Leasing

Introduction Lease is simply define as an agreement whereby one party, who owns the asset called the lessor, hereby transfer the right to use that asset to another party called the lessee, for a stated period of time at an agreed rental. The complication is in whose balance sheet will the asset be recognised, this entail the consideration of substance over form concept. Barry Elliot el al., (2009). The substance over form concept simply state that financial statement should reflect the economic effect of a transaction rather than its legal form, the International Accounting Standard Board (IASB) framework codifies this principle and requires financial statement to reflect the economic substance of transaction rather than its strict legal form. As leasing becomes a vital source of finance for an organization and with the massive growth in the leasing industry not only in the UK but worldwide, it is vitally important that user of financial statement are provided with complete information about companies leasing transaction. According to R.Perera the value of lease equipment in 1985 represent more than 20% of capital expenditure in the UK. However, the current leasing accounting standards require companies to classify leases as either finance or operating leases. Operating leases is not recognised on the balance sheet, while finance lease is revealed as company’s liability. The current leasing standard has been criticised by user of financial statement including the chairman of the (IASB). Sir David Tweedie “the current lease accounting standard allowed companies to understate their financial commitment as their lease are kept off balance sheet,’’ this is as a result of the current lease standard based on rule based standard which allow companies to structure their leasing transaction that suit them. For instance, companies can negotiate for 89.99% of the fair value of the asset, which they will classify as an operating lease and are not recognised on their balance sheet but rather charged as an expense in the income statement; potentially large liabilities build up off balance sheet. Consequently to this approach both board of the International Accounting Standard Board (IASB) and the Financial Accounting Standard Board (FASB) has proposed a new approach to leasing accounting standard that will eliminate the discrepancy in the current lease standard and require all lease transaction to be recognised on the balance sheet. The history and development of lease accounting standard The current accounting leasing standard in the UK, is based on the Statement of standard Accounting Practice No.21 (SSAP21), which came into force 1984 and was introduced by the Accounting Standard Committee “Accounting for lease and hire purchase contracts,’’ (IASB 2003). The SSAP21 include a bight line test and it distinguish between a finance lease and operating lease, the standard define a finance lease as a lease with the present value of the minimum payment at the commencement of the lease amount to 90% or more of the fair value of the lease asset and other lease are classify as operating lease While the international leasing standard is based on International Accounting Standard (IAS17), this standard was issue 1982 by the International Accounting Standard Committee (IASC). With the financial objective to curtail the use of off balance sheet financing (OBSF) and reflect the economic substance of the leasing transaction. The justification for this is that the legal form is distorted as large liabilities then build up as off balance sheet finance which result the lease asset not recognised on the balance sheet, whereby the following ratios will be distorted; Non-current asset turnover, Return on capital employed, Debt/Equity gearing. IAS17 was revised in June 1996 due to some essential issue that was communicated to (IASC) by the International Organization of Securities Commissions (IOSCO). The IOSCO advised the IASB to consider as a long term project a new approach for lease capitalization. IOSCO emphasise that all lease with a term that is more than one year with the current lease that are classified as operating lease should be classified. And in the U.S. accounting leasing standard is based on Statement of Financial Accounting Standard (SFAS13) which was issue November 1976, and has been edited nine times and subject to several clarifications. The SFAS13 is similar with the IAS17 the only difference is the bright-line test of 75%-90% that is not mention in IAS17. SSAP21 as well as IAS17 and SFAS13 simply distinguish between finance lease and operating lease (Perrin 2008). A finance lease is a lease that transfers all the substantial risk and rewards of ownership (IASB 2003), while an operating lease is a lease that is not finance lease. The process of the proposed new accounting leasing standard jointly undertaking by the IASB and FASB A working group comprise of board members and senior staff member from the G4+1 group. The G4+1 group are a group that comprise of representative of accounting- settlers from New Zealand, Australia, Canada, United Kingdom, the United States and the IASC. The working group was created as to undertake a study on current lease accounting standard. The working group affirm that the existing national and international accounting leasing standards is arbitrary and not satisfactory and as a result of the study they issue a special report in 1999, which concluded that operating leases should be recognised on the balance sheet and treated as same way as the finance lease, this treatment is on the basis that a lease contract will create a right and obligation that meet the definition of asset and liability that are align with the conceptual framework of IASC. W.McGregor explained that: “A lease contract convey a right to a lessee to use the leased property; in the language of the conceptual frameworks, the lessee controls the future economic benefits embodied in the leased property for the period of the lease term. Similarly, the lease contract establishes an obligation on the lessee to sacrifice future economic benefits to an external party in the payment for the use of the leased property.’’