Analysts’ lease dilemma

A recent letter* from ESMA (European Securities and Markets Authority) to the IFRS Interpretations Committee** gives rise to an interesting new discussion about the length of the lease contract (lease term): IFRS16 Leases is, as it turns out, not so explicitly clear. ESMA is therefore asking the IFRS Interpretations Committee (which objective it is to explain IFRS’s*** in more detail when requested) for an explanation.

Analysts of annual reports of large companies have complained for years that the lack of operating lease transactions on the balance sheet resulted in an incorrect financial analysis. In the run-up to the new IFRS16 standard, we saw that for the average analyst it did not matter that proposals for a new lease regulation were not perfect, as long as the result was that lease transactions were on the balance sheet. As a result, in the past and still, there is and has been a tough and expensive regulatory environment for companies; as a result now too, an analysts lease dilemma has arisen.

Now that the new international lease accounting standard IFRS16 has come into force for large companies and institutions, it appears that analysts have not been so smart at all. As in all areas, more roads lead to Rome and all these variants are not all  — rightly so, bearing in mind the IASB’s**** principles-based approach — extensively elaborated in the new standard. So ESMA, the umbrella organisation to which the Dutch AFM (Netherlands Authority for the Financial Markets) is affiliated, has identified several alternatives in use to determine the length of the lease period.

Fundamental to the discussion should be the freedom of choice and own interpretation of companies, but instead of interpreting the abundant information on the basis of the choices made by those companies, a simple rule is sought, so that the figures can be used thoughtlessly in an analysis model. Let us hope that sentiment will not become such that companies are being accused of having used their freedom of choice.

Of course, there is often the possibility to use – or not – an extension option or an option for early restitution of the object. Too bad, if in the past options were found less important by analysts, because a lease was simply considered a loan with fixed agreements. It is for good reason that the lease community has repeatedly called for separate treatment of a lease transaction versus loans (passive side) or assets (active side of the balance sheet).

Not all companies are alike and in addition, companies are free to make their own choices; apparently an abomination for analysts. The result of the introduction of IFRS16 is indeed that ‘everything’ appears on the balance sheet, but it does not automatically serve transparency. Uniformity and insight are not always friends. It would then be very unpleasant if, in addition to the already abundant rules, there were more instructions as to how exactly determine the term of a lease transaction. This may appear to be good for the presentations of accounts and also for transparency, but figures are emerging in the balance sheet, which have less and less to do with reality.

*The letter can be requested via Tweuus via contact.

**) The IFRS Interpretations Committee used to be called IFRIC = International Financial Reporting Interpretations Committee.

***) IFRSs: System of International Financial Reporting Standards, issued by the IASB, which sets out rules on how to account for and report on transactions in the financial statements. The IFRS standards originate from an essentially private organisation, but have been declared applicable by the EU for each individual IFRS standard for use in the EU.

****) IASB = International Accounting Standards Board.