Re-Exposure Draft on leases and its potential impacts on the financial and taxation accounting in Sweden

2.1 Classification of lease contracts

In general, a lease is defined as a contract that conveys the right to use the underlying asset for a period of time in exchange for consideration.3

Schedule 1: Classification of lease contracts at the commencement date4

After identifying a contract as a lease contract and separating its different components5, at the commencement date of the lease, both, lessees and lessors, have to classify the lease contract.

Only in the case that the maximum possible term of a lease at the commencement date under the contract does not exceed 12 months, lessees and lessors are allowed, independently from each other, to recognise lease payments on a straight-line basis or another systematic basis over the lease term in profit or loss.6 Therefore these short-term lease contracts can be accounted analogous to the operating leases in the current IAS 17. According to ED/2013/6. 120, the accounting policy election has to be made by class of underlying asset to which the right of use relates.

After that, all (other) lease contracts are classified into two different classes of lease types. This classification in two lease types is based on the rationale that lease contracts may differ by the grade of consumption of the underlying asset. In dependence of the grade of consumption of the underlying asset the calculation scheme for the lease payments differs, and therefore the accounting models have to reflect this.7 If the consumption of the underlying asset is not insignificant, than the lease contract is classified as a type A lease. In the other case, the lease contract is classified as a type B lease.

For lease contracts which do not qualify as short-term leases (and also for short-term leases if the entity does not elect the simplified accounting rules in ED/2013/6.118 f.) it has to be first checked, if there is a significant economic incentive to exercise an option to purchase the underlying asset. In comparison with the criterion of IAS 17.10 b) for classifying a lease contract as a finance lease under the current accounting model of IAS 178, for the assessment if an economic incentive to exercise an option to purchase the underlying asset exists the entity has to consider all relevant factors which influence the decision. This involves a much broader assessment that has to take into account contract-based, asset-based, market-based and also entity-based factors.9 Nevertheless ED/2013/6 contains no aggregation method for the assessment performed by the entity. If the entity concludes in an overall assessment that there is a significant economic incentive to exercise an option to purchase the underlying asset, this lease contract is classified as a type A lease.10

If a significant economic incentive to exercise an option to purchase the underlying asset does not exist in the next step the lease contracts are subdivided in dependence on the underlying asset. In the case that the underlying asset is immovable property, the consumption of the underlying land and buildings is presumed to be in general insignificant so that the lease contract is classified as a type B lease. This classification is changed to a type A lease if the criteria mentioned in ED/2013/6.30 a) or b) are satisfied which indicate a substantial consumption of the underlying property. In the opposite case that the underlying asset is not property (e.g. machinery, equipment, vehicles), the consumption of the underlying assets is presumed not to be in general insignificant. Therefore these lease contracts are classified provisionally as type A leases. Similarly, this classification is changed if the criteria mentioned in ED/2013/6.29 a) or b) are satisfied which indicate that there is no substantial consumption of the underlying asset.

2.2 Lessee Accounting

2.2.2 Type B leases

The accounting model for type B leases deviate from those of type A leases only in regard to the subsequent measurement of the right-of-use asset. Due to the characteristics of the lease contracts classified as type B leases, the consumption of the underlying asset is not material. Therefore, the lessor would be expected to charge the lessee only to use the leased asset over the lease term (providing the lessor with a return on its investment in the underlying asset). The lessor would not require recovery of any of its investment in the underlying asset because it would be expected to retain virtually all of its value or service potential over the lease term.22 From there, the lessor recognises a lease income in profit or loss over the lease term in general on a straight-line basis.23 Corresponding to this, the lessee recognises a lease expense in profit or loss over the lease term on a straight-line basis. This result is reached by calculating the amortisation of the right-of-use asset as the difference amount of the (regularly constant) periodic lease cost and the periodic unwinding of the discount on the lease liability.24 Due to the declining remaining balance of the liability over the lease term, the amortisation portion of the lease expense increases over the lease term. Nevertheless, if the recoverable amount of the right-of-use asset is less than the amortised cost of the right-of-use asset (using this progressive amortisation method), in addition to the regular amortisation an asset impairment has to be charged to profit or loss. In the income statement both, the interest (i.e. the unwinding of the discount on the lease liability) and the amortisation of the right-of-use asset are presented together as lease expense25; also in the notes the above-mentioned components need not to be disclosed.

See ED/2013/6. BC 47.

See ED/2013/6. 93.

See ED/2013/6. 50.

See ED/2013/6. 56 b).

Example 2:

In Example 1 the annual lease payment (due at each year end) amounts to 500.000 SEK. The lessee’s incremental borrowing rate is 5 % p.a. There are no initial direct costs incurred by the lessee or any lease payments between the lessee and the lessor at or before the commencement date. As already mentioned under example 1 above, the lease contract is classified as a type B lease. At the commencement date (01.01.01), the right-of-use asset and the lease liability are measured at the present value of the lease payments:26

If there are neither adjustments to the lease liability nor asset impairments on the right-of-use asset the lessee has to recognise a lease expense of 500.000 SEK each year over the lease term. Schedule 2 shows the development of the carrying amount of the right-of-use asset, of the remaining balance of the lease liability, and the components of the lease expense.

Schedule 2: Lessee’s accounting for a type B lease

As the example shows, in an ideal case (without any direct incidental costs or payments between the lessee and the lessor at or before the commencement date) the remaining balances of the right-of-use asset and of the lease liability are identical. Only from the effect on the income statement, the accounting of the type B leases is at least similar to the accounting of the operate leases according to IAS 17.33 f.27 The main difference from the current accounting model for operate leases is that the type B leases are also recognised on the statement of financial position, on the one side as a right-of-use asset and on the other side as a lease liability.

See ED/2013/6.38 a) and b).

In contrast to IAS 17.33 f., due to the recognition of the right-of-use asset in the balance sheet, asset impairments (and their reversals) have also to be recognised as expenses (resp. income) according to ED/2013/6.

2.3 Lessor Accounting

2.3.1 Type A leases

At the commencement date of a type A lease, the lessor derecognises the carrying amount of the underlying asset and recognises instead of this a lease receivable which is calculated at the present value of the lease payments plus any initial direct costs, and a residual asset. The residual asset represents the lessors’s retained interests in the underlying asset.28 The residual asset is calculated as the sum of the present value of the amount the lessor expects to derive from the underlying asset following the end of the lease term, of the present value of expected variable lease payments, and of any unearned profit.29 At the commencement date, a difference between the lease receivable and the residual asset on the one side and the derecognised underlying asset on the other side might exist. In the case of a gain, the lessor recognises a profit only to the extent that this profit is realised by the lease contract. The realised profit is calculated as the difference between the fair value and the carrying amount of the underlying asset immediately before the commencement date, multiplied by the present value of the lease payments, divided by the fair value of the underlying asset.30

See IASB, Snapshot Leases, May 2013, p. 8.

See ED/2013/6. 71.

See ED/2013/6. 74.

Example 3:

An automobile production company leases a new car to a customer over a lease term of four years. The useful life of the car is six years. Immediately before the commencement date, the automobile production company has capitalised the production costs of the car of 300.000 SEK as inventories on its balance sheet. At this date, the fair value of the car is 350.000 SEK. The present value of the lease payments over the lease term, discounted using the rate the lessor charges the lessee, amounts to 280.000 SEK. The automobile production company assumes that immediately after the lease term the car can be sold for a present value of 70.000 SEK. There are no variable lease payments or any initial direct costs.

At the commencement date, the automobile production company recognises a profit of 40.000 SEK (= (350.000 SEK – 300.000 SEK) · 280.000 SEK/350.000 SEK).30 The residual asset is calculated as the present value of the amount the automobile production company expects to derive from the sale of the car immediately after the end of the lease term (70.000 SEK), less the unearned profit (at the commencement date) of 10.000 SEK (= 350.000 SEK – 300.000 SEK – 40.000 SEK). At the commencement date, the automobile production company has to make the following booking entries:

After the commencement date, the carrying amount of the lease receivable is increased by unwinding of the discount on the lease receivable according to the effective interest method and reduced to reflect the lease payments during the period.32 Additional adjustments of the lease receivable may result from adjustments of the lease payments, the discount rate, or an impairment of the lease receivable.33 After the recognition of the residual asset, its carrying amount is increased by the unwinding of the discount on the (gross) residual asset. Furthermore the carrying amount of the residual asset is adjusted to reflect changes of the expected future variable lease payments included in the carrying amount of the residual asset and impairments of the residual asset.34 Either in the income statement or in the notes, the lessor shows the income arising from leases of this type.35 Lessors who would otherwise sell the goods in order to realise value from these goods shall present revenue and cost of goods sold relating to its leasing activity in separate line items so that income and expenses from sold and leased items are presented consistently36 (see example 3).

The lessor’s accounting of the type A leases is quite similar to the accounting of the finance leases according to IAS 17.36 ff. One major difference from the current accounting model for finance leases is that the proposed accounting model for type A leases splits-up the current receivable which amounts to the net investment in the lease37 in its components, lease receivable and residual asset. Furthermore, the proposed accounting method for profit realisation according to ED/2013/6 takes into account that the realisation of profits is limited to the extent that, at the commencement date, the present value of the (fixed) lease payments covers the fair value of the underlying asset.

See ED/2013/6. 74.

See ED/2013/6. 76 a).

See for further details ED/2013/6. 78–80 and 84 f.

See ED/2013/6. 76 b) in combination with ED/2013/6. 78, 83 and 85.

See ED/2013/6. 90.

See ED/2013/6. 91 a).

See IAS 17.36 in combination with the definitions in IAS 17.4.

2.4 Sale and leaseback transactions

The proposed accounting rules for sale and leaseback transactions in ED/2013/6 differ in dependence upon whether the transfer of the asset is a sale. A sale is a transfer if the transferee (i.e. lessor) obtains the control of the asset. However, if the leaseback provides the transferor (i.e. lessee) with the ability to direct the use of and obtain substantially all of the remaining benefits from the asset, then the transferee does not obtain control of the asset and the transfer is not a sale. The transferor is considered to control the asset, if the lease term is for the major part of the remaining economic life of the asset, or the present value of the lease payments accounts for substantially all of the fair value of the asset.42 In schedule 3, the proposed accounting methods for both cases of sale and leaseback transactions are presented.

Schedule 3: Accounting for sale and leaseback transactions according to ED/2013/6

Schedule 3 shows that in the case the transfer of the asset is a sale, the sale and the lease are recorded as separate contracts. Only in the case that the consideration for the sale of an asset is not at fair value or the lease payments are not at market rates, the transferor and also the transferee shall make adjustments so that the sale and also the lease reflect current market rates.43 If an entity concludes that the transferee does not obtain control, the entire transaction is accounted for as a financing arrangement.44

3.1 Financial accounting rules

Current Swedish accounting legislation does not at all contain any specific rules regarding leases. Following the Swedish Annual Accounting Act (årsredovisningslagen 1995:1544, ÅRL), both the single and the consolidated financial statements should be set up according to Good Accounting Practise, “Swedish GAAP”.45 However, companies that set up the consolidated statement according to IAS/IFRS standards are not subject to Swedish GAAP. In this respect, the proposed new definitions of leases will naturally affect Swedish companies. Regarding companies whose entities are listed on a regulated market, and therefore are parent companies in a group subject to IAS/IFRS standards regarding the consolidated statement, special accounting standards has been set by the Swedish Financial Reporting Board (Rådet för finansiell rapportering, RFR).46 The main principle in this standard is that IAS/IFRS standards should be followed also while setting up the single statement in the parent company, as long as these standards do not interfere with binding Swedish law, primarily the ÅRL.47

However, concerning leases the RFR has stated that the rules in IAS 17 regarding financial leasing are not practically possible to apply, since there is a lack of special tax rules for this kind of leases.48 Financial leasing contracts may therefore in the parent company be treated as operational leasing.

It should also be mentioned that the RFR has given a rather critical comment on the draft.49 According to the board, “the present model under IAS 17 where leases are classified as either operating or finance leases still represents the best solution for lease accounting”.50 The board also believes that adoption of the draft will lead to a higher burden of administrative costs, regarding both parties in a lease.51

Non-listed limited companies are subject to the standards produced by the Swedish Accounting Standards Board (Bokföringsnämnden, BFN). The BFN has produced a standard applicable on all non-listed companies, also known as “Category 3” (K3).52 In this standard, the definitions of financial and operational leasing are defined very close to the wording of IAS 17.53 The valuation of financial leasing contracts also resembles IAS 17, since the asset and debt should be measured to the fair value of the leased property or, if lower, the present value of the minimum lease payments, determined at the inception of the lease.54 It should however be noted, that the similarity between the K3 standard and IAS 17 mainly concerns the consolidated statements, since it in the single statements is possible to treat all financial leasing contracts as operational leasing.55

However, the vast majority of Swedish limited companies may choose not to apply the K3 standard and choose to apply the simplified accounting rules, also known as “K2”.56 According to this standard, all leases are considered to be operational leases.57

3.2 Tax rules

Swedish income tax law does not contain any specific rules regarding leasing.58 A main principle in Swedish business taxation is that the tax system is heavily depending on Swedish GAAP in respect of periodization of incomes and costs. Unless there is a specific tax rule, Swedish GAAP should be followed for tax purposes.59 Swedish GAAP regarding leases should therefore be accepted for taxation purposes. Nevertheless, there are a number of court decisions concerning leases where not only Swedish GAAP has been in focus, but sometimes also Swedish civil law. The main reason for this is that, even if leases are not regulated in Swedish tax law, write-offs on inventories definitely are.60 As a consequence, the assessment when an item should be seen as an inventory (and subsequently not as a lease) is a matter of tax law, where the accounting standards are of no importance.61

Since financial lease as a phenomena does not exist in Swedish tax law, a contract labelled as a lease, which is found in fact not constituting operational lease, is qualified as a hire-purchase agreement. The qualification of civil law contracts in tax law disputes has been a rather controversial matter in Swedish tax law. The main principle in Swedish tax law has been that a transaction is assessed after its “real meaning”, rather than the civil law label. This does, however, not mean that a specific “economic” or “tax law meaning” should be sought by the courts, even if such a meaning was possible to determine. Instead, the “real meaning” of the civil law circumstances should lay the ground for taxation.62 This is shown rather elementary in RÅ 1987 ref. 166. A farmer leased a pipe draining facility from a leasing company. When mounted, the facility was seen as a part of the farmer’s real estate and was not possible to move without considerable cost. According to the court, it must have been intended from the start that the facility should become the property of the farmer. The contract therefore constituted a hire-purchase agreement and not a lease. Tax rules then could be applied on the case on basis of this conclusion.

The importance of Swedish GAAP has been shown when a contract is considered to be a lease also in a tax law perspective.63 Some older, but still valid, court cases where accounting standards has been referred to regarding periodization of prepayments of leases are RÅ 1989 ref. 82 and RÅ 1994 ref. 17.