Accounting issues in the asset finance and leasing industry
The Association of Chartered Certified Accountants (ACCA) is pleased to have the opportunity to comment on the above draft Statement of Recommended Practice (SORP).
In general we support the issuance of the SORP at this point, as an interpretation for the asset finance industry of SSAP21. While we support its main provisions, as noted below, this is as an interpretation of the existing standard and not necessarily an endorsement of the continuation of SSAP21's accounting approach indefinitely for lessors or lessees. We are aware that the ASB and the G4+1 group of accounting standard setters have a revision of lease accounting on their agenda.
Our response to the questions on pages 7 to 9 of the SORP is set out below, followed by other comments that we have.
Responses to the SORP's specific questions
Q1. Do you agree with the proposed accounting treatment in paragraphs 5.4.14 to 5.4.17, and in particular, do you agree that it is only incremental costs which are treated this way?
We are satisfied that the definition of lessor's direct costs is restricted to incremental costs very closely associated with the setting up the lease. This seems right for finance leases, being costs directly recoverable out of the leasing income. This seems also in line with the treatment in FRED17 Measurement of Tangible Fixed Assets of the attributable costs of tangible fixed assets (for operating leases).
The SORP, however, allows the option of either including such direct costs in the lease or writing them off as incurred. We consider that alternative treatments in accounting standards are inherently undesirable, and we would not support an option in the SORP either. The SORP should recommend one treatment or the other, and we would prefer that of capitalisation to that of immediate write-off.
Q2. Paragraphs 5.3.32 and 33 set out the circumstances under which the annuity and after-tax methods can be used in accounting for the profit from operating leases. Do you agree that the use of such methodologies, and the corresponding depreciation charges arising as a consequence, is appropriate in the circumstances described?
This question asks whether depreciation spreading methods (the annuity or after tax methods on page 30) should be allowed, which make the time profile of net income from some operating leases comparable to finance leases. The dividing line between finance and operating leases can in some cases be a fine one, and if a lessor has a lease which just fails to qualify as a finance lease then it seems reasonable that a comparable accounting could be allowed. SSAP12 encourages the use of depreciation methods appropriate to the particular circumstances.
If these methods are to be allowed, then the conditions should be amended slightly. Paragraph 5.3.32 should read "e.g. the asset generates net positive cash flows over the term of the lease", perhaps this should say "positive net cash flows". Also the term of the lease should be for a significant part of the asset's useful economic life.
We note that the SORP refers to three "principal" methods of depreciation. This is not therefore an exclusive list and others (e.g. reducing balance or usage related) could therefore be used.
Q3. Do you agree with the draft SORP's proposal for the treatment of volume related bonuses?
Yes. We agree that rebates to lessors are treated as income and spread in a similar way over the life of the lease. The alternative treatment, of reduction in the cost of operating leased assets, would not always be allowed under the Companies Act's netting-off rules.
Q4. Do you support the proposed disclosures set out in paragraph 5.9.1 of the draft SORP?
The disclosures set out in paragraph 5.9 are additional to those in SSAP21. Some of these, particularly (c) and (d), look significant new additions. They are, however, all required by IAS17 (revised), which also requires other disclosures for lessors including:
- gross investments in finance leases
- unearned finance charges
- allowance for uncollectable receivables
- contingent rental income under operating leases
- We think that the first two of these could be usefully incorporated into the SORP.
We agree with the SORP's exclusion of this option from SSAP21.
Other comments
Definition of finance leases
In paragraphs 3.6 to 3.8 of the commentary section, two key attributes of the distinction between a finance and an operating lease are discussed - residual value risk and break points. In our view these need also to be included in the statement of recommended practice section itself.
Alternative income allocation methods
The SORP's preferred method for finance leases is the actuarial after tax method. It does, however, discuss various other methods which can only be used where income is not taken significantly earlier than under the preferred method. This implies that the preferred method has to be calculated anyway, even where the alternative's main attraction is that it is simpler to calculate (e.g. sum of the digits). In these circumstances the SORP may as well insist that the preferred method is used.
Impairment
The SORP should ensure that it is consistent with FRS11 on impairment that has now been published. Paragraphs 5.4.8 and 5.4.9 do not at present seem to be so, for example on discounting.
Provisions
Likewise paragraph 5.4.19(d) suggests that provisions for maintenance costs could be made. This seems unlikely to be allowed under the expected provisions standard.
PFI
ASB is developing guidance on these contracts, and perhaps the SORP should make reference to that.