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Leasing and off-balance sheet finance

Substance over form

The view of standard setters is that transactions and other events and conditions should be accounted for and presented in accordance with their substance and not merely their legal form, as this will enhance the reliability of financial statements.

The standard setters have no reason to object to leasing. Leasing assets is a common strategy for many reasons:

- Lack of capital: pay for the asset as you use it to generate funds rather than up front.

- Possible lower cost of finance from the leasing company compared to a bank: this may well be due to taxation issues, capital or investment tax allowances being of no immediate use to a company but highly effective in reducing a profitable bank's tax bill - the saving could be shared with lessees.

- Availability of funds: banks might balk at giving a general loan to a company but would be happier to lend against specific leased assets, specific security.

- Lower cost: based on the fact that lessors buy in bulk and maintain more efficiently through economy of scale.

What standard setters have against leaser accounting is lack of comparability between entities that make similar goods or provide similar services, one owning assets, the other leasing. A strong argument for substance over form is that if a company leases a piece of equipment for the greater part of its useful economic life, it effectively owns it; also the finance company, the bank, does not consider that it owns equipment, although it does have legal title. The bank sees the transaction as one of being a loan to be repaid over the term of the lease.

Improving accounting for leases has been a very long-running saga for accountants and we may at last have a new US and international standard in 2014 - or maybe not! In May 2013, IASB issued a second Exposure Draft (ED) proposing a new approach to lease accounting, both for lessees and lessors. All assets and liabilities arising from lease contracts, apart from a limited exemption for leases of less than 12 months, will be recognized in the balance sheet, the statement of financial position.

For lessees, this would result in existing operating leases being brought onto the balance sheet, which would recognize a right-of-use asset and a corresponding leasing obligation. The proposed requirements would extend to all leases of land and buildings.

 
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