SANOFI. . Right of use : the right-of-use would be then defined as the counterpart of the liability, which is actually how the model works in the ED

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1 G Hans Hoogervorst, Chairman lnternational Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom Paris, September Re: Gomment Letter on the Exposure draft ED/2013/6 Leases Dear Sir Sanofi, a leading global pharmaceutical company is pleased to take this opportunity to respond to the exposure draft Leases (the ED). We understand the Board objective to review lessees' accounting for current operating leases although we consider that las17 based on the transfer of risks and rewards related to the asset is well understood and applied consistently. We would support a single approach to lease accounting if the approach was based on sound and robust concepts and definitions. Regarding the current ED, our main concern relates to the fact that there is no conceptual basis for the key aspect of the proposals, namely the definition of a lease. The exposure draft defines a lease as "a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration". We consider that many flaws in the ED come from the definition of a lease in the ED which starts with the asset side although the actual objective of the Board was to recognize in the balance sheet the liabilities related to the use of assets. We consider that a definition starting with the liability side rather than the asset side would make the whole ED much more robust than it is today and would solve some of the questions raised in the ED:. Right of use : the right-of-use would be then defined as the counterpart of the liability, which is actually how the model works in the ED o Type A / Type B : type B would not be consistent with the definition, as a lease defined as a financial commitment would require a split between a financial interest and an operational expense Lease term and remeasurement : those discussions would benefit from a definition starting with the liability side o Disclosures : IFRST disclosures would cover the disclosures for the liability side 54, rue La Boétie, Paris Cedex 8, France - Té1. : +33 (0) Fax : +33 (0X Slågosdal:54,ruola8oól e,75oo8padb,frem-s.a.auøfilaldo28il8' g503o844r.c.s.psris-codeape7010z-n' ntmæmmunautalro:fr

2 ã However, some questions would remain or new questions would arise: o lt would still be crucial to define the line between leases and service agreements.' The date of recognition of the lease in the balance sheet (inception vs. commencement) would need to be reviewed as a financial commitment exists from the inception of the agreement o lt would be beneficial to test the new definition with intangible assets The ED creates accounting and financial reporting requirements that are not consistent with the IFRS conceptual framework. This is a real concern to us as we consider that this undermines the future work on the Board in other areas. ln other words, we consider that a standard based on right concepts and definitions would enhance the framework and help solve issues currently unsolved in other areas than Leases. For that reason, we strongly urge the Board not to implement the ED as it stands today and to undertake a revision of the draft based on a definition that captures better the type of transactions that the Board would like to see on balance-sheet. You willfind below our comments to the questions 1,2,4,5, 6 and B where we underline how, in our view, a new definition starting with the liability side would strengthen the project. Sincerely, L VP t Gilhodes Accounting 2J\" eå^^ Emmanuelle Cordano Accounting Standards Director e m m a n u e I le. co rd a no@sa n of i. co m -2-

3 {À Question 1: identifying a lease This revised Exposure Draft defines a lease as "a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration". An entity would determine whether a contract contains a lease by assessing whether: (a) fulfilment of the contract depends on the use of an identified asset; and (b) the contract conveys the right to control the use of the identified asset for a period of time in exchange for consideration. A contract conveys the r ght to control the use of an asset if the customer has the ability to direct the use and receive the benefits from use of the identified asset. Do you agree with the defin t on of a lease and the proposed requirements in paragraphs 6-19 for how an entity would determine whether a contract contains a lease? Why or why not? lf not, how would you define a lease? Please supply specific fact patterns, if any, to which you th nk the proposed definition of a lease is difficult to apply or leads to a conclusion that does not reflect the economics of the transaction. As raised in the cover letter, we consider that many flaws in the ED come from the definition of a lease. A lease is defined as "a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration". ln this definition a lease is defined primarily by the right of use (the asset side) although the actual objective of the Boards was to recognize in the balance sheet the liabilities related to the use of assets. The ambiguity of the definition is illustrated by the example of assets (such as company cars) used by employees that are in substance "fringe benef ts". Paragraph 18 states that "the customer's ability to derive the benefits from use of an asset refers to its right to obtain substantially all of the potential economic benefits from use of the asset throughout the term of the contract". According to this paragraph, it might be questionable whether the assets used by employees are in the scope of the ED as the employees obtain a significant part of the potential economic benefits of the asset (in being able to use it outside working hours). ln this example, the customer (the lessee) does not obtain substantially all of the potential economic benefits from use of the asset throughout the term of the contract. However if leases where defined as financial commitments, there would be no doubts that assets financed by the employer and used by employees would fall into the lease definition. There are probably to ways to solve this ambiguity: View 1: in substance, this is a sub-lease to a third party and for this reason it is included in the Lease scope View 2: the entity has a financial commitment and for this reason it is included in the Lease scope -3-

4 ã lf View 1is correct, it should be clarified that "in substance sub-leases" are in the scope of the ED as this assumption is not clearly stated as such in the ED. This would be the "expeditive way" to handle the problem. lf View 2 is correct, the definition of a lease should be reviewed to start by the liability side. This view should be preferred as we consider that a definition starting with the liability side rather than the asset side would make the whole ED much more robust than it is today. lf the definition of the lease was for instance "a contractual obligation to deliver cash or another financial asset to another entity in exchange for the use of an asset" the right-of-use would be defined as the counterpart of the liability, which is actually how the model works in the ED. This would make apparent that there has been a shift from the Board related to lease transactions: a shift from focusing on the asset (las17 is based on the transfer of risks and rewards related to the asset) towards focusing on the liability. Clarifying the definition by starting with the liability side would clarify the intention of the boards. However with a definition starting with a liability it would still be crucial to define the line between leases and service agreements. Question 2: Lessee accounting Do you agree that the recognition, measurement and presentation of expenses and cash flows arising from a lease should differ for different leases, depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset? Why or why not? lf not, what alternative approach would you propose and why? With a definition starting with the liability side, type B leases would not be consistent with the definition as a lease defined as a financial commitment would require a split between a financial nterest and an operational expense. As for the recognition date, it would be necessary to discuss the date of recognition of the lease in the balance sheet (inception vs. commencement), as it should be assessed whether a lease defined as a financial commitment should be recognized on balance sheet from the ncept on of the agreement (date from which the commitment exists). -4-

5 ñ SANOF I Question 4: classification of leases Do you agree that the principle on the lessee's expected consumption of the economic benefits embedded in the underlying asset should be applied using the requírements set out in paragraphs 28-34, which differ depending on whether the underlying asset is property? Why or why not? lf not, what alternative approach would you propose and why? We consider that the criteria used to classifli a lease should not be based on the underlying assets. Furthermore, we consider that the ED, with a definition starting with the liability side, would benefit from being tested with intangible assets. Question 5: lease term Do you agree with the proposals on lease term, including the reassessment of the lease term if there is a change in relevant factors? Why or why not? lf not, how do you propose that a lessee and a lessor should determine the lease term and why? "Lease term" is an area where we consider that a definition starting by the liability side would help clarify the issue. The lease term would not need to be defined in the lease project if leases were defined as "a contractual obligation to deliver cash or another financial asset to another entity in exchange for the use of an asset". ln that case, lease renewals would be treated by reference to the definition of a financial liability in the conceptual framework. The ED refers to "significant economic incentive". lt's interesting to note that many discussions already arose in relation the related concept called "economic compulsion". IFRIC Update (November 2006) reports that the Board had discussed in June 2006 whether the economic compulsion should affect the classification of a financial instrument (or a component of a financial instrument) under IAS 32. For a financial instrument (or a component of a financial instrument) to be classified as a financial liability under IAS 32, the issuer must have a contractual obligation either to deliver cash or another financial asset to the holder of the instrument, or to exchange financial assets or financial liabilities with the holder under conditions that are potentially unfavourable to the issuer. The Board confirmed that such a contractual obligation could be establ shed explicitly or indirectly, but it must be established through the terms and conditions of the nstrument. Thus, by itself, economic compulsion would not result in a financial instrument being classified as a liability under IAS 32. The Board also stressed that IAS 32 requires an assessment of the substance of the contractual arrangement. lt does not, however, require or permit factors not within the contractual arrangement to be taken into considerat on in classifoing a financial instrument. The same issue was discussed recently by the IFRS lnterpretat on Committee with the discussions around levies, discussions that led to the poor interpretation lfrlc21. The view described above might not be anymore the view from the Board: as stated in the Review of the Conceptual Framework for Financial Reporting DP/2OL3/L, published in July 2013, "some aspects of the existing Conceptual Framework are out of date and fail to reflect the current thinking of the -5-

6 {D\ IASB. For example, the existing Conceptual Framework states that an asset or a liability should be recognised only if it is probable that there will be a flow of economic resources. However, the IASB has concluded in some situations that recognising an asset or a liability would provide useful information even when a flow of economic resources is not probable." Whatever the current thinking of the Board is on that matter, we consider that it would be beneficial to the ED Lease as well as to the project currently undertaken by the Board in relation with the Conceptual Framework to link the definition of a lease with the future definition of assets and liabilities in the new conceptualframework. lf the "lease term" should only be for the non-cancellable period for which a lessee has the right to use an "underlying asset", treatment which would be in line with the current definition of a financial liability ("a contractual obligation to deliver cash or another financial asset"), options to renew the lease should be considered as embedded instruments not to be separated from the lease contract. Economically, cancellation and extension options can be seen as some sort of insurance to the lessee that is reflected in the pricing of the lease agreements. Question 6: variable lease payments Do you agree with the proposals on the measurement of variable lease payments, including reassessment if there is a change in an index or a rate used to determine lease payments? Why or why not? lf not, how do you propose that a lessee and a lessor should account for variable lease payments and why? "Variable lease payments" is another area where we consider that a definition starting by the liability side would help clarifu the issue. Here again, adding this question to the revision of the Conceptual Framework would certainly make the ED and the framework more robust. This would help the IASB address similar issues relating to the potent al adjustment of asset carrying values, e.g. in connection with the acquisition of items of property, plant and equipment or intangible assets which may include some form of variable consideration. Question 8: disclosures Paragraphs and set out the disclosure requirements for a lessee and a lessor. Those proposals include maturity analyses of undiscounted lease payments; reconciliations of amounts recognised n the statement of financial position; and narrative disclosures about leases (including information about variable lease payments and options). Do you agree with those proposals? Why or why not? lf not, what change do you propose and why? We consider that IFRST should cover the disclosures related to the liabilities. -6-