IFRS update October 2005 – Leasing

Leasing in the UK is big
business. More than a million vehicles are leased every year, along with
property, land and equipment. But there is a cloud on the horizon of the
industry, notably in the shape of IAS17.

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The standard is yet to challenge others in the race for unpopularity, having
little effect on straight operating leases, but for companies with large capital
assets its impact is likely to be far reaching.

The standard that has existed since 1982 but was amended in 2003 as part of
an improvements project, is an attempt to merge US rules-based GAAP with UK
principles-based practice.

The US standard, FAS13, sets very clear criteria for defining an operating or
finance lease, while UK GAAP was based on a series of presumptions and ‘a degree
of common sense.’ IAS17 sets out such principles, but with practice examples
that are suspiciously similar to the US rules.

The main impact of IAS17 has been to force companies to treat land and
buildings as separate leases. Businesses that have leased property are now faced
with the rather onerous task of separating and assessing the rental value of the
land and buildings, then determining the type of lease they have and how they
should be accounted for.

‘It is very complicated,’ says John Williamson, director and leasing
specialist at PwC. ‘It’s not an easy task to split the two. The IASB hasn’t set
clear guidelines on how these should be done and the valuers have struggled with
the methodology,’ says Williamson.

‘The changes for lessees will be on long-term real estate leases and even
here it is not all leases that will be affected. The main impact will be on
property leases that were perhaps marginal under UK GAAP but when split under
IFRS clearly fall for the buildings to be treated as finance leases.

‘Cars and assets other than property are likely to be classified similarly
under IFRS as they are under UK GAAP’, he adds.

The waters become rather muddy when leases become complicated or when assets
can be depreciated and the interest charges change over time. This could apply
to buildings and to equipment with the higher charges up front. In these cases
they can be treated as capital finance leases and go straight on the balance

‘There are aspects of accounting standards which don’t seem particularly
important but when you put them in the context of numbers they can be
significant,’ Williamson says. ‘This could have a significant effect on
businesses with large capital assets, such as transport or logistics.’

Companies with long property leases are also grappling with the standard and
have been forced to go back to the start date of the arrangement to separate the
rental values and restate their accounts. For those 20 years into a 35-year
contract it has not been an easy experience.

This has meant a huge amount of work ­ particularly for large leasing
companies. This is because the amounts recognised in the income statement are
calculated on a different basis under IFRS even though the cashflows to the
company are unaffected.

Tax structured leases will be particularly affected and often need to be
evaluated on a one by one basis to work out the correct amounts that should be
included in profit in each financial period.

But most of the vehicle leasing industry has breathed a collective sigh of
relief, with the standard having little impact to date on businesses and

However, the IASB is keen to ensure that as much is on balance sheet as
possible, famously claiming that the only genuine operating lease is a taxi
journey. It has already begun initial work on redefining leasing accounting but
progress has been slow and most don’t expect any changes until 2008 at the

‘There is a planned refinement to the leasing standard that could move assets
obtained under an operating lease on to the balance sheet,’ says John Boon,
finance director of vehicle management company LeasePlan. ‘This is a research
project, still in its early stages and developments could be years away.’

He adds that any reforms would need ‘extensive consultation and a long
transition period’.

So like many of the current standards, IAS17 is still a work in progress and
there could be significant changes.

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resource centre

Related reading

Fiona Westwood of Smith and Williamson.