Presenting two different approaches to defining the scope of the new lease accounting standard

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The first proposal of the discussion paper was the proposal of two different approaches to defining the scope of the new lease accounting standard. The first approach outlined that the scope of the proposed model should be based on the scope of existing leasing standards. In contrast, the second approach considered was to take a fundamental restructuring of the existing definition of a 'lease'. The board's preliminary view is to take to first approach and base the scope on the existing standards. [1] 

Logically speaking, basing the scope of the new standard on the existing scope will make a new standard easier to understand and implement, this is because the existing standards will be familiar to constituents. [2] It could also be possibly more proficient to concentrate on the key features of a new accounting approach for leases before seeing whether any modifications in scope are necessary. This is important to allow a substantial amount of time for a new standard to be completed by 2011, as intended by the boards. [3] 

Although the board has taken a strong stance against a fundamental reconsideration of the existing scope, they have considered making adjustments and appropriate inclusions/exclusions to facilitate improvements to the scope. In chapter 2 of the discussion paper, the boards conversed about whether 'non-core assets' and 'short-term leases' should be excluded from the scope [4] . Favouring to exclude or include either in the scope will be dependent on many aspects.

In terms of supporting the exclusion of 'non-core assets', users may believe that leases of assets that are not essential to the operations of an entity (non-core assets), are of little interest to them and other users of the entity's financial statements. The discussion paper provides an example in chapter 2 (2.16) whereby it states that an aircraft lease provides important information to the users of financial statements of an airline company, but does little to provide interest for users of a consumer's products company.

The second argument against inclusion of non-core assets is the fact that the costs associated with recognising and measuring the assets and liabilities arising from non-core asset leases overshadow the benefits. Costs would include professional costs such as legal and accounting costs. [5] 

There are also several rationales in supporting the inclusion of non-core assets. The first is that diverse entities may interpret the meaning of non-core assets differently, thereby reducing comparability for users. Secondly, non-core asset leases may give rise to material assets and liabilities. Users are likely to be interested in material assets and liabilities whether they arise from leases of non-core assets or from leases of core assets. [6] 

Further on, it can be argued that all assets are essential to the operation of a business. If an asset is not required for the business to operate effectively, why was it obtained?

From the two perspectives, we would advise the board to include non-core assets in the scope because it is essential to not compromise the quality of the standard for the sake of saving costs, while it also provides users of GPFRs a clearer picture of the company's position.

The treatment of 'short-term leases' should be similar to that of 'non-core assets'. Even though a rise in costs is likely, 'short-term leases' may be material and useful to users of GPFRs. By excluding this in the scope, it may also motivate businesses to make an effort in altering their leases as short-term in order to gain benefits (by making leases 'short-term', it classifies the lease as an operating leases and therefore cannot be stated in the balance sheet).

From the above considerations, it is advisable for the board to take the first approach in basing the scope on the existing one, however some changes are recommended, though not to the extent of the second approach (full reconsideration of scope).

RIGHTS AND OBLIGATIONS

The board proposes to implement an approach to lessee accounting that would oblige the lessee to recognise an asset representing its right to use the leased item for the lease term (the right-of-use asset), while also recognising a liability for its obligation to pay rentals. [7] 

By adopting this approach, it is advantageous for users of GPFRs because the IASB Framework represents the concept that GPFRs should provide information that is useful for decision-making purposes. A reason why it is useful for users is because the implementation of the measurement perspective indicates that all rights and obligations are required to be shown on the statement of financial position and not in the notes [8] . This may be useful to many users of GPRSs who do not fully understand the concepts or structural requirements of GPFRs (eg. being unaware of 'notes' in reports). Therefore it will provide them will a clearer picture of the company's position.

The current lease standard AASB 117 states that certain requirements are needed to be met in order for a lease to be classified as a finance lease, and consequently be show on the balance sheet. This means some operating leases are kept 'hidden' from users of GPFRs. IFRS 3 shows an example of the proposed method where the definition of control centres on rights rather than how much of a subsidiary is owned, despite of whether the control is obtained by holding 50% of the subsidiary or 99% of the subsidiary. [9] 

Reasons for not adopting this approach are far and few, one could possibly be arguing that this change is fundamental to the scope, and thus will be costly to implement and could possibly be difficult to adapt.

It is evident to us that the proposal is advantageous to users of financial statements.

INITIAL AND SUBSEQUENT MEASUREMENTS

The next proposal issued by the board is to initially measure the lessee's right-of-use asset at cost using the lessee's incremental borrowing rate, while implementing an amortised cost-based method to subsequent evaluation of both the obligation to pay rentals and the right-of-use asset.

Some companies have responded by saying the allocation of costs to the right of use asset and other amounts would be complicated, especially if the allocation would be made on the basis of the estimated future relative fair values or selling prices discounted using the incremental borrowing rate. [10] 

On the contrary, initially measuring the lessee's right-of-use asset at cost would be coherent with accounting for similar assets (i.e., an ownership interest that shares a similar right to use) and is coherent with the proposed method and practicable. Since the cost of the right-of-use asset will be an appropriate estimation to its fair value at the inception of the lease, consequently requiring lessees to initially measure the right-of-use asset at cost will provide users of GPFRs with similar information to measuring the asset at fair value at the inception of the lease.

In terms of amortised costing for subsequent measurement, it shows the financing costs inherent in a lease contract whereby the lessee reimburses for its right to use the leased asset over time as interest expense. The requirement for ongoing fair value measurement of the obligation to pay rentals would also be conflicting with the initial measurement of those amounts and also conflicting with the way similar liabilities are dealt. [11] 

Hence, we agree with the board's proposal on measuring both initial cost and subsequent costs.

Options to Extend or Terminate a Lease

The board proposes the lessee should recognise an obligation to pay rentals for a stated lease duration, (i.e., in a 10-year lease with a choice to lengthen for another 5 years, the lessee needs to choose whether its liability is an obligation to pay 10 or 15 years of rentals.) The boards tentatively decided that the lease term should be the most likely lease term. [12] 

Some would agree that this approach is better to addressing uncertainty about the lease duration through measurement, i.e. using an expected outcome approach to measurement. [13] The expected outcome approach could result in the lessee recognising an obligation to pay rentals that does not reflect a possible outcome. Moreover, measuring the likelihood of the exercise of a renewal option may be complex. This is highly conflicting for users of GPFRs as they cannot gain a reliable understanding of the current state of the obligation.

Under the present accounting model, some renewal periods (i.e., bargain renewal periods) are integrated within the initial lease term to avoid the potential evasion of the capitalization criteria. Those anti-abuse requirements would not be required in a model that acknowledges all right to use assets and rental obligations where there is not an "all or nothing" threshold for recognition. [14] 

Another argument is that an 'option' differs in economic substance from a non-cancellable commitment, because an option is an entitlement but not an obligation, to continue a lease. Incorporating the option periods within the lease term would overstate both the obligation under the lease and the right to use asset, and thus the essence of the agreement would not be fully represented, meaning it would not provide applicable information to users of the GPFRs.

For this reason, we disagree with the board's proposal and believe that information about options are economically valuable and would be useful to user. Therefore options should be recognised as assets and disclosed within the notes to the GPFRs.

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