202102 DCL Lease Liability Final

Mr. Hans Hoogervorst Chairman International Accounting Standards Board 7 Westferry Circus Canary Wharf London E14 4HD

(Date)

Dear Mr Hoogervorst

Following the UK's exit from the European Union, the Department for Business, Energy and Industrial Strategy (BEIS) is setting up the UK Endorsement Board (UKEB) to fulfil statutory functions of influencing the development and subsequent adoption of International Accounting Standards for use in the UK. The UKEB secretariat has begun influencing activities in preparation for the delegation of those statutory functions to the UKEB. This letter forms part of those influencing activities and is intended to contribute to the International Accounting Standards Board's (IASB) due process. The views expressed by the UKEB secretariat in this letter are separate from, and will not necessarily affect the conclusions in, any endorsement and adoption assessment on new or amended International Accounting Standards to be provided to the Secretary of State or the UKEB, once powers have been delegated.

We welcome the opportunity to contribute to the debate on this topic and our main points on the consultation are outlined below. For detailed responses to the questions in the IASB's Exposure Draft (ED) please see appendix 1.

We support the proposals in the ED, as they provide guidance on an area not covered by the existing standard. As such, they should reduce any diversity of practice, leading to consistency and comparability of financial statements. We understand that the information necessary to price and enter into the sale and leaseback transaction should be sufficient in most cases to meet the calculation requirements proposed in the amendment, so that improvement in consistency can be achieved at minimal incremental cost to preparers of financial statements.

We note the ED proposals create an inconsistency between the definition of a variable Lease Payment in IFRS 16, and the broader definition used in the ED. We can see that the benefit of the proposed approach is that any gain or loss on sale is captured, for the widest possible range of transactions, in a way that reflects the economic substance of the transaction. Consequently, given that a sale and leaseback transaction has taken place capturing this as a lease liability assists with the understandability of the financial statements.

Whilst we agree that accounting should reflect the economic substance of transactions we are concerned that the inconsistency between the IFRS 16 and the ED definitions will lead to inconsistency in financial reporting, as illustrated by the example we provide in paragraph A7 of appendix 1. We recommend that IASB resolve this discrepancy, either during the finalisation of the ED proposals or during the post implementation review of IFRS 16. In paragraphs A10-A11 of appendix 1 we explore different ways this could be achieved. Our preferred solution is to align the definition in the ED to the existing definition in IFRS 16, as explained in paragraph A10.

Yours sincerely

Pauline Wallace Chair UK Endorsement Board

UK Endorsement Board email: [email protected] website: www.endorsement-board.uk UK Endorsement Board | 8th Floor | 125 London Wall | London | EC2Y 5AS

Appendix 1: Questions on ED/2020/4 Lease Liability in a Sale and Leaseback (Proposed Amendment to IFRS 16)

Question 1: Measurement of the right of use asset and lease liability arising in a sale and leaseback transaction (paragraphs 100(a)(i), 100A and 102B of the [Draft] amendment to IFRS 16).

The [Draft] amendment to IFRS 16 Leases applies to sale and leaseback transactions in which, applying paragraph 99 of IFRS 16, the transfer of the asset satisfies the requirements to be accounted for as a sale of the asset. The [Draft] amendment proposes:

1. to require a seller-lessee to determine the initial measurement of the right-of use asset by comparing the present value of the expected lease payments, discounted using the rate specified in paragraph 26 of IFRS 16, to the fair value of the asset sold (paragraph 100(a)(i));
2. to specify the payments that comprise the expected lease payments for sale and leaseback transactions (paragraph 100A); and
3. to specify how a seller-lessee subsequently measures the lease liability arising in a sale and leaseback transaction (paragraph 102B).

Do you agree with this proposal? Why or why not? If you disagree with the proposal, please explain what you suggest instead and why.

A1We support the proposed amendments. They provide clarity on measurement requirements for an area not addressed in the current standard. This will provide the benefit of reducing any potential diversity of practice in this area leading to increased consistency and comparability of financial statements.

A2Sale and leaseback transactions can involve the sale of high value items of property, plant and equipment, potentially with long economic lives. So the benefits arising from the amendment are likely to be material to financial statements where such transactions occur.

Initial measurement of right of use asset

A3We agree with the approach of requiring the seller to determine the initial measurement of the right of use asset by comparing the present value of the expected lease payments, discounted using the rate specified in paragraph 26 of IFRS 16, to the fair value of the asset sold. This approach is consistent with the existing requirements of IFRS 16, and the fair value approach is familiar to both preparers and users of financial statements.

A4Though we have not gathered formal evidence on this topic we understand the information required for such an approach to be reasonably available to preparers, without undue additional cost. While acknowledging some of the information (for example estimates of future variable lease payments) will be subjective or require estimation, the information prepared to price and enter into the sale and leaseback transaction should provide sufficient basis for calculating the proposed fair value of the asset and expected lease payments.

A5We agree that the gain on sale should only be recognised on the portion of the underlying asset which is sold, as this reflects the economic substance of the transaction.

Payments comprising expected lease payments

A6We agree the amendment should specify the payments that comprise the expected lease payments for sale and leaseback transactions. This is particularly important given the alternative view described at AV1 and AV2 of the exposure draft, and the fact that the current definition of Lease Payments in IFRS 16 only allows for “variable lease payments that depend on an index or rate”. Hence the proposed definition in paragraph 100A, along with the worked example at Example 25, are necessary to clarify that the amendment applies to variable Lease Payments beyond the scope of those defined in the original standard when subject to a sale and leaseback transaction.

A7However, we are concerned that this addition relating to variable lease payments is likely to lead to further inconsistency arising from the use of two different definitions of variable Lease Payments, without clear explanation of the reason for the discrepancy. We can see that the benefit of the proposed approach is that any gain or loss on sale is captured, for the widest possible range of transactions, in a way that reflects the economic substance of the transaction. Consequently, given that a sale and leaseback transaction has taken place, capturing this as a lease liability assists with the understandability of the financial statements. However, we are concerned that the inconsistency between the IFRS 16 and the ED definitions will lead to inconsistency in financial reporting.

A8For example, when a lessee enters directly into a lease with variable payments based on a percentage of future revenues, these payments will fall outside the definition of Lease Payment for IFRS 16, and neither a Right of Use Asset nor Lease Liability will arise. However, if a seller-lessee enters into an otherwise identical lease via sale and leaseback the contract will meet the ED definition and create a Right of Use Asset and Lease Liability. This creates a lack of comparability in financial reporting between two entities who have entered into a lease contract with identical ongoing terms.

A9We recommend IASB resolve this discrepancy, either during the finalisation of the ED proposals or during the post implementation review of IFRS 16. We can see two ways in which this could be achieved.

A10Our preferred approach is that IASB use the definition currently in IFRS 16 for all purposes. The consequence of this is that those sale and leaseback transactions which have variable payments not based on a rate or index, would not give rise to a lease asset or liability. The correct gain on sale treatment could still be achieved by raising a non lease liability or deferred gain. This would result in lease contracts with the same characteristics being accounted for in the same way, irrespective of whether they were entered into directly or via sale and leaseback. This would resolve any concerns of inconsistency in financial reporting.

A11IFRS 16 paragraph BC169 describes several reasons why variable lease payments linked to future performance or use were excluded from the scope of IFRS 16, including the high level of measurement uncertainty, costs outweighing the benefits of implementation, and the possibility that the definition of a liability is not met until such time as the future performance/use occurs. As a result, IFRS 16 does not create lease assets or liabilities in these circumstances. We think that these remain valid reasons for excluding such leases from the definition in the ED.

A12This solution would reduce the impact for stakeholders, as it would only apply when there was a sale and leaseback featuring variable payments not based on a rate or index.

A13An alternative approach to achieving consistency of treatment is to change the definition of Lease Payment in IFRS 16 to align with the new definition in the ED, by including variable lease payments which are not based on an index or rate. This would result in lease contracts with the same characteristics being accounted for in the same way, irrespective of whether they were entered into directly or via sale and leaseback. This would also resolve any concerns about inconsistency in financial reporting.

A14This solution would also require the IASB to satisfactorily resolve the concerns raised at IFRS 16 paragraph BC169.

A15However, this solution is not our preferred approach as it would have a larger impact on stakeholders. This will particularly be the case if retrospective application was required, as the wider definition would apply to all leases the entity had entered into involving variable payments not based on a rate or index, not just those related to sale and leaseback.

Subsequent measurement

A16We agree with the proposed methodology for the subsequent measurement of the lease liability arising in the sale and leaseback transaction. The clarification will be helpful. If the lease liability is only remeasured in the event of a modification or change to the lease term, the regular recording of a gain or loss on the re-estimate of future events with significant measurement uncertainty is avoided.

Disclosure

A17Given the judgmental nature of certain calculations required for the amendment we have considered whether further disclosure of key assumptions and estimates would be of assistance to users of financial statements. The use of judgements and estimates in accounting standards is not unique to this narrow scope amendment. IAS 1 Presentation of Financial Statements and IFRS 16 already require disclosure of information relating to assumptions about the future and estimation uncertainty. Specifically, IFRS 16 paragraph 59b already requires disclosure of additional information that helps users assess future cash outflows including those arising from variable lease payments. We do not feel further prescriptive disclosure related solely to this narrow scope amendment to be necessary nor proportionate. Hence, we agree with the ED not specifying further disclosure on this topic.

Question 2: Transition (paragraph C20E of the [Draft] amendment to IFRS 16)

Paragraph C20E of the [Draft] amendment to IFRS 16 proposes that a seller-lessee apply the [Draft] amendment to IFRS 16 retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors to sale and leaseback transactions entered into after the date of initial application of IFRS 16. However, if retrospective application to a sale and leaseback transaction that includes variable lease payments is possible only with the use of hindsight, the seller-lessee would determine the expected lease payments for that transaction at the beginning of the annual reporting period in which it first applies the amendment.

Do you agree with this proposal? Why or why not? If you disagree with the proposal please explain what you suggest instead and why.

A18We would generally caution against retrospective application of narrow scope amendments. Whilst we acknowledge the benefit of the consistency that the restatement provides, the shorter consultation period associated with narrow scope amendments makes it difficult to gather sufficient evidence to fully understand the cost of historic application, and hence to form a robust view as to the cost/benefit of the proposal.

A19In this instance, IFRS 16 was introduced in 2019, so the retrospective application would only cover a time period where records related to the transactions are likely to be readily available. In addition, entities generally undertake limited numbers of material sale and leaseback transactions. Given these factors we believe it is reasonable to assume that the benefit of retrospective application would outweigh the associated costs and would support the proposed retrospective application.

A20We acknowledge that the proposals at paragraph C20E would help avoid the use of hindsight.