The pendulum swings again

The big news last month was that the FASB & IASB decided to reinstate a close cousin of operating lease accounting for lessees, with a level expense recognition pattern (though the leases would still be reported on the balance sheet). It was a sharply divided vote. Now, a few members of each board have switched sides, and in another divided vote, the boards have decided to ditch the "other-than-finance" lease category and account for all lessee leases the same way, as finance leases. This means a forward-leaning expense profile (depreciation is equal over the life of the lease, but interest is higher at the beginning of the lease, just like with a mortgage), which many respondents to the Exposure Draft vehemently protested. One reason given was that board members didn't like the options for how to account for the level expense recognition.

The boards also informally voted to eliminate the exemption of short-term leases (12 months or less maximum lease term, including renewal options) from the requirements of the standard that was agreed to in March. However, that will be reviewed and finalized at a later meeting.


Options

In another backtrack that most lessees won't like, the boards have increased the likelihood that options will need to be included in the lease term. In deciding whether to include an option, one must decide if there is a "significant economic incentive" to renew. A prior meeting decided that only economic factors should be considered in this determination (including contract-based factors such as below-market rents or penalties for non-renewal, and asset-based factors such as the existence of large leasehold improvements that would normally be amortized over a longer period). The boards have now decided to include "entity-specific factors," such as historical practice of the company or industry and management intention. The boards noted that a single factor does not have to be determinative, but the door is still opened up to an increase in subjectivity and need for ongoing review.

Lessor accounting

The boards haven't decided if lessors will use one or two approaches to accounting for their leases. So they made decisions for either possibility:

One approach

If all leases are treated the same way, the partial derecognition model will be used, with the residual value accreted over the life of the lease. This is, I believe, basically the same as current finance lease accounting (sales type accounting under FAS 13).

Two approaches

If two methods of accounting are used, leases will be distinguished based on whether the lease transfers substantially all of the risks and rewards incidental to ownership of the underlying asset. This is the concept underlying both FAS 13 and IAS 17. The boards clarified that among the indicators would be comparing rent to fair value and the existence of variable rent (the latter would be an indication that risks have been transferred to the lessee). Existence of embedded or integral services would not be considered in the determination.

For leases that transfer substantially all of the risks and rewards of ownership, the entire asset would be derecognized, with the residual initially measured at its present value and accreted over the life of the lease.

For other leases, the boards could not come to an agreement. The IASB preferred derecognition, while the FASB preferred current operating lease accounting. This will be revisited at a future meeting. (Neither board, though, preferred the Performance Obligation (PO) method that was presented in the Exposure Draft. That seems to be dead.)

Lease modifications

The boards decided that a "substantive change" in a lease agreement would result in treating the modified agreement as a new contract. This applies if the new terms would change the determination of whether the contract is or contains a lease, or the determination of whether substantially all the risks & rewards of ownership are transferred to the lessee. A change in circumstances (not of the contract itself) can cause reassessment of whether the contract is or contains a lease, but not whether risks & rewards of ownership are transferred.

Discount rate

The interest rate used to present value the rents and amortize the principal (obligation or receivable, depending on whether it's the lessee or lessor) will not be reassessed if the lease payments don't change. However, if a lease is extended because an option needs to be included (either because an option is exercised, or it is deemed to be includible because of a newly recognized "significant economic incentive"), the discount rate (which is typically the incremental borrowing rate for lessees) is to be reassessed, using the current rate, and the present value of the remaining rents is then recalculated.

#104- EBITDA ( Practical Guidance on how to compute)

EBITDA stands for Earning before Interest, Tax, Depreciation and Amortisation.

Here is a step by step guidance on how to compute a Company's EBITDA based on a financial statement:

1. Take the Profit before Tax number (from income statement)
2. Add: Interest (usually, this number can be found in cash flow statement.
3. Add: Depreciation ( most likely: depreciation number can be found in notes to account of Property, Plant & Equipment/ cash flow statement)
4. Add: Amortisation ( most likely: amortisation number can be found in notes to account of Intangible Assets/ cash flow statement)

#103- Provision for Doubtful Debt

We received queries from one of our blog readers in relation to provision for doubtul debt. We will summarize her queries as below:

a. Is general provision for doubtul debts still allowable? If a client provides an allowance of 60k per year as doubtful debt where the double entry is Dr. bad debts Cr. Provision for doubtful debts - is this practice still allowable?

b. Which IAS standard govern this area

Response from myauditing.blogspot.com

a. No. General provision is no longer allowed. IAS 39 states provision for doubtful debt is required when there's objective evidence that the receivable amount is no longer recoverable. As such, only specific provision is allowed. For accounting entries, it is Dr. Bad Debts Expense, Cr. Provision for Doubtful Debt

b. IAS 39

Dear Donut

Dear Donut,

Our relationship goes back a long way. I feel like you’ve become a big part of me. You used to be such a treat, but now, I fear you’ve become a bad habit. Three-thirty in the afternoon rolls around and suddenly you’re there, demanding my attention. It wasn’t supposed to be this way.

I don’t know how to say this without hurting your feelings, but let’s face it. You lied to me. You were supposed to be a snack, a burst of energy, a friend to carry me through until dinner. But that’s not what happened. Sure, the anticipation of meeting you was exquisite. Your softness against my lips. Your sweet taste . . .

But I digress. The sad thing was that after all that foreplay, you didn’t hold up your end of the bargain. After you were gone, I felt tired, not energized. In fact, worse than if I hadn’t had you at all. I put up with it for a while, but it has gone too far. This relationship has to end.

I’m sorry if I’ve never mentioned this before. I know you mean well. I appreciate the kind thought, but no, I really don’t think there’s anything you can do. No, another layer of frosting isn’t going to make a difference. Really. Yes, a fruit filling might make you more romantic, but that just doesn’t deal with the issue. We just weren’t made for each other.

Well, I wasn’t going to mention this to you, but yes, there is someone else. She’s from a different country. No, not Danish! She goes down smooth and gives me lasting energy. No, this isn’t about liking salty more than sweet. Besides, she’s a lot less salty now, more earthy, I’d say. She’s a vegetable juice.

No need to get personal! Vegetables may not be sexy, but they’re smart, and I have come to appreciate how much I like that. You know, I thought you would be a difficult habit to give up, but it turned out that you were easy to replace with something smart.

Look, let’s not part as enemies. You’re sweet. You’re fun, particularly when you’re fresh. And we have known each other a long time. Can't we just be friends?


Bill