Accounting

The Reasons Why IAS 17 Lease Was Replaced By IFRS 16

Accounting for leases by most countries is very comparable, in that most countries require the application of principles similar to those in IAS 17 (Leases). However, it is also recognized that the accounting principles applied are flawed.

 In July 2006, as a result of the agreement between the IASB and the FASB to converge accounting standards, a joint working party was formed between the two bodies to propose a new accounting standard on leases. The aims of the project were stated as:

  •  to produce an improved accounting standard that faithfully reports the economics of leasing transactions
  •  to develop a principles-based standard
  •  to produce a converged standard that can be applied internationally.

 As noted in the information provided for observers at the IASB meeting in July 2008, the main concerns about the current IAS 17 were:

  •  the dividing line between finance and operating leases is hard to define in a principled way
  •  any dividing line means that similar transactions are accounted for differently
  •  obligations under non-cancellable leases are little different from borrowings, but for operating leases they are not recognised as liabilities
  • assets used in the business that are held under operating leases are not shown on the statement of financial position, thereby overstating return on assets
  • leases are scoped out of the financial instruments standards, leading to inconsistencies between leases and similar transactions
  • lessor accounting is based on a deferral and matching model that is inconsistent with the direction the revenue recognition project is likely to take.

 Currently, leases are classified into finance and operating leases. The IASB staff produced five reasons why the requirement to classify leases should be removed:

  • All leases give rise to a right to use the leased item that meets the definition of an asset; a single conceptual model to account for all leases is preferable.
  • The removal of classification would result in a simpler accounting standard.
  • Classification is a difficult process, often resulting in similar transactions being accounted for differently. Removal of classification would result in similar transactions being accounted for in the same way.
  • Retaining the classification may result in inconsistencies in how the minimum lease payments are determined for classification purposes. For example, contingent rentals may be included for finance leases but not operating leases.
  • Any differences between current accounting requirements for finance leases and any new model developed for operating leases are unlikely to justify the additional complexity of a classification requirement.

At last, IFRS 16 Leases is issued on 13 January 2016 and has a mandatory effective date of 1 January 2019. Now, it would have a major effect on lessees that have a large number of operating leases because these would now be accounted for in the same way as finance leases. Also, all lessees would be affected by the changes in accounting for lease options and contingent rentals. 

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