It would perhaps be best to explain the features of this standard with a simple example. Say there are two companies, Loan Ltd and Lease Ltd, both with identical assets, liabilities, revenues and expenses. Both decide to invest in an identical new machine. Loan Ltd decides to borrow the money from a bank, repayable over five years, and purchase the machine with that money. Lease Ltd decides to go to a leasing company to finance the machine with a five-year lease. The leasing company will purchase the machine from the vendor and lease it to Lease Ltd. Lease Ltd will pay lease rental to the leasing company for five years, after which it has the option to purchase the machine from the leasing company at a nominal cost.

Under current accounting practices in Bangladesh, Loan Ltd is required to show both the machine and the corresponding liability on its balance sheet. However, Lease Ltd is neither required to show the asset, nor the financial commitment (which, for all practical purposes, is a loan) on its balance sheet. As a result, if both companies make equally efficient use of the machine, Lease Ltd will show better liquidity, lower borrowings, better asset turnover ratio and better return on assets employed than Loan Ltd, even though one is no better than the other.

All of the above is currently possible as Bangladesh follows the legal form of lease transactions, rather than the substance. As the asset is owned by the leasing company, and as Lease Ltd has not received the loan money, the asset and the corresponding liability will be excluded from its balance sheet. With introduction of IAS 17 in Bangladesh, accounting for lease transactions will be based on substance, rather than the legal form of the transaction. Our neighbours like India, Pakistan and Sri Lanka already follow IAS 17 principles, as is done by regional countries like Malaysia and Indonesia. Nearly all advanced economies, whether in this region or not, have been following IAS 17, or its local equivalent, for many years.

Under IAS 17, lease contracts can be of two types: finance lease and operating lease. In a nutshell, if the present value of future lease payments is substantially equal to the purchase price of the asset, or if the lessee has the option to purchase the asset at the end of the lease period at a price below the market value, or if the lease term is for most of the useful economic life of the asset, that lease contract will be a finance lease. Operating lease is any lease which is not a finance lease. According to IAS 17, financing an asset with a finance lease is no different from financing it with an interest bearing loan: both give a company the right to use an asset in return for periodic payments to a financing company for a pre-determined duration.

Both carry a finance cost, i.e., interest.

Following the principles of IAS 17, legal ownership of the asset is irrelevant in deciding the accounting treatment, and assets financed by finance leases must appear on the balance sheet of the borrower, along with an equal amount shown as a liability on its balance sheet. As it will rank equally with all purchased assets of the borrower, the leased asset will also have to be depreciated by the borrower, following existing accounting principles applicable in Bangladesh. Operating lease transactions will be accounted for as is done now for all leases in Bangladesh. IAS 17 becomes effective for financial period beginning on or after 1st January 2004. It is equally applicable for all companies listed and unlisted, lessee and lessor - reporting under Bangladesh Accounting Standards.

It is worth noting that if an analysis is carried out of all current lease contracts in Bangladesh, it is very likely that the vast majority of them will be found to be of finance lease category. The effect of ICAB's decision to adopt this standard is thus indeed very widespread.

It is really the lessee whose financial statements will bear most of the direct impact of this standard; for the leasing company, it will primarily involve a reclassification of the asset from a fixed lease asset to a receivable. With the introduction of IAS 17, an easy technique for off balance sheet financing will no longer be available in Bangladesh. The lenders and investors will however get a more transparent view of the financial position of a company. IAS 17 may be less than popular with some borrowers, but it is a major step towards truer and fairer financial reporting, thus taking Bangladesh to a higher level of corporate governance. It is now up to those who prepare financial statements and the auditors, who express an opinion on them, to carry the baton and ensure its implementation.

The author is a partner of Rahman Rahman Huq, Chartered Accountants.