Accounting for Leases
For financial years commencing on or after 1 January 2005, compliance with the International Financial Reporting Standards (IFRS) is required for Australian lessors and lessees. At first glance, the impacts appear minimal with the revised Australian Accounting Standard for Leases AASB 117 reading much like its predecessor. However there are some subtle and potentially significant differences – some of which are a result of other standards.
For finance lessors the impacts of IFRS primarily reside in AASB 139 - the Financial Instruments standard. Finance leases are a class of financial asset which result in income recognition on an effective yield basis, with any upfront fees received and incremental direct costs incurred in originating the business forming part of that yield. In addition, general bad debt provisions are no longer permitted with provisions only permitted for known or incurred losses.
The definition of an operating lease also changed, with the Australian definition moving into line with the current UK and US definition whereby any lease that is not a finance lease is defined as an operating lease. This is important for structured financiers who previously may have had to demonstrate that the lessor had retained substantially all the risks and rewards of ownership to qualify for operating lease treatment. There are some changes to the concept of ‘cancellability’. Under the old AAS 17, if a lease was cancellable, then prima facie this would present a strong case for operating lease treatment. Under AASB 117 however, lease cancellation needs to be ‘reasonably certain’ at inception. As a result, it will be more difficult to demonstrate operating lease classification based on cancellability alone.
For the medium term, the International Accounting Standard Board (IASB) continues to have on its agenda, a fundamental review of lease accounting moving from the long-standing ‘risk/reward’ basis to that of the more technically challenging ‘right-to-use’ concept. In July 2006, the IASB announced a joint project with the US Financial Accounting Standards Board (FASB) to rewrite the current International Lease Accounting Standard (IAS 17). Deliberations are on-going with more recently consideration being given to truncating and deferring the conceptual debate until after IASB/FASB standard convergence and applying current finance lease rules to all lessees, leaving lessor/lessee accounting asymmetrical.
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