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Changes to accounting rules for leases may “explode” balance sheets

Changes to accounting rules for leases may “explode” balance sheets

Burnt Oak Partners has been working with the IFRS, IASB and various outsourcing industry representatives to better understand the changes to the accounting rules for leases (IAS 17) and how this will affect the outsourcing industry.

What the change in rules is trying to establish is basically the removal of the notion of operational leases which do not have to be recognised on the balance sheet and the fact that all leases would be treated as financial leases are today. We have now assembled an industry working group to better establish the potential impact on the accounting in outsourcing relationships for both vendors and clients.

Fundamentally, the key word here is “leases”. The outsourcing contract would be amortized over the life of the lease using the effective interest embedded in the lease, which the IASB accountants equate to a mortgage situation. Under the proposed rules, the key issue is one of mirroring. In an outsourcing relationship, if the client accounts for the transaction as a lease and books the asset and the liability, then the vendor has to match the accounting treatment (and the other way around).

This raises a number of potential questions for the outsourcing market in that:

  • In a standard outsourcing transaction this would force both the client and service provider to account for the lease on their balance sheets, which they do not have to do today.
  • A “cloud” type of outsourcing transaction where the assets used to deliver the services are not specifically allocated and the vendor has control over how the service is rendered would likely remain outside the new lease definition, but the issues of variability leave a great deal of ambiguity still, and the IFRS goal of increased transparency and comparability may not be met
  • Services which lie between the two extremes would need to be analysed line by line (tower by tower). In this case a dedicated and identified asset supporting the outsourced service would be treated as a lease but a public cloud service would not.

The IFRS comment period continues until December 15 and the rules are expected to be published in 2011 for imposition globally in 2013 or 2014. We will continue to monitor the process….

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