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The Accounting Standards Board of the UK published the now infamous “G4+1 Paper” in December, 1999. The Discussion Paper was expected to constitute the framework upon which national and international accounting standard setting bodies would consider revisions to current lease accounting. The paper was the joint work of the following standards boards: Australia, Canada, New Zealand, United Kingdom, United States and the International Accounting Standards Board. It proposes that the objective should be to record, at the beginning of the lease term, the fair value of the rights and obligations that are conveyed by the lease measured by the fair value of the consideration given by the lessee, including the liabilities incurred, except where the fair value of the asset received is more clearly evident. The G4+1 further states that Leases that are at present characterized as operating leases (and therefore not included on the balance sheet) would give rise to assets and liabilities – but only to the extent of the fair values of the rights and obligations that are conveyed by the lease. A G4+1 Special Report on lease accounting, “Accounting for Leases: A New Approach-Recognition by Lessees of Assets and Liabilities Arising under Lease Contracts” (1996), examined the deficiencies in existing national and international accounting standards on leasing and explored a conceptual approach to accounting for leases based on the financial reporting principles adopted by the standard-setting bodies represented in the G4+1. That report, which focused mainly on lessee accounting, concluded that the distinction between operating leases and finance leases that is required by present standards is arbitrary and unsatisfactory. The main deficiency of these standards noted in the report is that they do not provide for the recognition in lessee’s balance sheets of material assets and liabilities arising from operating leases. The report suggested that the comparability (and hence usefulness) of financial statements would be enhanced if the differing treatments of operating leases and finance leases were replaced by an approach that applied the same requirements for all leases. This position Paper also concludes that leases can be distinguished from executory contracts by the fact that leases cease to be executory when the lessor has provided the lessee with access to the leased property for the lease term. The proposals would, therefore, not apply to executory contracts, including take-or-pay contracts or service contracts. The Paper also proposes significant changes to lessor accounting practices. Lessors would report financial assets (representing amounts receivable from the lessee) and residual interests as separate assets. The amounts reported as financial assets by lessors would, in general be the converse of the amounts reported by lessees as liabilities. The definitions of assets and liabilities within the frameworks are particularly well suited to cope with leases, since they focus on control of rights acquired and on obligations incurred rather than on “quasi-ownership” that requires polarizing alternatives. Where a lease contains a contract for services the two elements should be accounted for separately. No specific exemption should be proposed for short leases; reliance should instead be placed on the principle of materiality. The Group believes that leasing is not similar to ownership – and the accounting treatment should not make transactions that are not alike appear to be alike. Indeed, an important effect of the Group’s recommendations is that the accounting treatment of leases would generally reflect differences between leasing and ownership. Some leases contain multiple options. For example, the lessee may have the choice of either purchasing the asset at the end of the initial term or renewing the lease for a further term. The lessee’s assets and liabilities at the beginning of the lease term would generally be determined as those arising from the least cost option. The exercise of options will give rise to additional assets and liabilities, reflecting the fair value of the additional rights and obligations obtained and assumed by the lessee as a result of the exercise. Contingent rentals (in excess of the minimum payments, or greater amount, recognized at the beginning of the lease term) should be recognized when the contingency criteria are met. As a general principle, it is the Group’s view that a gain should be recognized at the beginning of the lease term if (a) there is evidence that the value of the lessor’s assets (less its liabilities) has increased as a result of its performance in entering into the lease contract, and (b) the increase can be measured reliably. The Group therefore proposes that there should be a presumption that no gain or loss arises at the beginning of the lease term unless there is evidence that the carrying amount of the property immediately before the beginning of the lease was less than its fair value. For example, a manufacturer leases equipment that cost 100 to produce, and has a normal selling price of 120. The present values of the lease payments and the estimated residual value, calculated by discounting the expected cash flows to the selling price of 120, are determined as 70 and 50 respectively. The manufacturer-lessor would recognize a receivable of 70 and reduce the carrying amount of its asset by 70 / 120 of 100, ie 58. This would leave its interest in the residual value stated at 42 (100 – 58). The manufacturer-lessor’s total assets would be 112 (70 + 42), resulting in a recognized profit of 12 (ie 70 / 120 of 20, the profit arising on a normal scale). |
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