Reactions to the Leases Exposure Draft

1. Reactions to the Leases Exposure Draft Mark Venus 5 November 2010

2. Reactions to the Leases ED The Leaseurope position • Leasing in Europe • Project motivations • Lessee accounting • Lessor accounting • Boundaries • Fudges and approximations

3. Reactions to the Leases ED Leasing in Europe • €209 billion new leases granted in 2009 • More than 5 million individual contracts • Average contract size of €27,000 • Types of assets leased: • Industry responsible for financing 20% • of all European equipment investment • Crucial for business of all sizes to • be able to access the assets they need: Types of finance used by European SMEs Real estate Other Machines & industrial equipment Rolling stock, ships, aircraft Leasing and renting 51% Overdraft 50% Loans > 3 years 45% % of new volumes 2009 Loans < 3 years 31% ICT 19% Factoring 9% Capital (private) Cars 6% Capital (venture) Commercial vehicles 0% 10% 20% 30% 40% 50% 60% Excluding real estate, if real estate is included, average of €35,000 Sources: Leaseurope 2009 Annual Survey of European Leasing and SME Access to Finance, Flash Eurobarometer, conducted by TNS Sofres/EOS Gallup Europe on behalf of the European Commission, 2005, covers EU15

4. Reactions to the Leases ED Leaseurope position on motivations • Some leases are structured, but leasing is not a structuring industry • IAS 17 does not have bright lines, but its application is influenced by FAS 13 and the 10% and 75% rules • The right answer would be to • Remove bright lines from FAS 13 • Tighten up IAS 17 disclosure requirements • A few thousand structured leases should not call into question millions of standard equipment leases

5. Reactions to the Leases ED Lessee accounting in the ED • All leases on lessee balance sheet (right of use), with corresponding financial liability •  Operational complexity • Rentals in optional extension periods and contingent rentals are included in the measurement on an estimated basis •  Accounting complexity • Purchase options are excluded and accounted for when exercised •  OK • Asset is depreciated straight line (generally) and liability amortises like a loan •  Acceleration of lease costs

6. Reactions to the Leases ED Leaseurope position on lessee accounting • Leases for fungible and readily exchangeable equipment should be considered as service contracts • Leases for less than 12 months should receive the same treatment • Rentals and optional period and contingent rentals (those not linked to a rate or index) do not constitute lessee liabilities and should be ignored • Asset and liability should depreciate via the annuity method to remain aligned (except non standard payment patterns)

7. Reactions to the Leases ED Lessor accounting in the ED • Short term  Operating lease accounting • Performance Obligation  Retain the underlying asset, create a new asset (receivable), and a new liability (performance obligation) • De-recognition  Recognise a receivable and reduce value of underlying asset accordingly, leaving a residual value • Transfer of control and all but a trivial portion of risks and benefits  Recognise an asset sale and a financing operation • Investment property  Apply IAS 40 unless using historic cost option

8. Reactions to the Leases ED Leaseurope position on lessor accounting • Performance Obligation is an accounting aberration • Does signing a contract create a new asset ?? • How does impairment of the underlying asset work ?? • Leave IAS 40 as it is • All other leases can be catered for by • De-recognition • Accruals accounting for short leases and leases that are service contracts • Rentals in optional periods and contingent rentals are not assets, and should be excluded

9. Reactions to the Leases ED Boundaries in the ED • Lease versus purchase • ED proposes that leases that transfer control and all but trivial amount of risks and benefits are NOT leases, but sales of the underlying asset • Lease versus service • ED reproduces IFRIC 4 guidance around the notion of specific asset and transfer of control • Leases of intangibles • Leases of all intangibles are scoped out, contrary to existing IAS 17

10. Reactions to the Leases ED Leaseurope position on boundaries • Leases are not sales and purchases and should not be accounted for as such  Danger: recognition of property rights, supervisory issues and tax status • Lease versus service boundary must be more clearly defined & scope to consider leases of fungible and exchangeable assets as being service contracts must be introduced  Gain: limitation of lessee complexity and right of use • Intangibles should be ‘in’  Convergence with US should not imply regression

11. Reactions to the Leases ED Fudges and approximations in ED • Nature of RoU (intangible/tangible): issue avoided • Disclosures • Major expansion of requirements • Inconsistent with an ‘improved’ model • Term option penalties: taken into account, but not defined • Residual value guarantees: inconsistent treatment between lessors and lessees • Impairment issue under Performance Obligation avoided • Sale and lease back: a different definition of ‘sales’ Inconsistent with right of use model • Cost/benefit analysis: superficial treatment only

12. Reactions to the Leases ED Conclusion • ED is probably unworkable as it stands, IASB should take the time to get it right, which is feasible • Beyond the conceptual flaws • Working group not used properly • Reality of the leasing market not catered for • Lip service paid to cost benefit to date and too little time going forward • Project driven by convergence agenda

13. Reactions to the Leases Exposure Draft Mark Venus 5 November 2010