Accounting for leases – the problem of rent reviews in capitalising lease liabilities

Abstract

In 1996, an International Accounting Standards Committee (IASC) working party suggested that current methods of accounting for leases should be changed and in 1999 this work culminated in a position paper from the UK Accounting Standards Board (ASB) which made a number of suggestions for consultation (ASB, 1999). The paper assumes that the overall thrust of the proposed changes will be accepted and that will mean that occupying lessees will be required to capitalise the liability to pay rent for their lease and place that liability on the balance sheet. It will also require that property owners identify the value of the lease and the residual property value separately. These are by no means the only issues that are raised by the position paper but it is the implications of these two proposals for valuation methodology that is the subject of this paper. The property industry response in the UK to these two proposals is outlined and it shows that a minimalist approach is recommended, which incidentally is the preferred approach of the UK ASB. This paper argues that market valuations should already be carried out by techniques that attempt to identify the different values of the lease and the residual property value. The minimalist approach will replace one missing set of information with a misleading set, meaning that the IASC attempt to improve the ability of accounts to provide a “fair view” of companies will be thwarted. Alternative valuation models should be adopted which accurately appraise the assets and liabilities distributed by the lease and also identify the residual property value. Conventional market valuation approaches do not work in this context.