Leases

The ASB is undertaking a research project on leases for the IASB. The project aims to develop a single method of accounting for leases that is consistent with the IASB’s Framework. The ASB presented a project plan to IASB at its meeting in May 2003. The recommendations of the G4+1 in its position paper Leases: Implementation of a New Approach (1999) and the responses provide a valuable resource for the project. However, it is intended that all of the issues to be considered in the project will be examined from first principles and that the G4+1 conclusions will not be assumed. Indeed, several of the IASB’s ongoing projects are addressing issues that are similar to those that arise in leasing. These include work being undertaken on revenue recognition, measurement, financial instruments, derecognition and consolidation. In some of these cases, current thinking has moved ahead of the thinking at the time of the G4+1’s work.

At the IASB’s meeting in November, the ASB presented a paper discussing the foundations of a conceptual model for analysing the assets and liabilities arising from lease contracts. The paper focused on major rights and obligations that are usually conveyed by leases, ie rights of use, rights and obligations to return property, rights to receive and obligations to pay rentals. The IASB tentatively agreed that recognising the assets and liabilities that arise from all leases would provide more relevant, reliable and comparable financial information than recognising assets and liabilities only in respect of finance leases. Therefore, rather than focusing on whether a lease conveys rights similar to outright ownership, it was proposed that a conceptual model should analyse the contractual rights and obligations in lease contracts and identify the changes to assets and liabilities that arise from them.

The paper considered the application of a conceptual approach to some simple lease examples through the analysis of contractual rights and obligations, including the identification of recognition points for changes in assets and liabilities. Under this analysis, the signing of a lease (ie before the equipment is delivered to the lessee) gives rise to certain contractual rights and obligations, but these resemble a forward contract where each party has the right to require the other to engage in the transaction. In many cases, delivery of the leased asset (which gives the lessee control over the right of use and access to future economic benefits) would be a significant act of performance by the lessor and the appropriate point for the recognition of changes in assets and liabilities. This approach is consistent with that being explored in the IASB’s revenue recognition project - after all, a lease may be viewed as a contract giving rise to a sale of rights of use to the lessee. The IASB was keen to consider lessor accounting issues, including when it is appropriate for lessors to derecognise leased assets and recognise revenue, early in the project.

Some suggest that a lessee should recognise an asset reflecting the right to use the whole of the leased property and a liability that includes the obligation to pay rentals and return the leased property at the end of the lease. Neither ASB nor IASB supported a ‘whole asset approach’. Instead, the assets and liabilities that arise from a lease would reflect the conveyance of the right of use for the period of the contract. This analysis also suggests that where a lease is freely cancellable by the lessee or lessor, the asset and liability amounts recognised by the lessor and the lessee should reflect both (i) the conveyance of the right of use up to the date at which the lease can be cancelled and (ii) the lessee’s or the lessor’s option in respect of periods beyond that date.

A further paper addressing cancellation and renewal rights was considered at IASB’s January meeting.

Reporting financial performance

The ASB is engaged in a joint project with the International Accounting Standards Board in the area of reporting financial performance. The main focus of the project is the development of a single statement of comprehensive income to replace the profit and loss account and statement of total recognised gains and losses (STRGL) required by FRS 3 ‘Reporting Financial Performance’.

The IASB/ASB have adopted a principles-based approach to revising the format of the income statement. This approach takes as its starting point an overall objective: “to categorise and display all income and expenses* for the period in a way that enhances users’ understanding of the entity’s financial results and that assists users in forming expectations of future income, expenses and profit or loss.”

In 2003, IASB and ASB discussed an outline statement with companies and small groups of preparers and users of financial statements. Many of those consulted in the field visits doubted the need for a radical re-shaping of performance reporting and, particularly in continental Europe and Japan, urged that net income in its present form should be retained. Others, especially users but also some preparers, welcomed the project as an attempt to bring greater standardisation into the reporting of the activities of a period and to find a means of dealing with the often large and volatile gains and losses that were increasingly becoming recognised in financial reporting. Many respondents also urged the need for the project to be co-ordinated with a similar project by FASB.

In the light of these findings, the two Boards agreed that more time should be taken to permit a fuller debate with all interested parties. The next step would be a discussion paper. This would cover all the issues, including those relevant to the FASB project.

*In IASB terminology ‘income and expenses’ includes all changes in equity other than transactions with owners. The equivalent expression in UK GAAP is ‘total recognised gains and losses’.

Business combinations

In December 2002 the IASB published the results of Phase I of its work on this topic, ED 3 ‘Business Combinations’ together with the associated exposure drafts of revisions to IAS 36 ‘Impairment of Assets’ and IAS 38 ‘Intangible Assets’. At the same time the ASB published a Consultation Paper including the IASB text but proposed not to adopt it into UK standards until the IASB had completed the whole of its business combinations project including Phase II.

The IASB invited comments on its proposals by 4 April 2003 and in June 2003 started considering the comments received as well as the feedback from field visits with companies in various countries and round table discussions with people working with the North American equivalent standards in the USA and Canada.

Some of the key proposals in ED 3 (and the associated proposed revisions to IAS 36 and IAS 38) were:

• the abolition of merger accounting and instead a requirement to identify an acquirer in every business combination;
• the non-amortisation of goodwill, to be replaced by an impairment-only approach using a two-stage impairment test;
• ‘negative goodwill’ to be treated as a gain immediately;
• greater recognition of intangible assets in a business combination (through amendments to the definition and presumptions about reliability of measurement);
• detailed disclosures relating to the recoverable amount of cashgenerating units containing goodwill or intangible assets with indefinite useful lives.

During its redeliberations of the proposals in ED 3 the IASB has decided to amend certain of its original proposals. In particular:

• the impairment test to be applied to goodwill;
• the recognition of intangible assets;
• the disclosures relating to recoverable amount.

Impairment test

The IASB has decided to retain the existing IAS 36 approach to measuring impairments of goodwill (which is very similar to the impairment test in FRS 11). This means that a consistent impairment test will be applied to goodwill and other assets and also that, where a cash-generating unit is impaired, the impairment will be applied initially to goodwill with any excess then being applied to the other assets in the unit.

Recognition of intangible assets

The IASB has decided to clarify that where a group of related tangible and intangible assets generate the same cash flows they can be recognised as a single asset provided they have similar useful lives.

Disclosures relating to recoverable amount

The IASB has decided to amend the proposed requirements relating to these disclosures in a number of ways which should have the effect of meeting their objective, but reducing the volume of disclosure required.

The IASB is planning to publish the final standards arising from Phase I of the Business Combinations project before the end of March 2004.

Proposed Interpretation of the Statement of Principles for Public Benefit Entities

In May 2003 the ASB published a Discussion Paper including a Proposed Interpretation of the Statement of Principles for Financial Reporting, for Public Benefit Entities. Comments were invited and during the Autumn the ASB and its Public Sector and Not-for-profit Committee (PSNC) have reconsidered a number of issues in the light of the comments received.

The main issues that have been discussed include:

• the defining class of user;
• the definitions of the elements of financial statements;
• business combinations;
• contributions from controlling parties;
• notional transactions;
• liabilities; and
• grants.

Following its discussions an initial conclusion has been reached by PSNC on the way forward in relation to most of the topics above, but not all are likely to result in significant amendments to the Proposed Interpretation included in the Discussion Paper.

For example, the PSNC continues to believe that there should be a defining class of user for the financial statements of public benefit entities, and that the defining class of user should be ‘funders and financial supporters’. However, it is likely that the revised Interpretation will include some further discussion of the reasons for identifying a defining class of user, state why ‘funders and financial supporters’ were chosen and refer to more other users, such as beneficiaries.

It is possible that some more significant changes will be made to the Interpretation relating to contributions from controlling parties and notional transactions. The current intention is to suggest that only those contributions that have clearly established rights over the residual interest in an entity should be deemed ‘capital contributions’, with all others being gains reported in the performance statement.

Further discussion will be needed in relation to ‘notional transactions’, and if relevant to clarify differences between notional transactions and donated services.

The two most difficult issues relate to liabilities and grants (in particular capital grants). PSNC has spent some time discussing these issues and aims shortly to propose solutions to the Board. It is hoped to publish the revised Interpretation in 2004.