5 ms·

That seems to be what it's already requiring: "Under IFRS 16, a lessee is required to recognize an asset for the right to use the leased item and a liability f

That seems to be what it's already requiring: "Under IFRS 16, a lessee is required to recognize an asset for the right to use the leased item and a liability for the present value of its future lease payments." https://en.m.wikipedia.org/wiki/IFRS_16 https://en.m.wikipedia.org/wiki/IFRS_16

jasode 9y ago
At meta level, it would be interesting to know why IFRS chose the philosophical position that the lease remaining unpaid term is a "debt". It seems like another valid way to look at the lease (for renting space) is to consider it a "call option" on a agreed upon price with an expiration date. Therefore, you don't count the whole lease as a bank-like debt but instead, count the "lease termination" fee. (Or maybe I'm taking the examples discussed in HN too literally and the actual IFRS text already covers both situations and the company can choose to record "remaining term" or "termination fee" -- whichever is the lower amount. The termination fees for equipment like airplanes and tractors is higher percentage (must pay remaining residual value) than office space which makes it behave more like a "loan".)
- vpribish 9y ago
  if there's a way out of paying it other than default that's an interesting notion. option-pricing models are a bit more complex than accounting seems to like though. seems like an opportunity for a data-vendor or hedge fund: option pricing of leases for improved valuation models. hmm...
- jeffdavis 9y ago
  For accounting you probably want to keep it simple. Accounting should be a baseline sanity check to keep numbers somewhat in line with reality. It's not meant as a valuation model.
  - jasode 9y ago
    >It's not meant as a valuation model. That's not my intention. I'm staying within the bounds of plain accounting for the concept of "debt liability". If a company has a 5 year lease of $1000/month rent, I think the new accounting rules says it's a 60x$1000=$60000 "debt". But in my mind, the company really isn't on the hook for all $60k. If the company has an "early termination" or "lease buyout" clause that they can exercise at year 2 with a 6-month notice to the landlord, they are really only in "debt" for 30 months (24+6), not 60. The rest of the 30 months act more like a "call option" than a debt instrument because the company really doesn't have to pay it. I'm not an accountant and just thinking out loud. And to reiterate, this "optionality" math applies more to office space leases than equipment leases like airplanes.
    - jeffdavis 9y ago
      In general, there are a lot of contract terms that affect your flexibility as a business, and they are often major negotiating points for large deals. Almost any of them could be considered a call/put option. But I don't think the goal of accounting is to expose all of those contract terms to casual investors.
    - heos 9y ago
      If you ha these terms the debt would be for 30 months. Quite clear from IFRS 16, only the amount which you are contractually obligated to pay is debt.
- acchow 9y ago
  > is to consider it a "call option" A lease is really closer to a set of futures contracts than a call option. You can't just walk away from a lease if you don't want it anymore.
  - jasode 9y ago
    The company walks away by paying the early termination fee. We assume that type of clause is often negotiated into the contract because the company wants flexibility to break the lease to respond to changing business conditions.
    - firebird84 9y ago
      I don't know about corporate leases, but early termination fees on a lease AREN'T a given. Some states have next to no regulation on it, and landlords are free to write terms without one. The early termination fee there is simply "the remaining rent", which is what is reflected here.
      - jasode 9y ago
        >but early termination fees on a lease AREN'T a given. Correct, and that's why I specifically wrote "often negotiated" and not "always included". I wasn't writing in absolutes. >The early termination fee there is simply "the remaining rent", which is what is reflected _here_. (Not sure what previous comment the "here" in "reflected here" is referring to.) I was talking about leases where the negotiated termination fee is much less than the remaining rent. It depends on market forces. (If the office landlord has lots of vacancies and is desperate for tenants, favorable termination fees will be more common.) If not putting leases on balance sheets understates actual liabilities, then likewise, adding entire lease terms with optionality overstates it.
- sologoub 9y ago
  Since you have to balance asset/liability entries, if you try to model out the cost of termination (which can include TI allowance refunds, commissions, fees and other not so straightforward cals), you might end up with an unrealistic asset picture where the lease is showing lower overall cost than it should.
- epa 9y ago
  It is required because bad actors historically manipulated lease accounting to misrepresent their contracts and future payments they are liable for. It is not 'debt' - it is a contractual liability, valued at a fair and reasonable value (including valuation of termination provisions).
- JumpCrisscross 9y ago
  > is to consider it a "call option“ Early termination is an example of optionality. Callable bonds and demand deposits also contain optionality. That doesn’t make them options.
  - jasode 9y ago
    >That doesn’t make them options. Yes, I know. I was using <quote>"call option"<unquote> as analogy and not a strict legal financial instrument. Sort of like the "Greenspan Put" isn't really a "put option". Or how some might saying investing in Uber is a sort of like a <quote>"call option"<unquote> on future taxi & employee regulations favoring companies like Uber.

jasode 9y ago

At meta level, it would be interesting to know why IFRS chose the philosophical position that the lease remaining unpaid term is a "debt". It seems like another valid way to look at the lease (for renting space) is to consider it a "call option" on a agreed upon price with an expiration date. Therefore, you don't count the whole lease as a bank-like debt but instead, count the "lease termination" fee. (Or maybe I'm taking the examples discussed in HN too literally and the actual IFRS text already covers both situations and the company can choose to record "remaining term" or "termination fee" -- whichever is the lower amount. The termination fees for equipment like airplanes and tractors is higher percentage (must pay remaining residual value) than office space which makes it behave more like a "loan".)

vpribish 9y ago
if there's a way out of paying it other than default that's an interesting notion. option-pricing models are a bit more complex than accounting seems to like though. seems like an opportunity for a data-vendor or hedge fund: option pricing of leases for improved valuation models. hmm...
jeffdavis 9y ago
For accounting you probably want to keep it simple. Accounting should be a baseline sanity check to keep numbers somewhat in line with reality. It's not meant as a valuation model.
- jasode 9y ago
  >It's not meant as a valuation model. That's not my intention. I'm staying within the bounds of plain accounting for the concept of "debt liability". If a company has a 5 year lease of $1000/month rent, I think the new accounting rules says it's a 60x$1000=$60000 "debt". But in my mind, the company really isn't on the hook for all $60k. If the company has an "early termination" or "lease buyout" clause that they can exercise at year 2 with a 6-month notice to the landlord, they are really only in "debt" for 30 months (24+6), not 60. The rest of the 30 months act more like a "call option" than a debt instrument because the company really doesn't have to pay it. I'm not an accountant and just thinking out loud. And to reiterate, this "optionality" math applies more to office space leases than equipment leases like airplanes.
  - jeffdavis 9y ago
    In general, there are a lot of contract terms that affect your flexibility as a business, and they are often major negotiating points for large deals. Almost any of them could be considered a call/put option. But I don't think the goal of accounting is to expose all of those contract terms to casual investors.
  - heos 9y ago
    If you ha these terms the debt would be for 30 months. Quite clear from IFRS 16, only the amount which you are contractually obligated to pay is debt.
acchow 9y ago
> is to consider it a "call option" A lease is really closer to a set of futures contracts than a call option. You can't just walk away from a lease if you don't want it anymore.
- jasode 9y ago
  The company walks away by paying the early termination fee. We assume that type of clause is often negotiated into the contract because the company wants flexibility to break the lease to respond to changing business conditions.
  - firebird84 9y ago
    I don't know about corporate leases, but early termination fees on a lease AREN'T a given. Some states have next to no regulation on it, and landlords are free to write terms without one. The early termination fee there is simply "the remaining rent", which is what is reflected here.
    - jasode 9y ago
      >but early termination fees on a lease AREN'T a given. Correct, and that's why I specifically wrote "often negotiated" and not "always included". I wasn't writing in absolutes. >The early termination fee there is simply "the remaining rent", which is what is reflected _here_. (Not sure what previous comment the "here" in "reflected here" is referring to.) I was talking about leases where the negotiated termination fee is much less than the remaining rent. It depends on market forces. (If the office landlord has lots of vacancies and is desperate for tenants, favorable termination fees will be more common.) If not putting leases on balance sheets understates actual liabilities, then likewise, adding entire lease terms with optionality overstates it.
sologoub 9y ago
Since you have to balance asset/liability entries, if you try to model out the cost of termination (which can include TI allowance refunds, commissions, fees and other not so straightforward cals), you might end up with an unrealistic asset picture where the lease is showing lower overall cost than it should.
epa 9y ago
It is required because bad actors historically manipulated lease accounting to misrepresent their contracts and future payments they are liable for. It is not 'debt' - it is a contractual liability, valued at a fair and reasonable value (including valuation of termination provisions).
JumpCrisscross 9y ago
> is to consider it a "call option“ Early termination is an example of optionality. Callable bonds and demand deposits also contain optionality. That doesn’t make them options.
- jasode 9y ago
  >That doesn’t make them options. Yes, I know. I was using <quote>"call option"<unquote> as analogy and not a strict legal financial instrument. Sort of like the "Greenspan Put" isn't really a "put option". Or how some might saying investing in Uber is a sort of like a <quote>"call option"<unquote> on future taxi & employee regulations favoring companies like Uber.