Table of contents

  List of abbreviations  II

  List of figures  III

I.  Introduction  1

II.  International financial reporting for leases  2

  A. Objectives of international financial reporting  2

  B. Accounting for leases under IAS 17  3

1.  Classification of leases  4

2.  Accounting for leases  4

3.  Key differences between IFRS, US GAAP and German Commercial Code  6

III.  Improvements on current lease accounting  8

  A. Assets and liabilities: Different perceptions  8

1.  The IASB’s understanding of assets and liabilities  9

2.  Should lease contracts be separated at all?  9

3.  Leases and executory contracts  10

  B. Measurement and accounting for leases under the new approach  11

1.  Proposed lessee accounting under the new approach  11

2.  Leases with optional features  12

3.  Financial components approach vs. whole asset approach  15

4.  Recent developments  18

  C. Effects on profit determination and distribution  18

1.  Operating leases vs. finance leases  19

2.  Sale and leaseback transactions  19

3.  Financial components approach vs. whole asset approach  21

IV.  Conclusions  22

  Appendices  IV

Appendix A:  Classifying lease transactions under IFRS and US GAAP  IV

Appendix B:  Accounting for finance leases under IAS 17  V

Appendix C:  Accounting for leases according to German Commercial Code  VI

Appendix :D  Renewal options according to the G4 1 position paper  VII

Appendix E:  Financial components approach vs. whole asset approach  VIII

  References  IX

  Other references  XI

I

List of abbreviations

II

  List of figures  

  Figure 1 : Objectives of financial reporting according to IFRS  

  Figure 2 : Synoptic presentation of leases’ optional features  

  Figure 3 : Financial components approach vs. whole asset approach  

  Figure 4 : Treatment of sale and leaseback transactions according to IAS 17  

  Figure 5 : Classifying lease agreements under IFRS and US GAAP  

  Figure 6 : Additional criteria for classifying lease agreements under US GAAP  

  Figure 7 : Accounting for finance leases under IAS 17  

  Figure 8 : Accounting for leases according to German full amortisation contracts  

  Figure 9 : Accounting for leases according to German partial amortisation contracts  

  Figure 10 : Accounting for renewal options according to the G4 1 position paper  

  Figure 11 : Financial components approach vs. whole asset approach  

III

I. Introduction

The globalisation of capital markets is driving the increasing convergence of accounting standards worldwide. Recently, the progress toward attaining a global financial reporting framework has accelerated, and many significant steps have been taken. The most important step is the formation of the International Accounting Standards Board (IASB), which replaced the International Accounting Standards Committee (IASC), as part of a comprehensive restructuring of the international accounting standard-setting organisation in March 2001. Since then the acceptance and adoption of International Accounting Standards/International Financial Reporting Standards (IAS/IFRS), hereafter referred to as IFRS, has been growing rapidly. From 01 January 2005 all publicly traded European companies shall account for their consolidated accounts according to IFRS. 1

In accordance with § 292a German Commercial Code (Handelsgesetzbuch, HGB) German parent companies may account for their consolidated accounts only according to international accepted accounting standards, according to prevailing opinion such are IFRS and the United States Generally Accepted Accounting Principles (US GAAP). Due to the Accounting Law Ref-ormation Act (Bilanzrechtsreformgesetz, BilReG) all publicly traded German companies shall account for their group accounts according to IFRS from 01 January 2005 except those that are already applying US GAAP (from 01 January 2007). Furthermore all enterprises may account for their individual accounts according to IFRS in addition to German Commercial Code which still is obligatory for tax, and profit determination and distribution purposes. Due to the commitment of applying IFRS for consolidated accounts international financial reporting issues need to undergo a closer examination. This paper deals with the accounting for leases. First current lease accounting standards are described with a focus on IAS 17 and its key differences to US GAAP and German Commercial Code. Next proposed improvements on current lease accounting standards are dealt with, focussing on new approaches discussed in the accounting and lease literature and a possible treatment of leases with optional features. After this the proposed approaches’ effect on profit determination and distribution is discussed. The final part offers a conclusion to some of the issues raised in this paper.

¹ Publicly traded companies are companies, whose shares are traded on a regulated market in the EU.

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II. International financial reporting for leases

A. Objectives of international financial reporting

The main objective of the IASC Foundation as described in its constitution is “[…] to develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world’s capital markets and other users make economic decisions.” ² The IASC Foundation is an independent organisation consisting of two main bodies, the Trustees and the IASB, as well as a Standards Advisory Council (SAC) and the International Financial Re-porting Interpretations Committee (IFRIC). The IASB only has responsibility for setting accounting standards. ³ In order to secure consistency the IASB Framework for the Preparation and Presentation of Financial Statements (Framework) is the basis of deducting future IFRS and revising existing IAS. ⁴ The Framework first states underlying assumptions and qualitative characteristics of financial statements, and then deals with constraints on relevant and reliable information, being based on the main objective

“[…] to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.” 5

Figure 1: Objectives of financial reporting according to IFRS

² IASC Foundation, Constitution (2002), par. 2.

³ See http://www.iasb.org/about/general.asp (13.09.2004).

⁴ See KPMG (ed.), International Financial Reporting Standards (2003), pp. 6 f.

⁵ IASB, Framework (2001), par. 12.

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To be useful the information provided in financial statements have to fulfil the qualitative characteristics which are understandability, relevance, reliability and comparability. An essential aspect in lease accounting is the principle of substance over form as element of the principle of reliability:

“If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form.” 6

The international harmonisation process of accounting does not only give rise to considering in-formational aspects but also aspects of profit determination and distribution. Even though the IASB Framework does not provide information about any other objective than providing decision useful information it can be assumed that profit determination and distribution is considered by developing accounting standards. ⁷ Referring to the IASB Framework other research regarding profit determination and distribution is done by Schmidt. He comes to the conclusion that due to the fact that the IASB Framework admits the revaluation of assets but distinguishes between realised and unrealised profits, where the latter do not go through profit and loss, a possible profit determination and distribution purpose of accounting can be assumed. ⁸ One can not yet foresee IFRS’s future development but it would be negligent not to consider a possible profit determination and distribution purpose. Chapter III.C of this paper addresses this aspect in detail. After defining the general purpose of accounting the following chapter provides an overview and a comparison of current lease accounting standards. B. Accounting for leases under IAS 17

Since the previous chapter already touched on the principle of substance over form the author now connects this principle to current lease accounting standards. Accounting for lease transactions is an outstanding example for the appliance of the principle of substance over form, embodied in the IASB Framework. ⁹ According to IAS 17 a lease is defined as

“[…] an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.” 10

⁶ IASB, Framework (2001), par. 35.

⁷ See SIGLOCH, J., Rechnungslegung (2003), pp. 81 ff.

⁸ See SCHMIDT, I.M., Bilanzierung des Goodwills (2002), pp. 107 f.

⁹ See IASB, Framework (2001), par. 35, also see the previous chapter of this paper.

¹⁰ IASB, IAS 17 (2003), par. 3.

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