Exposure Draft 2010 and Its Affects on Lease Accounting

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Existing lease accounting standards require lessees to classify their lease contracts as either finance or operating leases. If a lease is classified as a finance lease, assets (and liabilities) are recognized in its statement of financial position. For an operating lease, the lessee simply recognizes lease payments as an expense over the lease term. This split into finance and operating leases has given rise to a number of problems.

The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) has recently issued a combined exposure draft on Leases (ED 2010/09) resulting in a converged standard, in an attempt to rectify the weaknesses in the current standard. Significantly impacting how lessees and lessors account for and report leasing transactions in their financial statements.

Australian Accounting Standards Board (AASB) 117 Leases incorporates IAS 17 Leases as issued and amended by the IASB. Entities that comply with AASB 117 as amended will simultaneously be in compliance with IAS 17 as amended, with the exception of entities preparing general purpose financial statements under Australian Accounting Standards – Reduced Disclosure Requirements.[1]

Paragraph 4 of AASB 117 defines a lease as:

A lease is an agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an asset for an agreed period of time.

At the inception of the lease, the lease is classified either as an operating or finance lease; as required by paragraph 8 of AASB 117, with the lease classification depending on the substance of the transaction rather than the form of the contract. The key criterion of the finance lease is the transfer of substantially all risks and rewards without the transfer of ownership. The Standard provides examples and indicators of situations that individually or in combination would normally lead to a lease being classified as a finance lease.[2]

Under the paragraph 20 of AASB 117 the lessee is required to recognize and determine the arising assets and liabilities in its records, upon successful classification of the lease either as a finance or an operating lease. The major difference arises in the subsequent measures of the finance lease apportioning the finance charges and the outstanding liability. Depreciation is charged in accordance with the AASB 116 Plant, Property and Equipment in the finance lease, where as the operating lease is charged on a straight line basis. As lease payments for finance leases are made over the duration of the lease period, paragraph 25 of AASB 117 requires lease payments to be classified into the following components:

• Reduction of lease liability

• Interest expense incurred

• Reimbursement of lessor costs

• Payment of contingent rent

Disclosures requirements under the AASB 117 for both operating and finance leases slightly differ as well, where the contingent rent for finance lease is recognized as an expense in the financial statements where as for an operating lease the contingent rent along with minimum lease payments and sublease payments is disclosed separately. A full and in-depth analysis is shown in table 1 and 2, stating the recognition, measurement and disclosure requirements for the finance and operating leases respectively, adhering to the AASB 117.

Table 1: Measurement and Disclosure Requirements for Finance Leases in the Financial Statements of Lessees according to AASB 117

Table 2: Measurement and Disclosure Requirements for Operating Leases in the Financial Statements of Lessees according to AASB 117


Due to the thin distinction between operating and finance leases, the IASB and the FASB issued a joint venture Exposure Draft (ED) 2010/09. The previous models were severely criticized for failing to meet the needs of financial users keeping in mind the basic of accounting principles;...
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