposed standard, which can go under procedural and philosophical difference, as subsequent measurement is, seems to be an important limb of the lease. So we would like to give a brief discussion on it.
The proposed discussion paper is similar to the requirements of the IAS 17 and AASB 117 that the both the asset and obligation to pay rental should be measured subsequently at amortized cost or depreciable amount. There should not be any linked approach as mentioned in the paragraph 5.5 and 5.6 as board rejected this approach.
For the obligation to pay rental amortized cost based approach should be used rather than fair value. As mentioned in prior part of the assignment no doubt fair value reflects the current condition (5.15) of the market and provides the users with the relevant information. As board says that the fair value technique is costly and complex (5.16) for the preparers and it also outweigh the potential benefit of the users (5.19). So better to adopt the amortized cost based approach. KPMG says that if any changes occur in the measurement of the obligation to pay rental at the reporting date of the entity would be accounted in using the catch-up approach as mentioned in the proposed standard.
Sir Tweedie is also agree on the saying in the proposed standard which are based on the existing standard that lessee should consider every terms and conditions on the initiation of the contract. Once the contract is formed all the rights and obligation are fixed and there is no way you can alter them. On the basis of the above discussion it reasonable to say that amortized cost based method is best approach for the subsequent measurement for the lease.
Lease with option: -
Chapter 6 discusses how to account for leases that include options that grant the lessee the right to extend the lease, terminate the lease or purchase the leased item.
The proposed standard is presenting totally a new approach to deal with option in the lease contract. Paragraph 6.8 tells us that board tentatively decided not to adopt a components approach to lease contract and instead decided to adopt a single asset and liability approach.
Board considered two approaches to accounting for leases that incorporate the option to extend and terminate the lease contract.
· Uncertainty about the about the lease term addressed through measurement.
· Uncertainty about the about the lease term addressed through recognition.
After having narrow consideration board decided that the recognition criteria is far better than the measurement. Board came to this decision after gone through Example 4. Board says that measurement approach deals with many problems and it is difficult for the preparers to apply (paragraph 6.22, 6.23).
There is not such a big difference on this issue between existing and proposed standard. Existing standard goes with only one option at the end of the lease term, which is bargain purchase option. For make the option exercisable they do evaluation of the option at the inception date. Parties assure that the difference between the option price and fair value of that asset will be large enough to make the option work.
However proposed standard says that renewal option such as bargain purchase option, option to extend and option to terminate the lease are included in the lease term. So this could be regarded as procedural difference between the existing and proposed standard.
But lessee should recognize the lease term based upon the ‘most likely' lease term. This could be determining by the factors in 6.39.
Reassessment of the lease should be done at the end of each reporting date. This tells us about the procedural difference of the proposed standard with the existing standard. This says there should be no reassessment.
It is more relevant to reassess the lease term at every reporting date as it will reflect the current market situation. This in turn will increase the relevancy (6.47) of the users of the financial reports. So this might be treated as a philosophical difference between both of the standards.
Contingent rental: -
Existing standard said that the contingent rental should be expensed as they occurred. But in the proposed standard board tentatively decided that obligation to make contingent rental payment should reflect asset and liabilities. However board members decided contingent rental should be based upon the nature of contingency for the users of the financial reports. This difference can be treated as a procedural difference between both of the standards. (Paragraph 7.9, 7.10)
Philosophical difference is because there has been no event occurred so respondents think recognition of contingent rental in obligation to pay rental will overstate liabilities. Lessee has right-to-use the asset, so if we exclude the effect of contingent rental which can lead to understatement of asset, also it enhance the comparability for the users. Because this approach is much consisted with other asset acquisition.
Residual value guarantees: -
Difference in procedure of existing and proposed standard, in existing standard residual value should be included in minimum lease payment at present value. But in proposed standard board decided to use single asset and liability approach rather than component approach as mentioned above as well. The residual value guarantee should be included in obligation to pay rental based upon measurement of probability-weighted estimate or most likely rental payment. (Paragraph 7.37)
As speaking for the philosophical difference, board thinks that both of the new approached developed to measure the residual value guarantee is more relevant for the users
- in the existing standard board says that the obligation to pay rental and right-to-use asset should be on the face of balance sheet, but there should be no disclosure or extra note at the foot of the balance sheet. Other side proposed standard decided to use disclosure or foot note.
The philosophy behind this is again the same; it is more relevant for the user for their decision-making purposes. As the information is presented in separate disclosure or notes so it will be easily accessible.