December 22, 2011
ACCOUNTING CHANGES COMING FOR SOME LESSEES BUT FOR MOST COMPANIES, IT’S BUSINESS AS USUAL

In this article, CFLA Chairman, Jeff Hartley, reviews proposed changes to lease accounting standards and practices. While the full impact of the changes to GAAP (Generally Acceptable Accounting Principles) and IFRS (International Financial Reporting Standards) and how they affect your business will not be known much before 2015-2016, the framework of the intended changes should begin to become clear late in 2012. Jeff asks for your feedback, if you’re in the leasing business take time to contact him, it could help.

This is a period of change for Canada’s GAAP (Generally Acceptable Accounting Principles) rules, the standard framework of guidelines for financial accounting.

The first change came in January 2011 with the introduction of International Financial Reporting Standards (IFRS). In the next couple of years, companies that adopt IFRS or are Canadian subsidiaries of US parents will see important changes in the accounting treatment for leased vehicles.

In 2011, Canadian businesses operate under alternative forms of GAAP: either Canadian Private Enterprise Accounting Standards (essentially traditional Canadian GAAP) or International Financial Reporting Standards (IFRS). IFRS is obligatory for “publicly accountable enterprises” (publicly-traded companies or companies that issue public debt), government business enterprises and those private companies that opt for IFRS. Canadian subsidiaries of European parents have also shifted to IFRS.

The majority of businesses in Canada are small or medium-sized private companies. As such, they can elect to use Canadian Private Enterprise GAAP standards, in which case, nothing changes. Lease accounting rules that have been generally used over the years, remain the same.

New lease standards
Those businesses subject to IFRS or US GAAP will feel a second change in 2015-16 with the expected implementation of a new set of lease accounting standards. Decisions on the proposed new rules are not yet final (expected later in 2012), but directions are clear.

Under current standards, leases are structured either to achieve a finance lease presentation (on balance sheet) or an operating lease presentation (off balance sheet with footnote disclosure). These current standards provide a clear division between whether a lease qualifies for closed-end lease or open-end lease treatment. These conditions will remain the standard under Canadian Private Enterprise GAAP (for now).

Accounting standard regulators and setters are concerned that current operating (closed-end) lease accounting provides insufficient information on, and inappropriate presentation of the amount of lessee assets and liabilities, potentially creating confusion among readers of financial statements.

The proposal is that all leases be recorded on the balance sheet. Calling it a ‘right-of-use’ accounting model, lessees will initially record assets and liabilities arising from lease contracts based on the present value of the lease payments. The asset is subsequently measured using a cost-based method while the liability is subsequently measured as a financial liability.

By way of example, where a lessee subject to IFRS or US GAAP acquires the right to use an asset and pays for that right with a commitment to make lease payments, a lessee would record:

• an asset for its right to use the underlying asset (the right-of-use asset), and
• a liability to pay rentals (liability for lease payments).

The right-of-use asset would initially be recorded at the present value of lease payments. It would then be amortised over the life of the lease (or useful life of the leased asset if shorter) then regularly tested for impairment. The right-of-use asset would be presented within the Property, Plant and Equipment category on the balance sheet but separately from assets that the lessee owns.

So, what will this accounting change mean for lessees subject to IFRS or US GAAP? If implemented as currently proposed, all leases will go on the lessee’s balance sheet as right-of-use assets with a corresponding financial liability. While this may seem like a simple solution, current proposed guidelines will cause accounting to become more complex with the requirement for estimation and continuous reassessment of lease terms, contingent rentals, residual value guarantees from the lessee, and term option penalties added to the mix.

It is important for a company to understand how these changes will affect it since there are balance sheet and income statement issues that may have broad consequences for a company’s overall funding structure.

That said, the good news is this: the essentials that make leasing an attractive business option remain: an efficient use of capital, flexibility, fleet management, replacement and disposal, access to lessor expertise. Leasing is an additional source of funding for assets that require specialized knowledge and understanding to finance and operate.

The next steps
The Canadian Finance & Leasing Association (CFLA) has been following this issue closely for over a decade. In collaboration with nine other national leasing associations from around the world, the regulators have accepted some of the changes we have pressed for favouring simpler, and arguably better, rules than originally proposed.

A joint Re-exposure Draft on Leases is expected from the International Accounting Standards Board and the U.S. Financial Accounting Standards Board in spring 2012. There will be a 120-day public comment period, probably the last chance to present our views, but the CFLA will be reviewing the proposals and their implications.

How, in your view will these changes impact business in Canada? Let CFLA know, your feedback is invaluable. If we don’t speak up, we won’t be heard.