• Discussed with SAC: July 2001
• Discussed at May 2003 IASB Meeting
• Discussed at November 2003 IASB Meeting
• Discussed at January 2004 IASB Meeting
• Discussed at April 2004 IASB Meeting
• Discussed at June 2004 IASB Meeting
• Discussed at March 2006 IASB Meeting
• Discussed at April 2006 Joint IASB-FASB Meeting
• Discussed at July 2006 IASB Meeting
• Discussed at March 2007 IASB Meeting
• Discussed at April 2007 Joint IASB-FASB Meeting
• Discussed at May 2007 IASB Meeting
• Discussed at June 2007 IASB Meeting
• Discussed at October 2007 IASB Meeting
• Discussed at July 2008 IASB Meeting
• Draft Discussion Paper discussed at 7 October 2008 Working Group meeting
• Discussed at November 2008 IASB Meeting
• Discussed at January 2009 IASB Meeting
• 19 March 2009 Discussion Paper published
  Comment deadline 17 July 2009
• Discussed at May 2009 IASB Meeting
• Discussed at June 2009 IASB Meeting
• Discussed at July 2009 IASB Meeting
• Discussed at September 2009 IASB Meeting
• Discussed at October 2009 Joint IASB-FASB Meeting
• Discussed at November 2009 IASB Meeting
• Discussed at December 2009 IASB Meeting
• Discussed at 5 January 2010 Special IASB Meeting
• Discussed at January 2010 Joint IASB-FASB Meeting
• Discussed at 2 February 2010 Special Joint IASB-FASB Meeting
• Discussed at February 2010 Joint IASB-FASB Meeting
• Discussed at March 2010 Joint IASB-FASB Meeting
• Discussed at April 2010 Joint IASB-FASB Meeting
• Discussed at April 2010 IASB Meeting
• Discussed at May 2010 Joint IASB-FASB Meeting
• Discussed at 1 June 2010 Special IASB Meeting
• Discussed at June 2010 Joint IASB-FASB Meeting
• Discussed at July 2010 Joint IASB-FASB Meeting
• 17 August 2010 Exposure Draft published
  Comment deadline 15 December 2010
• Discussed at October 2010 IASB Meeting (jump to notes below)
• Discussed at January 2011 IASB Meeting (jump to notes below)
• Discussed at 1-2 February 2011 Special IASB Meeting (jump to notes below)
• Discussed at February 2011 IASB Meeting (jump to notes below)
• Discussed at 1-2 March 2011 Special Joint IASB-FASB Meeting (jump to notes below)
• Discussed at March 2011 IASB and IASB-FASB Meetings (jump to notes below)
• Discussed at 6 April 2011 IASB Meeting (jump to notes below)
• Discussed at April 2011 IASB Meeting (jump to notes below)
• Discussed at Special 12 May 2011 IASB-FASB Meeting (jump to notes below)
• Discussed at May 2011 IASB Meeting (jump to notes below)
• Discussed at Special 31 May - 2 June 2011 IASB Meeting (jump to notes below)
• Discussed at June 2011 IASB Meeting (jump to notes below)
• Discussed at July 2011 IASB Meeting (jump to notes below)
• 21 July 2011 IASB/FASB announce intention to re-expose proposals (more information)
• Discussed at September 2011 IASB Meeting (jump to notes below)
• Discussed at October 2011 IASB Meeting (jump to notes below)
• Discussed at 1 November 2011 Special Joint IASB-FASB Meeting (jump to notes below)
• Discussed at November 2011 IASB Meeting (jump to notes below)
• Discussed at December 2011 IASB Meeting (jump to notes below)

Timetable

• Click for IASB Project Timetable

IASB Project Insights

• A quick overview of this project is available on our IASB Project Insights page

Leasing is a global business, and differences in accounting standards can lead to considerable noncomparability. This project would seek to improve the accounting for leases by developing an approach that is more consistent with the conceptual framework definitions of assets and liabilities. The project would result in an amendment or replacement of IAS 17, Leases.

An earlier G4+1 Study had recommended capitalising property rights inherent in all leases.

Discussion at the IASB's May 2003 Meeting

At its May 2003 meeting, the Board indicated that this is an active research project being conducted jointly with the UK Accounting Standards Board. The Board discussed a project plan, which will be discussed with the Standards Advisory Council in June prior to being finalised by the Board in July.

Discussion at the IASB's November 2003 Meeting

P> The Board discussed the basis of a conceptual model for leases. It was proposed that the basis for lease accounting should be the analysis of contractual rights and obligations and the identification of resulting changes to assets and liabilities.

The staff, based on the above, made the following recommendations:

• Application of consistent asset and liability recognition principles in respect of assets owned, assets held under finance leases, and assets held under operating leases should provide more relevant, reliable, and comparable financial information than recognition principles that result in assets and liabilities only being recognised in respect of finance leases.
• Conceptually, the recognition of changes in assets and liabilities should not be limited to contracts that convey ownership rights or rights that are economically similar to outright ownership. The conveyance of rights to future economic benefits should be the focus of the conceptual model.
• Legal performance or transfer of legal ownership are not the most relevant points for recognising changes in assets and liabilities. The transfer of control of future economic benefits to the lessee, usually by delivering the leased property, is an economically significant act of performance by the lessor and an appropriate recognition point for changes in assets and liabilities.
• Assets and liabilities that arise from contractual rights and obligations under a lease should reflect the conveyance of the right of use and control of associated future economic benefits for the period of the contract (rather than conveyance of the whole of the physical property). It was recommended that only those future economic benefits controlled by the lessee are recognised (being the right to use the property for the lease term) and not to use the whole of asset approach (where the lessee recognises an asset equal to the entire value of the leased property and a liability being the obligation to return the leased property at the end of the lease term.)
• If a lease contract is freely cancellable by the lessee, the asset and liability amounts recognised by lessor and lessee should reflect both (i)the conveyance of the right of use up to the date at which the lease can be cancelled by the lessee and (ii)the lessee's option in respect of periods beyond that date.
• If a lease contract is freely cancellable by the lessor, the asset and liability amounts recognised by lessor and lessee should reflect both (i)the conveyance of the right of use up to the date at which the lease can be cancelled by the lessor and (ii)the lessor' s option in respect of periods beyond that date.

The Board agreed that the staff should continue researching the project based on the above recommendations.

The staff noted that they would anticipate an exposure draft in early 2007, although a discussion paper may be issued.

Discussion at the January 2004 IASB Meeting

It was noted that the Board had previously discussed the foundations for a model for lease accounting based on the analysis of contractual rights and obligations and the identification of resulting changes to assets and liabilities.

The Board continued by considering accounting for cancellation and renewal options in leases applying this model where the options are under the control of the lessee.

The Board considered the following examples using a ten year lease with an option to cancel after three years.

Example A: Lessee has an option to renew at a market rent at year 3.

The staff proposed that in the first three years the lessee and lessor had unconditional rights to use the equipment, receive payment, and have the equipment returned at the end of the lease and corresponding obligations.

In years four to ten they had a conditional right and obligation to receive and make payment. In addition there is an unconditional right to make use of the equipment and an unconditional obligation to 'stand ready' to provide the equipment.

The Board agreed with the staff's analysis.

Example B: Lessee has an option to renew at year 3 at a rent that is predetermined at the beginning of the lease.

The staff proposed the same analysis as for example A but noted that the call option may have an initial value.

In addition the staff noted an alternative view to recognise the entire 10 year lease term on delivery of the equipment if it is considered probable that the Lessee will keep the equipment for the full term.

The Board indicated a level of discomfort with the alternative view.

Example C: Lessee has an option to cancel at year 3; a cancellation payment is required.

The staff proposed the same analysis as for example B but that the cancellation payment is accrued over the first three years and deducted evenly from the payments in years four to ten if the lease is not cancelled.

Example D: Lessee has an option to cancel after a minimum period of 12 months; no cancellation payment is required.

The staff proposed a similar analysis to example A. The staff noted that the lessor may expect renewals and this may indicate the existence of an intangible asset.

Example E: Lessee has an option to renew at year 3 at a rent that is predetermined at the beginning of the lease and below the expected market rent (this type of arrangement is sometimes referred to as a 'bargain renewal').

The staff proposed the same analysis as for example B.

The staff noted the following example related to rentals contingent on the lessee's usage:

A lessee enters a three-year lease on a motor vehicle at an annual rental of CU 10,000. In addition, an extra CU 1 per mile is payable if the lessee exceeds 60,000 miles. The excess mileage charge reflects fair compensation for the additional wear and tear of the vehicle.

The staff proposed the following analysis:

• The lessee has an unconditional right to use the vehicle for 3 years or 60,000 miles and an unconditional obligation to pay CU 30,000 to the lessor.
• The lessee does not have an obligation to pay more than CU 30,000. The lessee has an unconditional right to obtain use of the vehicle for more than 60,000 miles. However, the lessee's actual right to use the car for more than 60,000 miles is conditional on the lessee assuming another liability.
• The lessor has an unconditional right to receive CU 30,000 and to have the vehicle returned when the lease comes to an end.
• The lessor has a conditional right to receive consideration for excess mileage. The lessor also has an unconditional obligation to stand ready to make the excess mileage available to the lessee at a predetermined price.

The staff believes that the call option over additional use represents a present unconditional right of the lessee (so may be an asset) and a present unconditional obligation of the lessor (so may be a liability). However the option may have little value at inception of the lease.

In addition the staff noted an alternative view will be considered of accounting for the expected value of the contingent rent payments at inception of the lease.

The Board expressed concerns as to both of the above views.

Discussion at the April 2004 IASB Meeting

The IASB (in conjunction with the staff of the UK Accounting Standards Board) explored further steps in a model for lease accounting based on the analysis of contractual rights and obligations and the identification of resulting changes to assets and liabilities. This approach could require the recognition of assets and liabilities by both the lessor and the lessee. The discussion focused on the accounting for lease payments that are variable either in whole or in part.

The outcome of these discussions will be a discussion paper on lease accounting that will take preliminary views for a future IASB exposure draft. Therefore, the document will not be neutral in its view of accounting positions. While there were significant discussions, only one vote was taken. That is, when a rent is set at 80% of market plus a variable return, the initial asset and liabilities should be measured based on market rent.

The Board further noted that the decisions in this project should be consistent with those decisions make in the revenue recognition project. Further discussions are expected.

Discussion at the June 2004 IASB Meeting

The Board discussed subsequent accounting for amounts recognised as assets and liabilities under leases. They noted that their previous discussions had concluded that the assets arising under lease agreements tend to be rights associated with the lease agreement, rather than physical assets, and that accounting should recognise those rights and obligations. Accordingly, the term depreciation was not considered appropriate, and Board members found it helpful to think of the charge as an allocation of rights of use over the period of the usage.

The Board discussed examples of subsequent accounting in the case of:

• Straight forward leases.
• Leases with lease payments that are conditional on external price changes.
• Leases with lease payments that are conditional on the lessee's usage.
• Leases with lease payments that are conditional on the lessee's revenues.
• Leases with renewal options.

The Board noted that it would be possible to make subsequent accounting adjustments to the value of the rights arising under the lease without necessarily being on the fair value model.

The Board asked the staff to prepare a paper considering the accounting for the rights of use (considering the appropriateness of IAS 16 and IAS 38) and the liability (in accordance with IAS 37 or IAS 39) for discussion at a future meeting.

Discussion at the March 2006 IASB Meeting

The Board held a preliminary discussion of a potential joint IASB/ FASB project on leasing transactions. The IASB and FASB are currently developing a project proposal that would then be subjected to each Board's agenda review process (in the IASB's case this would include a discussion at a future meeting of the SAC).

The staff asked the Board for its preliminary views on the potential agenda proposal, including the assessment of the agenda criteria, the proposal for a working group and the outline project timetable; for any further points that should be made to the SAC in its consideration of the agenda proposal; for its views on the form a joint project with FASB could take; whether and when consultation through an advisory working group or focus groups would be appropriate, and the form such consultation could take.

Discussion at the April 2006 Joint IASB-FASB Meeting

The staff presented the Boards with a paper that provided a summary of the discussions previously held by the two Boards and presented three possible approaches for a potential leasing project to be carried forward. The intention of this session was thus for the Boards to decide which of the three following approaches the Boards would support for taking the project forward:

• Option 1 - Add a joint project to the agenda with the first phase primarily involving the staff working with a working group of leasing experts and a group of users of financial statements with the intent to bring a complete package for Board consideration in the first half of 2007 (this was the staff's preferred approach).
• Option 2 - Add a modified joint project to the agenda with the IASB taking the lead.
• Option 3 - Defer an agenda decision on lease accounting until some of the projects on the Boards' agendas have been completed or substantially completed with a view to making the project a joint project at that time.

FASB members were reluctant toward option 2 as they were concerned about capacity problems. Furthermore they knew that there would be opposition in the US with moving forward this project letting IASB take the lead, as the intention is to progress this as a joint project.

Option 1 would not be a project not requiring significant Board resources in the first phase. It would however involve the staff spending time researching the project and developing ideas. This research phase might include:

• Discussing lease accounting issues with a working group of leasing experts and a group of users of financial statements.
• Identifying and analysing the conceptual and practical issues involved in further developing the ideas in the G4+1 Special Report.
• Developing a lease accounting model that is consistent with the current frameworks and developing standards.
• Holding voluntary education sessions for Board members.

The output of this would be a staff research paper.

Based on the discussion, the Boards voted for Option 1, with IASB members agreeing unanimously and FASB member disagreeing. The IASB expects to make a formal agenda decision in June 2006, which would allow time for consideration also by the SAC and the IASCF Trustees.

The staff was asked to come back with a proposed timetable for the project.

Discussion at the July 2006 IASB Meeting

Under the IASB-FASB Memorandum of Understanding, the two Boards have agreed to consider and decide on the scope and timing of a potential leasing project. Staff had two questions for the Board. The first was whether the Board agreed with staff's proposal to add a leasing project to the Board's agenda. The Board agreed with this proposal.

The second question was whether the Board had any comments on the project plan and timetable. Staff proposed to work towards issuing a discussion paper jointly with the FASB in the third quarter of 2008. The Board recognised that this was a fairly ambitious timetable, but did agree to it.

There was general agreement that the project should address the accounting by both lessor and lessee. At a later stage, it may be possible or necessary to split the project into two parts: one dealing with lessor accounting, and one dealing with lessee accounting. For example, it may be that more work needs to be done on lessor accounting, but that a discussion paper on lessee accounting can be issued more quickly.

December 2006: New IASB-FASB joint working group on leases

On 8 December 2006, the International Accounting Standards Board and the United States Financial Accounting Standards Board announced the membership of a new international working group that will help the boards in their joint project on lease accounting. The joint project involves comprehensive reconsideration of all aspects of lease accounting and is expected to lead to a fundamental changes in how lessees and lessors account for leases. The boards expect to publish a joint discussion paper in 2008 expressing their preliminary views. Click for Press Release (PDF 51k).

Discussion at the March 2007 IASB Meeting

The IASB held its first substantive discussion on the joint project on leasing. The FASB staff joined the meeting by video link for this session.

Identification of assets and liabilities arising in a simple lease

The staff presented a paper identifying the rights and obligations arising on the lessor's and lessee's side in a simple non-cancellable lease arrangement (the example). The current and proposed working definitions of assets and liabilities in the Conceptual Framework project were applied to the identified rights and obligations.

The Board unanimously agreed that the following rights and obligations in the example meet both the current and proposed definitions of assets and liabilities:

Lessee:

• Right to use the machinery during the lease term
• Obligation to make specified payments over the lease term

Lessor:

• Right to receive payments during the lease term
• Right to the economic benefits deliverable from the use of the machinery in the period after the lease term (residual rights)

The Board unanimously agreed that the following rights and obligations in the example do not meet the both the current and proposed definitions of assets and liabilities:

Lessee:

• Obligation to return the machinery at the end of the lease term

Lessor:

• Right to return of machinery at the end of the lease
• Obligation to permit the use of the machinery during the lease term

Even though the Board unanimously agreed to the outcome of the staff analysis some Board members pointed out that the example used ignored many of the complexities of real life leasing transactions. In particular the following comments were made:

• There should be a distinction between the right to use the machinery and the right to use the economic benefits (of the machinery).
• The economic benefits derived by the lessor may be different to those derived by the lessee and this might have implications when calculating fair values.
• Attention should be paid to the question when these rights and liabilities arise. Particularly the Board questioned the statement in the paper that 'under a non-cancellable lease the right to use the machinery and the obligation to pay for its use is unconditional once the machinery has been delivered to the lessee'.
• The obligation to return itself is not a liability but if the machinery has to be returned in a certain condition liabilities may arise.

The staff observed that all these issues will be taken into consideration at a later stage.

Analyses of accounting models for a simple lease

The Board discussed four accounting models:

The right of use model

This model is based upon the premise that once the physical item has been delivered, the lessee has an unconditional right to use that machinery during the lease term.

The lessee recognises as an asset its right to use the machinery during the lease term and a liability for the rentals payable under the lease. The lessee only recognises as an asset its right to use the machinery for the lease term. It does not recognise any rights in respect of the physical item beyond the lease term. Consequently, the lessee does not recognise a liability under the simple lease example in respect of its obligation to return the physical item as this obligation does not give rise to an outflow of economic benefits from the lessee.

The lessor recognises two assets: its right to receive rental payments (a contractual right under the lease); and its interest in the machinery (the residual property rights).

The whole asset model

The whole asset model is based on the premise that during the lease term, the leased item is under the control of the lessee. Accordingly, this model recognises the leased item in full as an asset of the lessee, i.e. both the right to the economic benefits during the lease term and the possession of the asset at the end of the lease term. In effect, the full economic value of the machinery is recognised. To correspond to these assets, the lessee recognises two liabilities; a liability for the payments to be made over the lease term and a liability representing the lessee's obligation to return the asset at the end of the lease term. Where the lease is for substantially all of the leased item's expected useful life, the obligation to return the item at the end of the term is comparatively insignificant. For a short-term lease the obligation to return will be more substantial.

The lessor recognises as an asset its right to receive payments under the lease and an asset representing its right to have the machinery returned at the end of the lease term. The lessor does not recognise its contractual obligation to permit the use of the machinery during the lease term. Instead, the lessor derecognises the machinery.

The executory contract model

Under this model, all leases are treated as executory contracts. It is based upon the premise that the lessee's right to use the machinery is conditional upon making payments under the lease ('day-to-day lease'). Similarly, the lessee's obligation to make payments is assumed to be conditional upon the lessor granting the lessee quiet enjoyment of the machinery throughout the lease term. The model is therefore very similar to the operating lease model used in current accounting standards.

The model adopted in current IFRSs

In contrast to the other three models the current accounting treatment of leases is based on a hybrid model classifying leases as either finance leases or operating leases.

The Board saw no merits in further developing the whole asset model and the executory contract model and decided to focus on the right of use model.

Discussion at the Joint IASB-FASB Meeting in April 2007

The Boards discussed the scope of the Leases project. The staff suggested two possible approaches: a 'narrow' approach and a 'broad' scope. The narrow scope would accept the scope in the current set of standards – FAS 13 Accounting for Leases and IAS 17 Leases, plus EITF 01-8 and IFRIC 4, both called Determining whether an Arrangement Contains a Lease.

Board members expressed support and frustration in equal measures. Some thought that the scope was crucial and needed to be examined rigorously now. These Board members saw that putting off significant questions until later was sub-optimal. The scope should be thoroughly considered at the outset. If it is not, constituents would criticise the Board for not doing so.

Others wanted the leasing model fixed and then tested against a wider scope subsequently. One FASB member objected that the project seemed to be addressing the wrong kinds of transactions and should have as a priority the lease of intangible assets.

Other Board members noted that the staff's preferred approach (narrow scope) was pragmatic, especially given that the project would address both lessor and lessee accounting.

One FASB member thought that leasing crossed over so many other contentious issues, including revenue recognition, that to do a narrow-scope project would be a waste of time and resources.

With the exception of one FASB member, the Boards agreed to a narrow scope approach to the Leases project. They appeared to support the idea that once a model was developed it should be tested against other types of arrangements to determine whether it would be suitable for those arrangements.

Discussion at the May 2007 IASB Meeting

\ Leases [Education Session]

The Board discussed an analysis of a lease contract in which the lessee has either an option to extend the term of the lease for an additional period, or an option to terminate the lease early.

The staff analysis aimed to assess the terms and conditions of a standard lease and attempted to re-characterise a long-term lease with an option to cancel early as a short-term leased with an option to extend; and to identify the assets and liabilities that arose. At a conceptual level, several Board members noted that the manner in which a lease is described should not affect the assets and liabilities recognised.

Although no decisions were requested or made at this session, Board members indicated that they favoured the staff undertaking further exploration of two possible approaches:

• Approach 1 – The lessee obtains the right to use the asset up until the option exercise date and an option to extend the lease; and
• Approach 2 – The lessee obtains a right to use for the full lease period and an option to terminate the lease.

Many Board members thought Approach 1 was the most conceptually pure and preferred it, but were willing to explore Approach 2 further. It was noted that some participants in the Leases Working Group were concerned that Approach 1 was potentially open to abuse and structuring. However, Approach 2 also had problems associated with it-particularly in the measurement of options. However, measurement difficulties should not, at this stage, preclude further examination of the Approach.

The Board indicated that it was highly unlikely to support either an approach under which the lessee obtains a right to use either for the full lease period or for the period to the option exercise date; or one under which the lessee obtains a right of use whose measurement is based upon the expected value of the payments under the lease. Both of these were criticised for being too intent-based, lacking a clearly-articulated measurement attribute and for departing from the previous assessment of the assets and liabilities identified in the lease.

Discussion at the June 2007 IASB Meeting

The FASB staff joined the meeting by video link for this session.

The Board discussed several issues regarding initial recognition and measurement of assets and liabilities under a simple non-cancellable lease arrangement with a fixed term, no options to extend or purchase and no residual value guarantees (the example).

Measurement of the lessee's liability to the lessor

Initial measurement

The Board discussed two approaches for the initial measurement of a lessee's liability for its obligation to make payments to the lessor:

• Present value calculated by discounting expected cash flows using the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee's incremental borrowing rate is used.
• Fair value.

Subsequent measurement

The Board discussed three approaches for the subsequent measurement of a lessee's liability for its obligation to make payments to the lessor:

• Fair value
• Amortised cost using the effective interest method
• Amortised cost using the effective interest method with an option to fair value.

The Board unanimously agreed that the lessee's liability to the lessor is a financial liability. A majority of Board members pointed out that the lease project should not amend the current measurement requirements for financial liabilities and that therefore the lessee's liability to the lessor should be measured in accordance with IAS 39 Financial Instruments: Recognition and Measurement, that is, initial measurement at fair value and subsequent measurement at amortised cost using the effective interest method with an option to fair value.

Measurement of the lessee's right to use the asset

The Board considered three approaches to determining the initial and subsequent measurement of a lessee's right to use an asset:

Approach 1: Intangible Asset Approach

A lessee's right to use the asset is deemed similar in nature to an intangible asset acquired outside of a business combination. Thus, the initial and subsequent measurements should be consistent with the Boards' existing standards on accounting for intangible assets acquired outside of a business combination (IAS 38 Intangible Assets).

Approach 2: Nature of the Leased Item Approach

A lessee's right to use the asset is deemed similar in nature to the item the lessee obtains the use of via the lease contract. Thus, a lease of property, plant and equipment (PP&E) should have initial and subsequent measurements consistent with the Boards' existing standards on accounting for PP&E acquired outside of a business combination (IAS 16 Property, Plant and Equipment). Similarly, a lease of an intangible asset (if within the scope of the revised standard) should have initial and subsequent measurements consistent with the Boards' existing standards on accounting for intangible assets acquired outside of a business combination (IAS 38).

Approach 3: Separate Accounting Model Approach

Either a lessee's right to use the asset is deemed different in nature from both an intangible asset and the nature of the item being leased or another measurement approach would result in more decision-useful information and the incremental benefits of that approach exceed the incremental costs. In either case, a separate accounting model should be developed for the initial and subsequent measurement of a lessee's right to use asset. The separate measurement approach considered was to require that a lessee's right to use asset be measured at fair value, with changes in fair value recognised in profit or loss (earnings).

A majority of eight Board members was in favour of approach B and noted that the 'possession of the asset' should determine the accounting treatment and that the treatment for leased and owned (bought) assets should be the same. The supporters of approach A or C pointed out that the right to use an asset is different from the (physical) asset and that this right should be treated differently. Those in favour of C indicated that they would prefer 'a fair value model'.

One Board member suggested that lessor accounting should be considered simultaneously in order to avoid inconsistent accounting treatments on the lessee and lessor side. However, lessor accounting was not discussed further at this meeting.

The Board tentatively decided that all three approaches should be included in the discussion paper with mentioning B as the Board's preferred approach.

Initial recognition of assets and liabilities in lease contracts

The Board deliberated whether assets and liabilities arising in the example should be recognised upon contract signing or upon delivery/acceptance of the leased item.

In principle the Board agreed to recognise assets and liabilities upon delivery/acceptance of the leased item. However, it was noted that between contract signing and delivery of the leased item the lease contract is a forward contract. No decision was made regarding the treatment of the forward contract but the staff was directed to analyse for discussion at a future meeting situations in which there is a long period between signing and delivery.

Discussion at the October 2007 IASB Meeting

Other Lease Obligations

At its meeting in March 2007, the Board tentatively concluded that a lessee's obligation to return the leased item at the end of the lease term does not meet the definition of a liability. However, a number of Board members noted that the terms of the lease contract might give rise to other obligations that meet the definition of a liability. For example, an obligation to return the leased item in a specified condition may meet the definition of a liability.

At the current meeting the Board analysed a number of lessee obligations to determine if they meet the definition of a liability and, if so, what should be the appropriate accounting treatment. In particular, the Board considered:

• Lessee obligations to incur costs to return the leased item.
• Lessee obligations to return the leased item in a specified condition.
• Lessee obligations to maintain the leased item.

The objective of the discussion was to provide feedback to the staff, rather than make formal Board decisions.

Lessee obligations to incur costs to return the leased item

The Board agreed that such obligations meet the definition of a liability. The Board noted that the treatment of the debit arising on recognition of the liability should be same as if the asset was owned.

Lessee obligations to return the leased item in a specified condition.

The Board were presented with three alternative views of when an obligation could arise in these circumstances:

• View A: At the end of the lease term.
• View B: When the leased item falls below the contractually specified condition.
• View C: When the leased item is delivered or made available to the lessee.

The majority of the Board members were inclined toward View B. One Board member noted that this may be at the beginning of the lease.

Lessee obligations to maintain the leased item

The Board were presented with two alternative views of when an obligation could arise in these circumstances:

• View A: When the leased item falls below the specified maintenance standard.
• View B: When the leased item is delivered or made available to the lessee.

The Board noted that these liabilities were similar to lessee obligations to incur costs to return the leased item and therefore the majority of the Board members were inclined toward View A.

Measurement of the liability – Initial measurement

The Board discussed initial measurement of liabilities, specifically whether they should be measured at fair value or at the expenditure required the settle the present obligation. The Board noted that other liabilities within the leases project have been recognised at fair value. Some Board members indicated that they did not believe there would be a difference between fair value and the treatment under IAS 37. No decisions were made.

Measurement of the liability – Subsequent measurement

The issue of subsequent measurement of such liabilities was not discussed.

Do lessee obligations give rise to assets for the lessor?

The Board briefly discussed whether terms in a lease contract that require a lessee to either return the leased item to the lessor in a specified condition or maintain the leased item would appear to create valuable rights for the lessor. The Board agreed that no additional asset would arise.

Variable Lease Payments

The Board briefly discussed agenda paper 12B.

In relation to lease payments with a variable factor based on price changes or an index, the Board agreed that the lessee has a liability that includes both fixed and variable components of the future rentals. No decisions were made in relation to subsequent measurement.

In relation to lease payments with a variable factor based on the lessee's financial or operating performance from the leased item the Board noted that this issue was similar to the 'sale of future revenues'. The Board noted that such sales were unlikely to be an obligation, however no decisions were made.

Discussed at the July 2008 IASB Meeting

The Board discussed in detail the revised project plan. The staff noted that the revised project approach takes into account the 'mid-2011 completion goal' discussed at the April 2008 joint Board meeting for projects that are part of the Memorandum of Understanding between the IASB and FASB (MoU).

The key proposals of the revised project approach were:

• to address lessee accounting and defer consideration of lessor accounting,
• to apply the current finance lease model to leases currently classified as operating leases, which means that the current finance lease model will be applied to all leases, and
• to remove the requirement for lessees to classify leases as finance leases or operating leases.

In addition, the staff presented analyses on the following issues that arise if the current finance lease model is applied to operating leases:

• options to extend or terminate a lease,
• contingent rentals, and
• initial and subsequent measurement of the lessee's asset and liability under the lease.

Several Board members expressed their disappointment that lessor accounting was scoped out but acknowledged that the time constraints make it impossible to address both lessee and lessor accounting. Some Board members stated that lessor accounting should not disappear from the IASB's agenda but should be addressed in a subsequent phase of this project.

By majority vote the Board agreed to the revised project plan in full.

Some Board members noted that residual value guarantees and the nature of the right-to-use asset should also be addressed in the discussion paper. The staff responded that residual value guarantees will addressed at the exposure draft stage and that issues regarding the right-to-use asset will be addressed in the discussion paper.

The Board then started its deliberations on the technical issues that arise if the current finance lease model is applied to operating leases.

Options to extend or terminate a lease

Without detailed discussion the Board decided that options to extend or terminate the lease should not be recognised separately from the right of use asset but that the assets and liabilities recognised by the lessee should be based upon an assessment of the lease term.

The Board did come to a conclusion on how the lease term should be assessed. The discussion was based on an example of a five-year lease that incorporates an option to extend the lease for an additional three years. Some Board members favoured a probability weighted approach, i.e. if the probability that the lease will be extended is 50% the estimated lease term would be 6.5 years. Other Board members disagreed to this approach since there would be no continuous range of possible outcomes. In addition, Board members expressed mixed views on whether the estimated lease term should be trued up on a regular basis. The issue was pushed back to staff for further elaboration. However, there was a consensus that all contractual, non-contractual financial and business factors should be taken into consideration when determining the lease term. The Board also decided that any new lease accounting standard should provide detailed guidance on the factors to be considered.

Contingent rentals

The Board decided not to retain the current accounting treatment for contingent rentals but to estimate contingent rentals at inception of the lease. Also the Board decided that the best estimate of contingent rentals determined in accordance with the methodology in IAS 37 Provisions, Contingent Liabilities and Contingent Assets should be used.

The FASB staff informed the Board that the FASB tentatively decided to also have an up-front estimate of contingent rentals but to use the most likely outcome when determining contingent rentals.

Initial and subsequent measurement of the lessee's asset and liability under the lease

The Board made the following decisions:

• The lessee's right-to-use asset should be initially measured at the present value of the 'expected lease payments'. The Board noted that the expected lease payments differ from minimum lease payments if they include contingent rentals.
• Accordingly, the lessee's liability should be initially measured at the expected lease payments.
• The discount rate used in calculating the expected lease payments should be the secured incremental borrowing rate.
• The payments for the lessee's liability should be apportioned between a finance charge and a reduction of the outstanding liability, consistent with the treatment of finance leases currently in place.

Regarding the subsequent measurement of the right-of-use asset the staff recommended allocating the depreciable amount on a systematic basis consistent with the depreciation policy the lessee adopts for depreciable assets that are owned. The right-of-use asset would be depreciated over the shorter of the lease term or the economic life of the leased item and for leases of items in which it is reasonably certain that the lessee will obtain title at the end of the lease term, the 'period of expected use' would be the economic life of the leased item. The staff noted that this recommendation is consistent with the current finance lease accounting model and is consistent with the basic approach to the project.

The Board seemed to agree. However, one Board member strongly demanded that further research work on the nature of the right-to-use asset should be undertaken before answering this question.

Lease classification

The Board decided to remove the requirement for lessees to classify leases as operating or finance and to develop a single model of accounting for all lease contracts.

Way forward

The Board intends to publish a discussion paper in November 2008.

September 2008: IASB-FASB leases working group will meet

The joint IASB-FASB Leases Working Group will meet on Tuesday 7 October 2008 at the FASB's office in Norwalk, Connecticut, USA. The principal agenda item for the meeting is discussion of a staff draft of the Leases discussion paper (DP). The draft DP – which has not been approved by the FASB or the IASB – would express a preliminary view of the two Boards in favour of replacing the current lease accounting model with a new model. The current model classifies leases as finance leases or operating leases, with the former accounted for as, in substance, financed purchases of the leased asset. Under the proposed new model, a lessee would recognise as assets and liabilities all material rights and obligations arising in all lease contracts, including those rights and obligations that arise under leases currently classified as operating leases.

Thus, a lessee would recognise:

• an asset representing its right to use the leased item for the lease term, and
• a liability for its obligation to pay rentals.

The operating and finance lease classifications would be eliminated. The observer note for the working group meeting includes a draft of the DP.

Click to Download the Observer Note from the IASB website (PDF 930k).

Discussion at the November 2008 IASB Meeting

(FASB staff joined the meeting by videolink.)

The purpose of this session was to resolve open issues before publication of a discussion paper (DP).

The issues addressed at this meeting were:

• Consideration of Lease Term, Purchase Options, Contingent Rentals and Residual Value Guarantees
• Subsequent Measurement of right-to-use asset and obligation to pay rentals
• Presentation of Leases
• Subleases

The staff said that while they hoped the Board would reach preliminary views on these issues before the DP is issued, to avoid significant delay of the DP an alternative approach could be to describe the unresolved issue, discuss alternative treatments, and ask respondents for their views in the DP.

Consideration of Lease Term, Purchase Options, Contingent Rentals and Residual Value Guarantees

Lease Term

The staff asked the Board whether assessment of the lease term is done for purposes of recognition or measurement. The example used was a lease contract over 10 years with a 5 year option to renew. The staff proposed two alternative approaches:

• Approach 1: Lessee recognises obligation to pay rentals, the uncertainty in the lease term is addressed through measurement.
• Approach 2: Lessee recognises obligation to pay rentals over a specified lease term. Uncertainty is addressed through recognition.

It was noted that the FASB voted for approach 2. The Board discussed various implications of both approached. Finally, the majority of the Board members voted in favour of approach 2.

Determining Lease Term under Approach 2

The staff highlighted that under approach 2 an entity would be required to establish a lease term for the purpose of recognition. Possible solutions to this issue presented were:

• Approach 2A: a probability threshold
• Approach 2B: a best estimate
• Approach 2C: a best estimate - most likely lease term

Some Board members expressed concern over the term 'best estimate' as it implied a certain degree of subjectivity. Again, the Board discussed certain implications and agreed with the staff recommendation that the most likely lease term (approach 2C) should be used.

Purchase options

The Board agreed with the staff recommendation that the possible exercise of a purchase option was reflected in the obligation to be recognised by the lessee and that it was to be included if exercise of the option was the most likely outcome.

Measurement of contingent rentals

The staff presented three possible approaches to measure contingent rentals:

• Best estimate
• Best estimate – most likely amount of contingent rentals
• Probability-weighted best estimate

Residual value guarantee

The Board decided to require that the initial assets and liabilities recognised by the lessee should reflect the obligation to make payments under a residual value guarantee.

Subsequent Measurement of right-to-use asset and obligation to pay rentals

The staff presented the Board with their approach to subsequent measurement of the lessee's right-to-use asset and obligation to pay rentals. The proposed accounting would be as follows:

• Amortise/depreciate right-of-use asset
• Apportion the lease payments between a finance charge and a reduction of the outstanding obligation
• Present interest expense and amortisation/depreciation in the income statement.

The Board discussed the interaction with the conclusions reached in the financial statement presentation project.

One Board member noted that the proposed accounting would not meet the cohesiveness objective. The Board agreed, however, with the staff recommendation.

The staff continued to address the issue of reassessment of lease term. The staff proposed to continuously reassess the lease term. The Board agreed.

The staff then turned to the reassessment of the obligation to pay rental. The staff proposed to reassess the obligation to pay rentals at every reporting date. The Board agreed.

For the resulting change in the estimated lease payments the staff proposed a cumulative catch up approach by discounting the new cash flow estimates with the original effective interest rate. Some Board members expressed concern over the use of the original effective interest rate. The Board had a lengthy discussion on whether also rate changes should trigger reassessment, or whether remeasurement should only be triggered if cash flows changed. The FASB voted for a cumulative catch up approach. The Board voted in favour of a cumulative catch up approach. The staff continued to ask the Board where the changes in estimated rental payments should be recognised. The staff recommended treating all reasons for changes in rental payments similarly and reflecting the balancing journal entry in an adjustment to the right-of-use asset. The Board agreed.

Presentation of Leases

Presentation of the right-to-use asset

The staff presented the Board with possible alternatives of presenting the right-to-use asset in the statement of financial position:

• Approach A: presentation in line with the underlying asset
• Approach B: presentation as an intangible asset
• Approach C: different presentation for different types of leases

Staff noted that additional disclosures should accompany any of the presentation approaches. The staff recommended approach A. The Board agreed with no support for a concept of an 'in substance purchase'.

Presentation of the obligation to pay rentals

The staff recommended that the obligation to pay rentals should be presented as financial liabilities not being required to be presented separately from other financial liabilities. One Board member was concerned that the staff recommendation would not be in line with the cohesiveness principle. Staff responded that it did not consider the outcomes of the current financial statement project. The Board agreed to the staff recommendation.

The staff informed the Board that the presentation in the statement of financial position will drive income statement presentation, but that this would not be addressed at this meeting.

Subleases

The staff informed the Board that in sublease scenarios, the different accounting treatment for lessee (accounted for under the new model) and lessor (accounted for under the IAS 17 model) accounting would create problems. This resulted from the Board's decision only to address lessee's accounting in the project. The staff recommended deferring this issue until after publication of the discussion paper. The Board agreed and asked the staff to use the comment period to address the issue of subleases. FASB staff informed the Board that the FASB indicated that if this issue would not be resolved, they would not move on with this project.

Discussion at the January 2009 IASB Meeting

(FASB staff participated by video link.)

The staff informed the Board that the FASB has made the decision that lessor accounting (including subleases) should be further analysed and included as a high level discussion in the upcoming discussion paper (DP) with specific questions, but without changing the scope of the DP.

The staff noted that the FASB has also discussed whether in-substance purchases should be within the scope of the project, but decided no change in scope.

Furthermore, FASB discussed how a right-of-use model as proposed for lessees in the DP could be applied to lessor and decided that its DP should have a high-level discussion of lessor accounting.

The staff asked the Board whether it was willing to defer publication of the DP to include the outcome of the FASB staff analysis.

The Board discussed several aspects of these outcomes of the FASB discussion and the possible impact on the IASB's project, particularly on the timing and possible delays. Staff was asked how long the additional analysis by the FASB on lessor accounting would take. Staff responded that could be a matter of weeks, but possibly a month.

The chairman noted that this would cast doubt over the 2011 completion goal and expressed concerns over the massive changes of the Board membership at that point. He proposed that the IASB should go ahead with the DP as it stands and publish any output from the FASB as a supplementary DP. The IASB DP, to be issued shortly, should highlight that there is more to come.

The Board agreed.

Lessor Accounting

The staff informed the Board that FASB staff saw itself in a position to provide a high-level discussion and issues on lessor accounting. The staff indicated that this analysis would not contain preliminary views. The Board agreed to defer issuing the leases discussion paper if the lessor section could be done within the timeframe indicated. The FASB also committed resources to further develop lessor accounting proposals.

March 2009: IASB publishes preliminary views on leases

On 19 March 2009, the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have published, for comment, a discussion paper (DP) Leases: Preliminary Views. Comments are requested by 17 July 2009. The DP is available on the 'Open for Comment' Section of the IASB Website. In the DP the IASB and the FASB propose a possible new model for lease accounting. The model is based on the principle that all leases give rise to liabilities for future rental payments and assets (the right to use the leased asset) that should be recognised in an entity's statement of financial position. Below are a few of the boards' preliminary views in the DP. Click for IASB Press Release (PDF 61k).

Deloitte's IFRS Global Office has published an IAS Plus Update Newsletter – Boards Issue Preliminary Views on Lease Accounting (PDF 129k).

Discussion at the May 2009 IASB Meeting

FASB staff joined the meeting via video link.

The staff introduced the paper by noting that the FASB staff is undertaking initial work on lessor accounting issues during the comment period of the Leases discussion paper. At this meeting the Board will be asked to consider analysis of rights and obligation in a simple lease contract.

The first question the staff asked the Board was whether the Board agreed that the lessor has an asset for its right to receive rental payments from the lessee. The Board unanimously agreed.

The Board then considered what is the credit? That is, does the lessor derecognise all or a portion of the leased item or does the lessor have a liability for the obligation to allow the lessee to use the leased item? The staff explained that under the first approach, the lessor is viewed as having transferred a portion of the leased term to the lessee (View A). Under the second approach, the lease contract is viewed as creating a new right, leaving the lessor's rights relating to the leased item unchanged. The leased item is treated as the lessor's economic resource and continues to recognise the leased item (View B).

Some Board members expressed support for view A, although the majority of Board members supported view B. There was disagreement amongst Board members as to which of the views is consistent with the framework. Those who supported View B expressed a number of concerns with View A, including the fact that they were concerned that following the approach in View A would give a day 1 profit. Those in support of View A were concerned that View B would result in entities (for example, banks) having assets on their balance sheet for which all the risks and rewards had passed on to someone else. Concerns were also expressed that View B was 'grossing up' the balance sheet and would potentially impact on ratios. It was noted, however, that this may be overcome by presenting the gross amounts on a linked (net) basis.

The (acting) Chair said he would like more time to reflect on the issues and requested the staff to consider the issues raised by the Board members, although it was noted that a significant majority of the Board members favoured View B.

Discussion at the June 2009 IASB Meeting

FASB staff joined by video conference.

Impairment of right-of-use asset

The staff opened the discussion by reminding the board that they have previously tentatively decided to requite initial and subsequent measurement of a right-of-use asset on an amortised cost basis. Consistent with other assets measured on an amortised cost basis it needs to be determined how a right-of-use asset will be reviewed for impairment.

The staff noted that they believe there are four options for impairment accounting for right-of-use assets:

1. require all entities to use IFRS approach
2. require all entities to use US GAAP approach
3. develop specific approach for right-of-use assets
4. require entities to refer to existing applicable standards (IAS 36 for IFRS preparers, SFAS 144 for US GAAP preparers)

The staff recommended the last alternative. The Board agreed with the staff recommendation.

Revaluation

The staff introduced the topic by noting that the discussion was about whether an option for revaluations should be included for right-of-use assets, not a requirement to revalue. The staff recommended that revaluation of right-of-use assets should be permitted. The staff further added that their recommendation did not change regardless of whether the right-of-use asset was considered to be intangible or tangible in nature. The staff believes that permitting revaluation may provide users of financial statements with more relevant information about the revalued assets than amortised cost based measurement. They also believe that revaluation will ensure consistency with other non-financial assets in IFRSs. The FASB staff did not agree with the IASB staff recommendation; the FASB staff recommended that revaluation of right-of-use assets should not be permitted. At their Board meeting the FASB agreed with the FASB staff recommendation.

One Board member asked the staff whether they thought the revaluation criteria would be IAS 16 or IAS 38? The Board member thought that the Board needed to decide this first as revaluation under IAS 38 requirements would be impossible as there is no active market. The Board member would favour no revaluation.

Another Board member supported the IASB staff recommendation. They thought that the appropriate standard to look to would be IAS 16, not IAS 38. The Board member did not see why financing a non-current asset by leasing rather than by an outright purchase should change whether a revaluation should be allowed.

Some other Board members thought that the right-of-use was an intangible.

Another Board member said that they agreed with the IASB staff recommendation. The Board should not revisit the current requirements. Whether IAS 16 or IAS 38 is applied depends on the nature of the asset you are leasing. A number of other Board members agreed with this notion.

In response to a Board member's question, the staff said that the FASB made their decision as it was consistent with current US literature. The FASB staff member added that the FASB think that rights-of-use are intangible. This is a difference.

The Board voted, and all favoured the IASB recommendation.

The staff summarised the discussion by saying that we should look to the nature of the underlying asset and apply that revaluation model. In that case the remainder of the questions in the paper were not required.

One Board member asked whether the staff thought that the revaluation should be applied to classes or assets or individual assets, as in IAS 40. The staff responded by noting that they need to consider the interaction between IAS 40 and the leasing proposals and will bring this back for Board consideration at a future meeting.

Initial direct costs

The staff introduced the discussion by stating that there are three possible ways of addressing how initial direct costs should be accounted for:

• (a) add initial direct costs to the carrying amount of the right-of-use asset
• (b) allocate initial direct costs between debt issuance costs and asset acquisition costs
• (c) recognise such costs as an expense as incurred.

The staff recommended (a), and the FASB at their meeting agreed with (c).

One Board member agreed with the FASB. Another noted that if the asset is revalued the initial direct costs would be expensed anyway. Another Board member said that they would like to get to the FASB answer. Another added that if the initial direct costs are added to the costs to the asset, then the asset would not equal the liability on initial recognition. It would also be inconsistent with the definition of cost in the discussion paper. A number of other Board members supported the IASB staff view.

The Board voted. The vote was split: 7 Board members favoured (a) while 7 favoured (c) - expense. The Chairman used his 'casting vote' (paragraph 35 of the 2009 IASCF Constitution) to make the vote 7 for (a) and 8 for (c).

Transition

The staff initially considered four ways of addressing how the new lease standard should be applied:

• Option A – retrospective application
• Option B – prospective application to new lease contracts entered into after the effective date
• Option C – measure all leases at fair value on the transition date
• Option D – measure all leases at the present value of the lease payments, discounted using the lessee's incremental borrowing rate on the transition date.

The staff recommended Option D. At their meeting, the FASB agreed with the staff recommendation. The Board also generally supported the staff view, subject to some modification.

Sale and leaseback

The final issue to be addressed was to obtain preliminary views from the Board on how a seller/lessee should account for a sale and leaseback transaction under a right of use accounting model. Lessors are also discussed in the staff paper; however, the Board would not be asked to reach a preliminary view on lessor accounting at this stage. The staff noted that they were not attempting to develop a general theory of derecognition for non-financial assets. The staff also noted that they have assumed that the sale proceeds received by the seller/lessee equal the fair value of the property sold and that the leaseback is at a market rate.

The staff said that the FASB preferred an approach where the entire asset was derecognised. They preferred to look at whether a sale had occurred, regardless of the existence of a leaseback. They would look at the existing control based assessment and consider the use of some specific criteria in making this judgement.

The staff then turned to the first question; whether the Board agreed with the staff recommendation that a seller/lessee should consider whether the entire asset qualifies for derecognition. Following some discussion, the Board agreed with the staff recommendation.

The second question posed by the staff was whether the Board would support (a) always derecognising the leased asset or (b) developing criteria to differentiate between transactions that qualify for derecognition and those that do not.

A number of Board members thought that they should use the revenue recognition (control) model. Following discussion the staff summarised by noting that the Board would look to the control model as to whether there is a sale or derecognition and look to revenue recognition for indicators as to whether this has occurred. The Board agreed.

The staff then asked the Board if they would like additional criteria beyond the revenue recognition criteria? The Board indicated that they did not; the revenue recognition criteria should be sufficient.

As a final question, the staff asked the Board if a sale is recognised, would they want to defer any gain associated with this. The Board indicated that they would not want to defer any gain.

Question 4 of the staff paper was not discussed.

Discussion at the July 2009 Joint IASB-FASB Meeting

The Boards discussed a staff paper on preliminary views on lessor accounting. At the May meeting the Boards tentatively decided that a lessor would recognise an asset representing its right to receive rental payments from the lessee (a lease receivable) and a liability representing its performance obligation under the lease.

The initial and subsequent measurement of the lessor's receivable

The Board agreed with the staff's proposal to measure lessor's receivable in line with the applicable requirements of IFRSs and US GAAP.

For initial measurement, the Boards agreed that little divergence is to be expected between the respective definitions as fair value is used under both systems (calculated as present value of future cash flows). Nonetheless, several members of the Boards raised the issue whether the lease receivable was a financial instrument or was to be scoped out from the financial instruments standard. The Boards were unable to agree on the answer. Several members were concerned about possible inconsistency between lessee and lessor accounting.

The Boards agreed that using the interest rate implicit in the lease for discounting the expected lease payments is appropriate.

Some Board members were concerned about the divergence between the proposed financial instruments standards by FASB and IASB and its impact on initial and subsequent measurement. On subsequent measurement, many of the Boards' members though that scoping out leasing from the financial instruments project would be necessary (as it is uncertain whether it would fulfil the basic loan feature and whether it can be assessed to be managed on a contractual yield basis) and its fair value could not be ascertained.

One Board member was concerned about the fluctuations of fair value of the receivable that can arise not only from the interest rate changes but also from the changes of the value of the underlying. As the Boards were unable to agree at this point if it would represent a receivable (as a financial instrument) or a right (within the meaning of revenue recognition project), the staff was directed to provide additional analysis. The Boards seemed to like the notion that in simple leases the receivable could be a financial instrument, whereas in more complex issues (contingent rent, options) the conclusions seemed to be the opposite.

The initial and subsequent measurement of the lessor's performance obligation

The Boards agreed that performance obligation should be measured at transaction price. Some Board members seemed to be concerned that this approach could instigate a Day 1 gain.

The Board also agreed with the subsequent measurement as reflecting decreasing in the entity's obligation to permit the lessee to use the leased item over the lease term. Some of the Boards' members noted that different principles for goods and services shall be developed in line with the principles within revenue recognition.

The presentation of a lessor's receivable and performance obligation

The Boards had divided opinions of how to present leases in lessor's accounting. The Boards were split between gross presentation of all three items (leased asset, lease receivable and performance obligation), lease receivable net of performance obligation, leased items net of performance obligation and a bifurcation between the present value and the estimate of residual amount. Several Board members noted that it is the old finance and operating lease issue. Other Board members noted that perhaps three distinct models of presentation would be required in order to capture the underlying economic reality (financing, provision of goods and provision of services). No decision was reached.

The Boards discussed various issues related to specific industries, requirements to Banks as lessors, real estate sector. The Boards were stuck in the debate of the recognition of the whole asset, rights previously not recognised being recognised, inconsistency between treatment of purchase finance and leases even though they represent the same economic reality.

The Boards concluded that significant issues of definition, scope and measurement would have to be revisited. The staff noted that the Board will be presented additional analysis (revenue recognition model versus financial instruments) in October, after taking into account the feedback from the constituents to the preliminary views discussion paper as well as input from the discussions at working group on leases in September.

Discussion at the September 2009 IASB Meeting

Comment Letter Summary

FASB staff joined the meeting by video link.

The Board discussed the summary of 290 comment letters received to the discussion paper Leases Preliminary Views. The Board did not take any decision during this session.

The staff highlighted the following issues where the majority of constituents expressed different preferences from those articulated by the Board:

• Lessor accounting – the decision to defer consideration of lessor accounting
• Probability-weighted estimate of contingent rentals payable
• Inclusion of the contingent rental in the lessee's obligation

The staff also highlighted the need for further guidance for distinguishing service contracts and leases in addition to that included in IFRIC 4 as this distinction would become much more pertinent under the new rules.

In addition, most constituents seemed to prefer a derecognition approach for lessor accounting. The Board considered the comments by the investment property companies that new leases accounting should not apply to lessors currently applying the fair value model in IAS 40. The Board agreed that it would assess the need for a separate model for the industry on one of the future meetings.

The Board considered the proposed timing of the new standard. It reaffirmed the timetable for lessee accounting with the ED expected in June 2010 and final standard in June 2011.

Regarding lessor accounting, the staff will provide additional analysis for the October meeting. The Board noted that the timetable for the lessor accounting would be based on the outcome of the discussions on the basic features of the lessor's accounting model. At that time, the Board will decide how to proceed with the lessor accounting (whether to issue a separate discussion paper or exposure draft on lessor accounting) and will decide on timing of the project.

One Board member was particularly concerned about the consistency between derecognition model for lessor accounting and the overall derecognition model that would be adopted as part of the IAS 39 replacement project. The Board agreed to address this issue as part of its deliberations.

Discussion at the October 2009 Joint IASB-FASB Meeting

Lessor Models under a Right-of-Use Approach

The staff began the leases portion of the meeting discussing potential models that could be used for lessors in accounting for leases. One model is the derecognition approach. Under this approach, the lessor is viewed as having transferred a portion or all of the leased asset to the lessee in exchange for a right to receive rental payments. The lessor derecognises the leased asset because it no longer controls the right to use that asset during the lease term. As such, the lessor derecognises the leased asset and recognises a receivable. The lessor continues to recognise those rights that have not been transferred to the lessee (the residual value of the asset).

Another model is the performance obligation approach. Under this approach, the lessor is viewed as having granted the lessee the right to use its economic resource (the leased asset) in exchange for the right to receive rental payments. The lessor does not lose control of the leased property and continues to recognise the leased asset. The lessor would recognise a receivable for the right to receive rental payments and a corresponding liability for the obligation to permit use of the leased asset.

The staff also discussed two other models: the current operating lease approach and the dual-model approach. The current operating lease approach would retain the current guidance for operating leases for lessors. The dual-model approach recognises that not all leases are the same and would provide guidance on when to use each model.

Both Boards decided on the performance obligation approach. Members supporting this approach noted that 'possession' of a leased asset is not synonymous with 'control' and that the derecognition approach confuses the underlying asset with a separable right to use the asset. The Boards directed the staff to perform further analysis on how this model would (a) be impacted by impairment, (b) affect manufacturing lessors, and (c) affect investment properties.

The Boards discussed the financial statement presentation of the receivable, leased asset, and obligation. Some Board members indicated that they may support a net presentation approach in which the receivable and obligation are netted, but no decision was made at this meeting. The Boards asked the staff to perform further analysis of possible presentation approaches under performance obligation approach.

Should lessees use the right-of-use approach?

The staff asked the Boards to confirm their prior decision that lessees apply a right-of-use approach for a simple lease contract. The staff did not ask the Boards to discuss the scope of the lease project, the definition of a lease, or leases with options and contingent rentals. These topics will be discussed at future meetings. The staff also acknowledged that the Boards will need to consider how lease accounting applies to short-term leases and immaterial leases. The Boards unanimously confirmed their decision to proceed with a right-of-use approach.

In-substance purchases/sales

The staff proposed that lease contracts that are purchases/sales of the leased item should be excluded from the scope of the new lease standard. The Boards agreed that sales/purchases should be excluded from the scope of the new lease standard.

The staff next recommended that an entity should consider applicable revenue recognition guidance in determining whether a sale/purchase of a leased item has occurred. The Boards expressed concern with this approach as there are different views on what 'transfer of control' means with regard to lease transactions, and therefore they rejected this recommendation.

The Boards agreed that the determination of whether a sale/purchase has occurred should be based on the specific terms of the lease. For example, Board members generally agreed that if title transfers at the end of a lease, then a sale/purchase has occurred. The Boards decided that the new lease standard should provide guidance on how an entity should determine whether a sale/purchase has occurred and directed the staff to develop criteria that would assist entities in this assessment.

The staff also asked Board members whether they supported creating a separate accounting model for transactions that were within the scope of the new lease standard but that had sales/purchases features. The Board members affirmed that only one model (the right-of-use model) should exist in the new lease standard and that another model for leases with some sales/purchases features should not be developed.

Timing of initial recognition

The staff proposed to the Boards that entities should recognise assets and liabilities from the lease transaction upon contract signing. Further, the staff recommended that between contract signing and delivery of the leased asset(s), the unit of account is the contract as a whole and that the contract position should be presented net in the statement of financial position. Upon delivery, the lease asset and lease obligation would be presented on a gross basis. The Boards agreed with the staff's recommendation.

Next, the staff recommended that entities should initially and subsequently measure the assets and liabilities (the net contract position) in a contract on a cost basis. The Boards agreed with the proposal but clarified that the cost would be subject to impairment under other applicable standards. In other words, if there was impairment on a lease contract between contract signing and delivery of the leased asset, the entity would 'write-down' the asset and the contract would be in a net liability position. If the lessee decided to cancel the contract, it would derecognise the net lease contract and record an obligation in the amount of the penalty to cancel the contract. The Boards also agreed with the staff to require additional disclosures in situations where the time between contract signing and delivery is long and/or the rights and obligations are significant.

Discussion at the November 2009 Joint IASB-FASB Meeting

Lessee accounting – Initial measurement

The Boards continued deliberating the Leases project by discussing the initial measurement of a lessee's obligation to pay rentals and the right-of-use model. The Boards reaffirmed their decision that the lessee's obligation to pay rentals should be measured at the present value of the lease payments. Two possible approaches to the discount rate were discussed:

• the interest rate implicit in the lease
• the lessee's incremental borrowing rate

Some Board members were concerned that the interest rate implicit in the lease was not consistent with the right-of-use model and would lead to considerable problems for the lessees. Most Board members preferred using the incremental borrowing rate on grounds that it is more operational. While acknowledging that such a decision would not create symmetry in the lessor/lessee accounting, most Board members noted that the lease accounting model being developed will not lead to lessor/lessee accounting symmetry, especially in more complex leases (due to different assessment of options and contingent rentals). Most Board members also noted that these two methods are not exclusive and in the simple examples should lead to the same result.

After a short discussion the Boards unanimously agreed that the lessee's incremental borrowing rate should be used to discount the lease payments. Nonetheless, the Exposure Draft will contain guidance on when the rate implicit in the lease might be indicative of the lessee's incremental borrowing rate. Moreover, some Board members said the definition of the rate implicit in the lease should be revised to conform to the right-of-use model. The staff will provide additional analysis of the definition on a future meeting.

The Boards also agreed that initial measurement of the lessee's right-of-use asset should be at cost, which is equal to the present value of the lease payments discounted using the lessee's incremental borrowing rate.

Finally, the Boards agreed that any initial direct costs should be added to the amount recognised as an asset. The Boards asked the staff to investigate any differences in the definition of direct cost between IFRSs and US GAAP, as some Board members expressed concerns that potential differences might exist (direct and incremental cost under IFRSs and direct cost under US GAAP).

Lessee accounting – Subsequent measurement of the obligation to pay rentals

The Boards agreed that the subsequent measurement of the lessee's obligation to pay rentals should be an amortised cost basis.

The Boards then considered the need for re-assessment of the incremental borrowing rate. The Boards first discussed re-assessment of the incremental borrowing rate for simple leases when cash-flows did not change significantly (that is, leases without options and contingent rentals). Most Board members agreed to prohibit incremental borrowing rate reassessment in such cases as they believed it is inconsistent with an amortised cost model.

Nonetheless, the Boards did not extend this analysis for more complex leases. In an indicative vote, both Boards tentatively agreed that if the cash flows changed significantly (for instance, due to options or contingent rentals), the incremental borrowing rate should be reassessed. The staff will provide additional analysis at a future meeting.

The Boards also agreed that there should not be an option to subsequently measure the lessee obligation to pay rentals at fair value. At that point one FASB member noted that such a decision might be reconsidered when scope of the Financial Instruments project is finalised, as he believed that all funding costs should be considered consistently. The IASB chairman also noted that the IASB has not yet considered scope of the Financial Instruments project. Consequently the Boards agreed to specify the required accounting for the lessee's obligation to pay rentals in the Lease standard, subject to modification of scope of the new IFRS 9 (and the FASB equivalent).

Lessee accounting – Subsequent measurement of the right-of-use asset

The Boards reaffirmed their respective decisions to require subsequent measurement of the lessee's right-of-use asset on an amortised cost basis.

The Boards continued their discussions regarding the decrease in value of the right-of-use asset. Some IASB members questioned the nature of the right-of-use asset and its implications. The Boards agreed that the right-of-use asset is an intangible asset and, consistent with this conclusion, they agreed that the decrease in the value of the right-of-use asset should be presented as amortisation rather than rental expense in the statement of comprehensive income. Some IASB members were concerned that such a decision would affect performance indicators (such as EBIDTA) without a change in economic substance. The Boards agreed that separate disclosure of the amortisation of the right-of-use might be warranted to facilitate analysis of underlying economic performance. In response the staff noted that disclosure requirements would be discussed at the December or January Board meeting.

Regarding impairment of the right-of-use asset, the Boards discussed using the existing applicable standards under US GAAP and IFRSs to recognise and measure impairment. The Boards agreed that convergence would be warranted in this area but noted that any potential impairment convergence project could only be part of the post 2011 agenda. The Boards also noted that a separate model for right-of-use asset would be impracticable, and a 'look-through' approach to the underlying assets would be impracticable as well. Therefore, the Boards agreed that the lessee should refer to existing applicable impairment standards to determine whether its right-of-use asset is impaired and a loss should be recognised (IAS 36 for IFRS preparers ASC 360-10-35 for US GAAP preparers).

The Boards continued to discuss the possibilities for revaluation of right-of-use assets. The IASB members discussed several practical issues connected to the revaluation issue:

• revaluation of the more complex lease with options
• identification of the asset that was to be revalued (and possible look-through approach)
• consistency between own and leased property (especially for investment properties)
• interaction with the earlier decision not to allow revaluation of the lessee's liability and scope of IFRS 9.

Finally, the IASB agreed that a lessee should refer to IAS 38 for revaluation of the right-of-use asset even though the conditions for revaluation of intangible assets are strict. The FASB reaffirmed that US GAAP did not permit revaluation of right-of-use assets.

Lessor accounting – Initial and subsequent measurement of the lessor's receivable and lessor's performance obligation

The Boards reaffirmed several past decisions. The Boards agreed to develop a specific approach for the initial and subsequent measurement of the lessor's right to receive rental payments within the Leases project. One FASB member nonetheless urged the staff to ensure consistency with the progress made on the revenue recognition project so as not to duplicate guidance.

The Boards also agreed that the initial measurement of the lessor's right to receive rental payments should be at the present value of the total expected cash flows discounted at the interest rate implicit in the lease. Some Board members noted that definition of the interest rate should be revised to clarify that the effect of contingent rentals and changes in estimated lease terms should be considered in measuring the interest rate implicit in the lease. The staff noted it would address those issues at a later stage.

The Boards agreed that any initial direct costs should be added to the lease receivable. The Boards asked the staff to ensure consistency in the definition of initial direct costs between IFRSs and US GAAP.

The Boards also agreed that the subsequent measurement of the lessor's receivable should be amortised cost using the effective interest rate. Nonetheless, at this point, the Boards noted that this decision depends on the progress on the Financial Instruments project (especially the scope of the FI project and applicability of the impairment model to lease receivables).

The Boards agreed that the initial measurement of the lessor's performance obligation(s) should equal the transaction price (that is, the customer consideration measured at the amount of the receivable).

The Boards also agreed that the subsequent measurement of the lessor's performance obligation should reflect decreases in the entity's obligation to permit the lessee to use the leased items over the lease term. One IASB member asked for further clarification on how this decrease would be articulated.

Lessee accounting – Leases with options to extend or terminate

The Boards discussed several approaches to treatment of options in leases (including component, disclosure, and measurement and recognition approaches). The Boards finally agreed to adopt the recognition approach (IASB split 10:4; FASB unanimous). Under this approach, options would not be recognised separately, and uncertainty about the lease term should be dealt with through recognition, that is, one of the possible lease terms is selected and the accounting is based on that lease term. Some Board members were concerned that this approach failed to capture the benefits of optionality for the lessee.

The Boards also agreed that the lease term should be the longest possible term that is more likely than not to occur. Nonetheless, some IASB members were concerned that such an approach would lead to an appearance of higher leverage than the underlying economic reality. Other IASB members noted that if the required information for alternative approaches (based on inceptive pricing) were available, full fair value of the options could be determined. Nonetheless, those Board members did not believe that these were available.

The Boards agreed that a lessee should consider all relevant factors in determining the lease term. Nonetheless, some Board members were concerned that the lessee-specific considerations were included (such as lessee intentions and past practice).

The Boards also agreed that an option to renew at a market rate should be considered when determining the lease term.

Finally, the Boards agreed that the lease term should be reassessed at each reporting date and that changes in the obligation to pay rentals resulting from such reassessment should be recognised as an adjustment to the carrying amount of the right-of-use asset. The Boards also agreed that a detailed examination of every lease is not required unless there is a change in facts and circumstances that indicates that the lease term needs to be revised.

Lessor accounting – Options to extend or terminate a lease

The Boards extended the agreed lessee approach to options on lessor accounting. Some Board members were concerned with prescribing a symmetrical approach between the lessor and lessee accounting. They noted that symmetry is illusory, as even though symmetrical considerations would be applied, the lessor and lessee might have different information and, thus, final accounting entries would not be symmetrical. Finally both Boards agreed with symmetrical considerations for lessees and lessors on options to extend or terminate (IASB with a bare majority of votes).

The Boards agreed that the lessor would recognise a lease receivable based on the longest term more likely than not to occur. The Boards also agreed that the lessor should be required to reassess the lease term at each reporting date similarly to requirements for lessees.

The Boards also agreed that any change in the lease receivable resulting from a reassessment of the lease term should be recorded as an adjustment to the performance obligation.

In addition, the Boards agreed that if a change in the lease receivable resulted from a decrease in the lease term results in an overstatement of previously recognised revenue, then that revenue should be charged to profit or loss in the current period.

Discussion at the December 2009 IASB Meeting

Contingent rentals and residual value guarantees

Lessee accounting

The Boards deliberated their revised proposed approach to the recognition of contingent rentals as expressed in the DP Leases in the light of the fact that most respondents to the DP disagreed with Boards' proposed approach.

The Boards acknowledged that the recognition of contingent rentals was the most controversial area of the DP but confirmed the view that as contingent rentals are included in a lease contract, it forms part of the lease obligation. Once a lessee has agreed to and signed the lease agreement, it has created a past event the gives rise to an obligation.

The revised approach considered by the Boards includes:

• recognition of all contingent rentals;
• no reliability criteria for the recognition of contingent rentals;
• the expected outcome technique be used in measurement of contingent rentals;
• if lease rentals are contingent on changes in an index such as consumer price index or prime interest rate, the obligation is measured using a forward rate;
• requiring the remeasurement of obligation for contingent rentals at each reporting date when there has been a material change in the obligation;
• changes in the obligation resulting from the lessee buying more or less of the right-of-use should be recognised as an adjustment to the asset. All other changes are recognised in profit or loss;
• residual value guarantees are recognised together with the obligation to pay rentals;
• residual value guarantees are measured in the same way as contingent rentals; and
• changes in the obligation resulting from changes in the residual value guarantee are recognised in profit or loss.

The majority of Board members expressed their support with for the revised approach; however, they disagreed with the proposed treatment of remeasurements of obligations for contingent rentals. As part of the deliberation on the matter, the following two additional methods were suggested:

• remeasurements that affect both the current and future periods are added to the asset and recognised through amortisation over the remaining term; or
• remeasurements are allocated pro-rata across the lease term and the portion allocated to future periods are added to the asset. The portion allocation to past periods is recognised in profit or loss.

The staff was instructed to analyse further the appropriate accounting for remeasurements, taking into consideration the alternative methods suggested and present the analysis at a future meeting. The Boards also did not vote on the treatment of changes in the residual value guarantee pending the outcome of the further analysis.

Lessor accounting

The Boards considered whether there should be symmetry with lessee accounting in the treatment of contingent rentals form the lessor's perspective.

One Board member questioned how there could be symmetry if the lessee and the lessor use different estimates to measure the lease obligation. The Boards clarified that symmetry relates to the principles to be applied and does not require the outcome to be the same.

Several Board members also expressed concern with developing a revenue model for lessors that is different to the revenue recognition model.

The Boards proposed that a reliability threshold should be instituted for the recognition of contingent rentals from the lessor's perspective.

With the exception of the reliability threshold, and pending the outcome of the analysis for treatment of remeasurements, the Boards agreed with the approach as proposed for lessees.

Scope – Intangibles and other possible exclusions

The Boards considered whether the scope of the proposed guidance on leases should exclude the following leases;

• exploration of natural resources such as minerals, oil and natural gas;
• biological assets; and
• intangible assets.

Several Board members remarked that although they agree with the direction that the staff is taking, they need to understand the reasons for excluding these leases from the scope. The Boards agreed that since there is a specific project to deal with extractive activities, and pending its outcome, these activities could not be included in the scope of this guidance.

The Boards further agreed that leases of intangible assets should be excluded from the scope but that the right to use an asset (that is, sub-leases) should be within the scope. It was agreed that since the accounting for leases is principally a cost-based measure, biological assets measured at fair value should also be excluded.

The Boards qualified that the decision to exclude these arrangements from the scope of the guidance is not an irrevocable decision and that these leases could later be included in the scope as other projects are finalised.

Scope – Non-core and short-term leases

The Boards considered whether an exemption from the proposed lease accounting should be provided for non-core leases and short-term leases.

The majority of Board members agreed to that an exemption for short-term leases should be provided. When discussing the criteria for the exemption there was uncertainty as to whether or not the criteria should be expanded to include a requirement that short-term leases should be immaterial, individually or collectively, in order to qualify for the exemption. The Boards had a long discussion about whether materiality should be specifically included in the criteria or whether the general materiality guidance would be sufficient to ensure that material leases are accounted for.

On the question of the time limit allowed for the exemption, the majority of Board members agreed that the exemption should be limited to leases with a contractual term less than one year without an option to renew the lease. Some Board members suggested a similar exemption for lessors.

Without much discussion, the Boards unanimously agreed the non-core leases should not be excluded from the scope of the proposed guidance.

Due to time constraints, the Boards did not consider the agenda papers dealing with the purchases and sales of the underlying asset or lessor accounting for investment properties. Those matters will be discussed at future meetings.

Discussion at the Special IASB Meeting 5 January 2010

Scope - Purchases and Sales of the Underlying Asset

The Boards started their discussion with identification of a principle that could be used to determine when a transaction was a purchase or sale of the underlying asset and thus should be excluded from the leases guidance.

Most Board members agreed with the staff proposal to base that principle on control: when a contract transfers control of the underlying asset, it is in fact a purchase or sale and should therefore be excluded from the scope of the leases standard.

Despite the unanimous support for that principle, several Board members expressed their concerns whether that principle would be operational and whether additional guidance that would encompass also risk and rewards type of guidance would not be required. Other Board members were concerned that control was to be defined in the same way as control in the revenue recognition project due to the specific nature of the leasing relationship with continuing involvement (which can be interpreted as a kind of a protective right). These members were concerned that without a more detailed specification (for example, identification of the control at the end of the lease term) the control principle would not be operational, as control is effectively shared for the lease term.

The Boards spent a considerable amount of time discussing the issue of the definition of control. Some Board members proposed to adapt the revenue recognition definition of control to include also a future ability to direct the use and receive benefits from the underlying asset or to include residual risk and rewards in the test. The Boards finally agreed with the concept of control but instructed the staff to try to find words that would better articulate that concept for the specific environment of leases. Following that decision the Boards decided to wait with the discussion on the perspective from which to assess the transfer of control for the next Board meeting, when the principle of control would be refined.

Some Board members were concerned that in case the definition of control differed in the revenue recognition and leases projects, some contracts might fall out of scope of both standards (and thus no guidance would apply to them).

The Boards agreed to include in the leases guidance indicators to help reporting entities determine whether control had transferred to the lessee. There was little disagreement among the Board members that control of the underlying asset was normally transferred in leases where title to the underlying asset transfers to the lessees automatically at the end of the lease or in leases that include a bargain purchase option. Nonetheless, some Board members were concerned how the bargain purchase option was defined and whether it should be assessed at inception or reassessed at each reporting date. The staff clarified that the bargain purchase option should not be reassessed: it should be considered only at inception.

On the other hand, views of Board members were split on whether control of underlying asset was normally transferred when a contract covers the whole of the expected useful life of the underlying asset or when a contract is expected to cover the whole of the expected useful life of the underlying asset because it includes options to renew the lease at a bargain price. Even though some members supported such extension, other Board members remained concerned and proposed alternative criteria that would capture these types of situations. The Board asked the staff to develop those indicators further and, particularly, to clarify how they were articulated.

The Boards agreed that purchase options should be accounted for in the same way as options to expend or terminate the lease. Some of the Board members expressed their concerns about the consistency of the treatment of purchase options (and options to expand or terminate) and contingent rentals, as both of those might capture the same economic substance.

Discussion at the January 2010 Joint IASB-FASB Meeting

Subsequent measurement of leases with options and contingent rentals under amortised cost

At their November 2009 meeting, the Boards tentatively decided that the subsequent measurement of the lessee's obligation and the lessor's receivable should be measured at amortised cost using the effective interest method. The Boards considered at this meeting whether the incremental borrowing rate used to calculate the lessee's obligation, and the interest rate implicit in the lease used to calculate the lessor's receivable, should be revised where there are a subsequent reassessment of:

• the expected lease term, and/or
• contingent rentals.

Lessees

Staff presented the following three approaches with regards to the revising of the incremental borrowing rate for subsequent changes in the expected lease term:

1. No reassessment of the incremental borrowing rate;
2. Reassess by updating for the current incremental borrowing rate for the remainder of the lease term; and
3. Reassess the incremental borrowing rate with the corresponding rate at initial recognition for the revised expected lease term.

The staff explained that they are split between approaches 1 and 2.

When discussing the staff's proposals with regards to changes in the expected lease term, several Board members expressed their surprise at the split views the staff presented. One Board member supported approach 3 as this would take the lessee back to what the answer would have been if all the estimates were known at the inception of the lease. Some Board members felt that this approach will involve hindsight and rather supported approach 2 as the expected lease term applied at inception of the lease is an estimate and all changes in estimates are accounted for prospective from the date of the change. These Board members also noted that the option to extend the lease term already existed at inception and that the exercise of the option does not result in a new lease being entered into. As a result they would not allow approach 3.

One Board member remarked that amortised cost and the effective interest rate method are defined in IAS 39 and IFRS 9. If the Boards decided to have separate accounting requirements for lessees, the methodology for measuring the lessee's obligation should not be labelled 'amortised cost' as amortised cost implies that the incremental borrowing rate is not reassessed for changes in estimates. Several other Board members expressed their sympathy with approach 1 although in their minds approach 2 represents the technically correct answer. It was also noted that approach 2 may result in frustration and additional burden on preparers.

The Boards discussed the issue at great length and were reminded by one Board member that if the requirements for lease accounting are being made too complex and result in overburden on preparers, the progress made to date on the project would be lost. When put to a vote, the Boards tentatively agreed on approach 1.

With regards to revising the incremental borrowing rate for changes in contingent rental payable, the staff identified five possible approaches and proposed that the effective interest rate is not adjusted unless all or part of the rate is contractually reset to current conditions [approach 2 in the agenda papers] as this approach is the most consistent with the strict application of amortised cost under IFRSs. Without much discussion, the Boards tentatively agreed with this approach.

Lessors

For accounting by lessors, the staff recommended the same approach to be followed as for lessees, that is, no revision of implicit interest rate for changes in the estimated lease term. One Board member was curious as to why the staff had split views from the lessee's perspective but not from the lessor's perspective. The staff explained that for lessors, the implicit interest rate already takes into account options to extend the lease term, whereas the incremental borrowing rate of lessees does not. The Boards did not discuss the matter any further and unanimously agreed with the proposal not to adjust the implicit interest rate [approach 1 in the agenda papers].

With any discussion on the matter, the Boards also unanimously agreed that the lessor should not reassess the interest rate implicit in the lease for changes in contingent rentals receivables, unless the rental payments are contingent upon variable reference interest rates.

Scope – Exclusion of short-term leases

At their previous meetings, the Boards discussed whether to provide a scope exclusion for short-term leases. When presenting their analysis to the Boards, the staff explained that a materiality threshold is applied to all accounting requirements and that immaterial lease assets and liabilities are not required to be recognised. The staff then asked the Boards whether there should be an additional exclusion for short-term leases beyond the materiality principle.

The Boards discussed the matter and mixed views were expressed by the Board members. Some Board members are of the opinion that the materiality threshold is the only appropriate measure and that no additional scope exclusion should be applied. They also noted that not recording material lease assets and liabilities would allow opportunities for the structuring of leases. One Board member pointed out that to determine whether a lease asset and lease liability are material, one has to perform all the calculations, and once an entity has done the calculations, they have already performed everything that would be necessary to apply lease accounting. In this Board member's view, an exclusion based on the materiality threshold will not achieve the relief asked for by preparers.

Several other Board members were of the opinion that there should not be a scope exclusion, but rather some form of simplified lease accounting for short-term leases, by not requiring the discounting of the lease obligation. An extended discussion followed on real-life examples from various jurisdictions and how the proposed relief from lease accounting would apply in those circumstances. Various alternatives for simplified lease accounting were also discussed.

One Board member questioned specifically what was meant by materiality and repeated the question as to whether other Board members would be comfortable with material lease transactions not being recognised because they are short-term leases. It was suggested that the Board expose a proposal for allowing relief for a specified period with an explanation to constituents on what they are trying to achieve and ask whether the proposal will provide the relief requested.

A vote was taken, and the Boards tentatively agreed to allow for simplified lease accounting for lessees rather than a scope exclusion for leases with a lease term of 12 months or less.

On the question of how the lease term should be determined, the Boards agreed that it should be the maximum possible lease term achievable under the existing lease agreement, and that any option to renew or extend a lease beyond 12 months would be excluded from the simplified accounting.

The Boards then turned their discussion to accounting by lessors and whether similar relief should be provided. Some Board members noted that for lessors the matter is different than for lessees as the lessor has already recognised an asset and that there should be no difference from what was agreed to in the revenue recognition project. One Board member felt that lessors should be applying accrual accounting rather than lease accounting. The Boards then agreed that for lessors, a scope exclusion will be provided for short-term leases and that the same period, that is, 12 months and restrictions, will apply to lessors.

Lessor accounting – investment properties

The Boards discussed how a lessor should account for leases of investment properties as the proposed lessor accounting requirements does not provide users of financial statements with useful information when applied to investment properties. The Boards were presented with three alternatives:

• A: Lessor accounts for all investment properties using the proposed lessor accounting guidance (recognition of lease receivable and performance obligation with revenue recognised over lease terms as interest income and amortisation of performance obligation);
• B: Lessor accounts investment property using either the cost or fair value model (accounting policy choice). Where fair value is used, a lease receivable and performance obligation are not recognised and lease income in recognised over the lease term.
• C: Same as B, except that lessor is required to measure investment property at fair value. If lessor is unable to determine fair value reliably, the lessor would apply approach A.

Several Board members questioned why there is a difference in the accounting for investment properties carried at fair value and other items of property, plant, and equipment carried at fair value. Those Board members felt that since under the proposed lease accounting requirements, the unit of account is the right of use and not the underlying asset, how the underlying asset is accounted for should not make a difference to the lease accounting. Other Board members also questioned why the concerns from only one industry are addressed, while the Boards are not developing accounting standards for specific industries.

Several Board members expressed strong support for approach C. In their view, the fair value of investment property already takes into account the fact that the investment property is leased out, and if a lease receivable is to be recognised as well, it will result in double accounting. However, in the light of the accounting policy choice currently allowed by IAS 40, it would require an amendment to IAS 40 to remove the choice. Some Board members felt that this project is not the right place to consider amendments to IAS 40 and that approach B is, therefore, the most appropriate approach at the moment.

Other Board members were of the view that by not applying lease accounting the economic reality of the transactions of the entity is not presented in the financial statements. In their opinion lease accounting should always be applied, and the fair value of investment property should be based on the property without the existing lease arrangements in place.

It was noted that the viewpoints of the Boards on this matter are different as there is no equivalent for IAS 40 under US GAAP. After a long deliberation, it was decided that the FASB and the IASB would each consider this matter independently.

When asked to vote, the IASB members expressed a preference for approach B, with a significant majority of the IASB members indicating that they would allow approach B to be applied.

The FASB members requested the staff to prepare an agenda request on the item to analyse the possibilities open to the FASB in addressing the accounting for investment properties and their related leases.

Discussion at the 2 February 2010 Special IASB-FASB Joint Meeting

Definition of a lease

The Boards started their discussion with components of the definition of a lease.

The Boards discussed how broad the definition of a lease should be and, more generally, how would the proposed definition interact with the scope of the leases Standard, given the tentative decision made in December 2009 that the proposed new leases requirements should exclude intangible and biological assets.

Some of the Board members were concerned that a broad definition of a lease could lead to reconsideration of the scope. Other Board members were concerned that such decision would send mixed signals to constituents how to apply the guidance, especially in the context of possible application of the guidance by analogy in line with IAS 8. One FASB member urged the Board to develop a comprehensive leases package including intangibles and biological assets. The FASB Chairman noted that such guidance would be part of a future project.

Eventually, the Boards agreed that the overall definition of leases should be broad, with a narrow scope of the Standard. The Boards also agreed to include a question regarding possible application of the guidance by analogy in the invitation for comments.

The Boards agreed to define a lease as a type of 'contract'. Both Boards preferred the term 'contract' instead of 'agreement' as they believed that it was consistent with other projects.

The Boards agreed that definition of a lease state that a lease is for a period of time. One Board member noted that some leases might be based on different criteria (for example, miles). Nonetheless, other Board members thought that even if a different base was agreed, the time factor would be still present and thus time should be used in the definition.

The Board agreed that a consideration is a necessary element in the definition of a lease.

After a significant discussion the Boards agreed that for a lease to exist, the lessor must convey the right to use a specified asset. The Boards agreed that additional guidance was necessary to describe the meaning of specified asset (in the context of a pool of assets or class of assets) in order to distinguish between supply of products/services and the right to use. Some Board members were also concerned with the relation between the leases project and the revenue recognition project.

Finally, the Boards considered when a lease conveys the right to use the underlying asset. The Board agreed that such condition is fulfilled when the purchase has the ability to control physically the use of the underlying asset either through operations or physical access. The Boards also agreed that such condition would be fulfilled in case of 'de-facto control' of an asset (not based on contractual terms). The Boards also noted that pricing mechanism can be an indicator of such control (payment for something different than products/services provided).

Some Board members were concerned that such a definition of a lease would blur the differences between leases and in-substance purchases. The staff will present a paper on such distinction for one of the following meetings.

Discussion at the February 2010 Joint IASB-FASB Meeting

Accounting for Changes in Contingent Rentals

The Boards agreed that changes in amounts payable under contingent rental arrangements arising from current or prior periods should be recognised in profit or loss and all other changes should be recognised as an adjustment to the lessee's right-of-use asset.

One FASB member disagreed with that approach as he believed that contingent rentals are unlike other estimates and, thus, should be allocated between profit or loss and the right of use asset on the same basis as the right-of-use asset is amortised.

One IASB member raised his concerns related to granularity of the reporting period, especially in case of interim reporting. Nonetheless, other Board members believed that the issue is not limited to contingent rentals and, if necessary, should be addressed in a review of the interim reporting standard, that is, outside of scope of this project.

The Boards also agreed that all changes in amounts payable under residual value guarantees should be accounted in the same way as other contingent rental arrangements. One IASB member noted that to he would prefer a formulation that would focus on booking of the changes in the current period unless they stem from the change of usage of the right-of-use asset.

The Boards also agreed that changes in the lessor's receivable should be treated as adjustment to the original transaction price and be allocated to the lessor's performance obligation. Further, if changes are allocated to a satisfied performance obligation, the effect should be recognised in revenues. On the other hand, if changes are allocated to an unsatisfied performance obligation, they will adjust the carrying amount of that performance obligation.

Although the Board agreed with the underlying principle of allocation, wording proved to be contentious. Therefore, the Boards decided to discuss the wording of the guidance offline. Moreover, some Board members were unsure that time would be always appropriate criterion for allocation of satisfaction of performance obligation. The Boards agreed to find a formulation that would reflect the allocation based on the most appropriate factor (time, cost, usage).

Scope – Purchase or sale of the underlying asset

The Boards agreed that the principle that would determine whether a transaction represents a sale or purchase of the underlying asset (rather than a lease contract) should focus on control and, in particular, on transfer of residual benefits. The principle sought would ensure that no gain/loss at the end of the contract is possible.

Subject of drafting of the principle, the Boards agreed that a seller (lessor) shall not apply these requirements to contracts that will transfer all benefits associated with the underlying asset by the end of the contract. Conversely, the Boards agreed that a buyer (lessee) shall not apply these requirements to contracts under which the buyer/lessee will obtain all benefits associated with the underlying asset by the end of the contract.

The Board also agreed that the focus should be on all (but trivial) benefits rather than significant.

Based on these decisions, the Boards decided to include examples of transactions that would generally be considered to be purchases or sales of the underlying asset (including contracts that automatically transfer title, contracts that include bargain purchase option, and contracts where the return the lessor receives is fixed). The Boards discussed additional examples and noted that the decisive condition is existence of any residual benefits.

Finally, the Boards discussed the very long leases of land (for example, 99 years). The Boards were split whether to account for them as sales of underlying land or as leases. The Boards discussed various examples and noted different practices in various jurisdictions (including when the sale of land is legally prohibited). The Boards noted that none of the models is perfect and each has its shortcomings. After a rather lengthy discussion, it was clear that the Boards were split on the issue, with a narrow majority in favour of treatment as sales. Most Board members felt uncomfortable with, for instance, a 200-year revenue deferral, particularly when consideration is transferred at inception.

Initial Direct Cost

The Boards discussed the definition of initial direct cost and agreed that these should be defined as incremental costs directly attributable to negotiating and arranging a lease. Despite agreement on this definition the Boards noted that the decision should be consistent with the treatment of the initial direct costs in other projects (Revenue Recognition, Insurance, and Financial Instruments). Subject to this caveat, the Boards agreed to include additional guidance to illustrate which costs are directly attributable to acquiring a lease.

Some Board members noted that definition of initial direct costs might vary if they are referred to from lessor or lessee perspective. Nonetheless, the main discussion by the Board focus on treatment of the unit of account of those costs and their treatment, for example, within the context of a lease origination department.

Lessee accounting – Transition

The Boards discussed transition requirements for capital/finance leases from lessee's perspective. The Boards noted that for simple finance leases there would be no significant difference between the old model and new model apart from classification. For more complex leases with extension options and contingent rentals, no solution would ensure the benefits of complete comparability as well as simplicity of implementation.

Board members held various views. One Board member was particularly concerned that the implications of the new model would lead to an overall increase in expenses in the first years following transition (as costs allocated to first years under the new model are higher than those allocated to the following years, and after transition all the leases will be in their first year thus increasing the overall expense).

Finally, after a brief discussion, the Boards agreed that for simple leases, assets and liabilities under finance leases remain the same on the transition date with no change to the accounting for those assets and liabilities subsequently. Nonetheless, for leases containing additional features such as contingent rentals, residual value guarantees, or extension options, the proposed general transition requirements would apply to both assets and liabilities (that is, modified retrospective application).

The Boards agreed that the right-of-use asset should be recognised and measured at the present value of the lease payments discounted using the lessee's incremental borrowing rate on the transition date, subject to impairment review and any further adjustments for rentals prepaid or accrued.

Without much discussion the IASB agreed that if an asset acquired under a finance lease is accounted for using the revaluation model, the revalued amount of property, plant, and equipment should be carried forward as carrying amount of a right-of-use asset.

Lessee accounting – Definition of 'interest rate implicit in the lease'

The Boards agreed with the principle that the discount rate that should be used to calculate the present value of the lease payments is the rate that the lessor is charging the lessee. Some Board members felt that such principle would not be operational, and additional guidance would be required.

One Board member suggested that the principle should the objective for determining the discount rate (that is, a finance lease includes a financing element that reflects the uncertainty of the cash payments). He noted that in many circumstances the rates might be marginally different for lessor and lessee, but those differences would not be significant as they relate only to allocation method. The Boards agreed.

Discussion at the March 2010 Joint IASB-FASB Meeting

Disclosure for lessees

The Boards were presented with the proposed package of disclosures to be provided by lessees. The staff explained that the overarching principle on disclosures is to ensure that the information in the notes complements the information presented in the financial statements, so as to provide decision-useful information for users. The Boards were asked to consider the proposed disclosure package in terms of the grouping of disclosures based on the disclosure objective, amounts related to leases, and the assumptions and estimates.

Disclosure objective

The proposed disclosure objective broadly requires the disclosure of quantitative and qualitative information that identifies and explains the amounts recognised in the financial statements and enables users to evaluate the nature and extent of risks to which the leasing activities have exposed the entity. Some Board members were concerned that the term 'risks' is too vague in the context of leasing activities and that they were expecting disclosure around the uncertainty of future cash flows and the flexibility involved in the management of those risks.

Although the Boards agreed in principle with the proposed disclosure objective, it was not considered to be explicit enough and the staff was requested to revise and expand the objective to incorporate Board members' concerns raised during the meeting.

Amounts related to leases

The discussion of proposed disclosures pertaining to the amounts related to leasing activities centred around the general description of leasing activities and the proposed reconciliation between the opening and closing balances for the right-of-use assets and obligations to pay rentals.

One Board member was concerned that the level at which a description of leasing activities are required was too general and will result in boilerplate disclosures. It was suggested that that description should be broken down into certain classes of leases. When questioned how these classes would/should be determined, the Board member responded that it could possibly be linked to the disclosure objective. Another Board member suggested a grouping based on the nature of the underlying assets, for example, real estate, machinery, office equipment. Other Board members agreed that disaggregated information will be more useful to users.

On the requirement to present a reconciliation between the opening and closing balances of the right of use assets and lease obligations, one Board member was opposed to including a roll-forward in the leasing standard when the Financial Statement Presentation (FSP) Standard contain a general principle on when roll-forwards need to be presented. Another Board member remarked that requested the wording of the requirement to be aligned to the wording used in the FSP Standard. The staff commented that they are committed to follow the development of the FSP Standard very closely and ensure that there is alignment in the wording.

Other Board members questioned how leases accounted for using the simplified accounting model will be included in the roll-forward. The Boards concluded that they agree in principle with the proposed disclosures and that comments from individual Board members should be dealt with off-line.

Assumptions and estimates

The Boards mainly discussed whether a lessee should disclose the fair value of lease obligations and a sensitivity analysis to changes in market risks in the notes.

One Board member questioned where else the Boards have required a sensitivity analysis to changes in market risks for liabilities measured on a cost-basis. The Boards entered into a long discussion on whether it would be possible to determine compile a sensitivity analysis for changes in market risks and whether entities would be able to determine the fair value of lease obligations reliably. One Board member asked the staff to clarify that the changes in market risks are only required to assess the impact on future cash flows and not the impact on fair values. Staff confirmed that the intention was to show the sensitivity of future cash flows to changes in market risks. Following this clarification, Board members were more willing to support the proposed disclosure.

Several Board members raised concerns about the practicability to determine the fair value of lease obligations and reminded the Board that the reason why a fair value measurement model was not adopted for lease accounting was the difficulty in determining a reliable measurement. Other Board members responded that the disclosure of the fair values of other financial liabilities is already required in accordance with IFRS 7 and there is no specific reason why lease obligations should be treated differently.

One Board member reminded the Boards that a number of new standards will be published within the next 15 months and that, in each project, new disclosure requirements have been added. This Board member warned that the Boards will be losing their audience if the disclosure burden becomes onerous. Another Board member remarked that the Boards should guard against the perception that a vast volume of disclosures for leases have been added, whereas some of the disclosures are already required under the existing lease accounting models. The chairman responded that it is important to identify which disclosures are already required under existing guidance which requirements are new as a result of the new accounting model.

The Boards concluded the discussion by tentatively agreeing that the fair value of lease obligations should be disclosed and that the sensitivity of market risks should be limited to the impact on future cash flows.

Lessor accounting – Transition

The Boards were presented with the following four alternatives for transitional provisions for lessors:

• A. Full retrospective application as if the new accounting requirements had always been applied;
• B. Modified retrospective application where the new accounting requirements are only applied to arrangements outstanding at the effective date and those entered into after the effective date;
• C. Simplified retrospective application which is applied to all outstanding leases at the effective date, but simplified so that lease receivable is measured using the interest rate implicit in the lease at the effective date; or
• D. Prospective application to new leases entered into after the effective date.

None of the Board members supported alternatives A or D. The FASB supported alternative B as they considered using the interest rate implicit at the effective date may result in the misrepresentation of revenue. The majority of the IASB members initially supported alternative C (which is consistent with the approach proposed for lessees), however after further consideration, some Board members agreed with the FASB view on the implicit interest rate and indicated that they wanted to switch their vote to alternative B. The staff reminded the Boards that alternative B is not consistent with the approached adopted for lessees.

After a short deliberation, the Boards asked the staff whether alternative C could be applied with the implicit interest rate at the date the lease was entered into. Staff confirmed that this could be done. The Boards tentatively agreed to this alternative subject to using the original interest rate implicit in the lease.

The Boards then considered how leased assets capitalised under existing finance leases should be reinstated on the lessor's statement of financial position. It was noted that under US GAAP an option to remeasure at fair value does not exist and therefore the reinstated asset would be recognised at depreciated cost. The IASB agreed with the reinstatement at depreciated cost adjusted for impairment and revaluation in accordance with IAS 16.

Measurement at initial recognition

At the October 2009 meeting, the Board tentatively decided that lease assets and liabilities arise when the lease contract is signed (inception of the lease) and that the net contract position between the signing and delivering should be measured on a cost basis. The Boards were then asked to consider whether initial measurement of the assets and liabilities should be determined at the inception date or at the commencement date.

Without any discussion, the Boards tentatively agreed that an entity should recognise the gross value of assets and liabilities at the commencement of the lease term, and that those assets and liabilities should be measured at the inception of the lease and that the discount rate to be used will be fixed at lease inception.

Lessor accounting – Residual value guarantees

The Boards considered how residual value guarantees (RVG) held by lessors should be accounted for. The majority of Board members were supportive of the staff's proposal to account for amounts to be paid by a lessee under an RVG consistent with the accounting for contingent rentals. As a result any change in the receivable arising from a change in the amounts payable under an RVG would be treated as an adjustment to the lessor's receivable and performance obligation.

One Board member questioned why a lessor needs to recognise an increase in the performance obligation when the amount to be paid by a lessee increases. The Board member was of the opinion that such an adjustment should be recognised as a gain. The staff responded by clarifying that the accounting by the lessee has been mirrored by the lessor's accounting.

It was further pointed out that the definitions of residual value under IFRSs and US GAAP are different, and the impact on the accounting treatment has not yet been explored in the context of lessor accounting. The Boards agreed to explore the differences further and consider aligning the definitions.

Lessee accounting – Presentation

The Boards considered how a lessee's assets, liabilities, expenses and cash flows arising should be presented in the financial statements, first in accordance with the existing presentation requirements and then in accordance with the proposals of the Financial Statement Presentation (FSP) project.

Considering the existing financial statement presentation requirements, the Boards agreed in principle with the staff proposal to present the right-of-use asset and lease obligation on the face of the statement of financial position but to ask a specific question in the exposure draft on whether separate presentation in the notes would be appropriate in certain circumstances.

One Board member questioned why the classification of the right-of-use asset should be based on the use of the underlying asset as opposed to the nature of the asset. This classification will determine whether the revaluation of the right-of-use asset is allowed. The IASB members seemed a little confused as to what was previously decided on whether the right-of-use asset should be accounted for in accordance with IAS 16 or IAS 38. A lively discussion followed, where after the staff was instructed to bring the matter back for discussion at a later stage.

The Boards then considered whether to require the separate presentation of amortisation and interest expense from other amortisation and interest expenses either on the face of the statement of comprehensive income or in the notes. After a short discussion, the Boards agreed that judgement should be applied to determine whether the amortisation and interest expense are presented separately on the face or in the notes.

The Boards also considered whether the cash repayments of the capital amount and interest payments should be classified as financing activities in the statement of cash flows. One Board member questioned which cash amount the Boards want to present - the total cash payment or separate payments of interest and capital amounts, as that will determine the classification in the statement of cash flows. By a narrow majority the Boards tentatively decided that the cash repayment of leases should be separately identified in the statement of cash flows.

For information purposes, the Boards considered how the proposed presentation principles of the FSP project would apply to lessee accounting. In general, the Boards agreed with the proposal that the right-of-use asset should be presented as an operating asset in the business section with the amortisation as an operating expense. The interest expense should be presented as financing costs from operating obligations and cash rental payments in the operating category of the business section in the statement of cash flows. On the proposal to present the lease obligation as a liability in the financing arising from operating activities sub-category, one Board member noted that the definition of that category will need to be amended to achieve that. The staff acknowledged the point and undertook to liaise with the FSP project staff on the definition. The Boards asked the staff to provide feedback at a later stage.

Lessor accounting – Presentation

The Boards considered how a lessor's assets, liabilities, expenses and cash flows should be presented in the financial statements. The Boards were presented with the following four alternatives:

• A. Gross presentation of the leased asset, lease receivable and performance obligation;
• B. Present the lease receivable net of the performance obligation;
• C. Present the leased asset net of the performance obligation;
• D. Net presentation of all three items as a distinct item in the SFP.

Some Board members indicated strong support for alternative A as this is the only alternative that is consistent with the proposed lease accounting model and that captures the economics of the lease arrangement. Another Board member questioned how lessors would present leases for investment property in accordance with IAS 40, since the Boards have scoped out these leases from the proposed leasing standard. This Board member is not comfortable with a difference in presentation between leases for investment property and other leases. The staff pointed out that since the accounting basis for investment property is different from other leases there will inevitably be a difference in presentation.

Other Board members indicated that they prefer some form of net presentation, although they were evenly split between alternatives B, C and D. When initially put to a vote, the FASB strongly supported alternative D, whereas a very narrow majority of IASB members indicated that they can accept alternative D.

One Board member made the remark that alternatives B, C and D appear to be consistent with the derecognition approach. Another Board member felt that the Boards have not deliberated the derecognition approach sufficiently to disregard it as the most appropriate approach for lessor accounting. The Boards entered into a very lively and extended discussion on the merits of the derecognition approach. Several Board members asked for the debate on the derecognition vs. performance obligation approach to be re-opened. The chairman put it to vote and the majority of Board members indicated their support to develop the derecognition approach further.

The Boards were asked how this decision would impact the expected timing of the publication of the exposure draft and how the derecognition approach will be presented to constituents. The Boards agreed to think the matter over for a while and discuss the various alternatives on taking the project forward on the following day.

Discussion at the April 2010 Joint IASB-FASB Meeting

Sale and leaseback transactions

As part of their discussion of whether a sale and leaseback transaction under the performance obligation model should be accounted for as a sale rather than a financing transaction, the Boards were presented with the following two approaches:

• Determine whether the transaction is a sale of the underlying asset. If not, then account for it as a financing transaction.
• Determine whether the leaseback is a lease. If the leaseback represents the repurchase of the underlying asset rather than a lease, it should be accounted for as financing.

Without much discussion, the Boards agreed that the most appropriate test to apply is whether the transaction represents the sale of the underlying asset. Having supported the sales approach, the Boards were then presented with the following two approaches to determine whether a sale has occurred:

• A: Apply the control criteria developed in the revenue recognition project.
• B: Determine whether control has been transferred and all but a trivial amount of the risks and rewards associated with the underlying asset have transferred to the buyer.

Several Board members supported approach B as they are of the opinion that it will ensure that most sale and leaseback transactions are accounted for as financing transactions, which is the substance of most such transactions. Those members also felt that considering the risks and rewards is the only approach consistent with the leasing model and that, when looking at the sale and leaseback transactions in combination, it will give the most appropriate answer. Some supporters of approach B questioned why such a high hurdle ('all but a trivial amount') should be cleared in order to recognise a sale.

Other Board members supported approach A. They questioned why the control criteria developed for the revenue recognition project are not applied to these transactions.

Another Board member did not support including any guidance on how to account for sale and leaseback transactions in the leasing standard as enough guidance have already been developed in other standards. The first test should be to determine whether a sale has occurred by applying the revenue recognition criteria. If the transaction is deemed to be a financing arrangement, then guidance on financial instruments should be applied. Lastly, if the transaction is deemed to be a lease, then the guidance on accounting for leases should be applied.

Following a long discussion on the merits of each approach, the majority of Board members supported approach B, although some members qualified their support for this approach by requesting that the same criteria be applied in the revenue recognition model.

The Boards then deliberated when a gain or loss arising on a sale and leaseback transaction should be deferred by considering two approaches:

• Defer gains or losses on sale and leaseback transactions that are not at fair value.
• Adjust the assets, liabilities, gains, and losses recognised to reflect current market rentals.

The FASB members indicated very strong support for the latter approach but questioned whether it is practicable. The staff responded that this approach is similar to the existing requirements of IAS 17 for sale and leaseback transactions and should therefore not be too difficult to apply in practice. Not all Board members agreed with this response.

One IASB member added another alternative by stating that when a sale and leaseback transaction is not established at fair value, the recognition of a sale, is precluded and the transaction should be accounted for as financing. Several other IASB members indicated sympathy with this alternative, while others favoured the same approach supported by the FASB members.

When put to a vote, Boards unanimously agreed that as long as the sale and leaseback transaction results in a sale and both the sale and leaseback are at fair value, gains or losses arising from the transaction should not be deferred. The majority of Board members also tentatively agreed that where either the sale or the leaseback is not established at fair value, the assets, liabilities, gains, and losses should be adjusted to reflect current market rentals.

Lessor accounting – Accounting for lessor's performance obligation, including consideration of recognising profit/loss at lease commencement

At their November 2009 meeting, the Boards tentatively agreed that the subsequent measurement of the performance obligation should depict the decrease in the entity's obligation to permit the lessee to use the leased item, but requested the staff to clarify how the performance obligation should be regarded as satisfied and revenue recognised. At this meeting, the staff recommended that the revenue should be recognised in a systematic and rational manner as the performance obligation is satisfied. This could be based on time, usage, or other measure that the economic benefit derived from the leased asset is provided to the lessee.

Some Board members questioned how the lessor is supposed to determine the rate of usage by the lessee. Another Board member remarked that this seems to imply that when a lessee is not using a leased asset properly, the lessor has not satisfied its performance obligation and does not get to recognise revenue. Other Board members also disagreed with the proposal as they deemed it inconsistent with the revenue recognition model where revenue is recognised as services are performed or goods transferred, regardless of usage by the customer.

In defence of the staff proposal, a Board member explained that the aim was to allow for a method of revenue recognition that is similar to the unit of production method of depreciation and usage by lessee does not refer to actual usage, but rather to usage agreed to as part of negotiating the contract. Following this explanation, the majority of Board members supported the staff's proposal.

The Boards then considered the following approaches in determining whether a lessor should be required/allowed to recognise a profit/loss at the commencement of the lease:

• A: Recognise profit/loss upon delivery of leased asset to the lessee.
• B: No profit/loss upon delivery of the leased asset to the lessee.
• C: Recognise profit/loss upon delivery of leased asset to lessee but only for some lessors.

Several Board members disagreed with the staff proposal to prohibit the recognition of a profit or loss at lease commencement and noted that it is not consistent with the revenue recognition or performance obligation model. Those Board members were of the opinion that once a performance obligation has been satisfied, revenue should be recognised and that the delivery of the leased asset to the lessee is one of the performance obligations of the lessor.

The Boards deliberated at length whether a lessor has more than one performance obligation. The FASB showed strong support for the staff proposal, but the IASB was split evenly. In the absence of the Chairman to cast a deciding vote, it was agreed that the staff should bring the matter back later in the week.

The staff then asked the Boards which lessors should be allowed to recognise a profit or loss. Again several Board members vehemently disagreed with the staff proposal that any lessor – whether the carrying amount of the underlying asset is different from its fair value – should recognise a profit or loss, as this approach focusses on the amount at which the lessor has recognised the underlying asset. In their view, this approach is consistent with the derecognition model and not the performance obligation model being discussed. Another Board member remarked that under the performance obligation model, the consideration receivable should be allocated to the various performance obligations based on their stand-alone selling prices, similar to the revenue recognition model. Other Board members questioned what the related cost would be for the revenue recognised.

The Boards tentatively agreed that the recognition of revenue on day one should not be limited to only dealer and manufacturer lessors, but that revenue recognised should not be based on the carrying amount of the underlying asset. With regards to how the revenue should be recognised, the Boards instructed the staff to explore the alternatives under the performance obligation model further, along with the earlier question on whether the lessor has more than one performance obligation. As this is likely to take the staff some time to prepare the necessary agenda papers, it was agreed that the matters be discussed at the special meeting in early May.

Accounting for subleases – performance obligation model

The Boards were asked to consider the accounting for subleases under the proposed new leases requirements under the performance obligation approach. Without any discussion, the Boards agreed that special recognition and measurement guidance is not needed for assets and liabilities arising under subleases.

The Boards discussed various alternatives for the presentation of assets and liabilities arising from a sublease. The FASB members preferred an alternative whereby the right-of-use asset, lease receivable, and the performance obligations of the lessor are presented gross with a subtotal as part of property, plant, and equipment in the statement of financial position, with the obligation to make rental payments presented separately as part of the liabilities (alternative C-prime). The IASB members initially expressed a preference to for the gross presentation of all amounts without any subtotals (alternative A).

The staff remarked that this will be totally inconsistent with the previous decision by the Boards with regards to the gross presentation with a subtotal for lessors and questioned whether the IASB is willing to accept the inconsistency and explain their reasoning in the basis for conclusions.

After careful consideration, the IASB members changed their preference to the gross presentation of all assets and liabilities excluding the obligation to pay rentals, with a net subtotal (alternative C). In order to achieve convergence between the Boards, the FASB members indicated that they can also support alternative C instead of C-prime as initially indicated.

The Boards further tentatively agreed to require the disclosure of the nature and amount of material subleases in the lessor's financial statements. The Boards will continue their discussions on lease accounting at later sessions.

Lessor accounting: Impairment of assets

The Boards were requested how impairment by lessors should be addressed under the performance obligation model where the lessor has two assets – the underlying leased asset as well as the lease receivable. In their deliberations, the Boards considered two approaches suggested by the staff:

• A: group the underlying asset and performance obligation as a single unit of account to assess for impairment in accordance with IAS 36, while the receivable is assessed for impairment in accordance with IAS 39.
• B: consider the underlying asset, lease receivable and performance obligation as a single unit of account in accordance with the requirements of IAS 36.

The Board members expressed mixed support for approaches A and B, with a few Board members indicating that they don't have a strong preference for either of them. Those Board members that supported approach A were of the opinion that the underlying asset and lease receivable are distinct assets with significantly different characteristics and need to be assessed separately.

The Board members supporting approach B were of the view that by entering into the lease contract, the underlying asset has been modified through the performance obligation and some of the economic benefits of the underlying are included in the measurement of the lease receivable. According to these Board members this is the purest form of a cash generating unit as defined in IAS 36 and should be assessed for impairment at that level.

Some Board members questioned why the performance obligation is netted against the underlying asset in approach A. In terms of the performance obligation model, the performance obligation arises as a result of the lease receivable and if the lease receivable no longer exists as a result from, for example, default by the lessee, the lessor no longer has a performance obligation and as such has recourse to the underlying asset. Some Board members regard this as economically similar to a secured loan and don't see enough reason to treat impairment on this differently to secured loans.

One Board member remarked that the proposed approaches highlight the weaknesses and problems with the performance obligation model and regarded the approaches as being overly simplistic. This Board member favoured an approach whereby the lease receivable is assessed for impairment first and if it is, to look at the rights and obligations of the lessor in terms of either recovering the outstanding receivable or repossessing the underlying asset. As several other Board members also favoured this approach above the other two presented, the staff was instructed to further articulate the alternative approach and develop a flowchart with the assistance of some FASB members to explore the interrelationship between the various components for discussion at a future meeting.

Long-term leases of land

At the February 2010 joint meeting, the staff was instructed to develop criteria for excluding very long leases of land from the scope of the proposed new leases requirements. The staff explained that they have requested input from constituents and do not think that an exemption should be provided from very long leases of land as criteria has already been developed to distinguish the outright sale or purchase of an asset from a lease. If the criteria for the recognition of an outright sale or purchase have not been met, then there would be no conceptual basis to differentiate these leases from other leases.

The Boards were supportive of the staff's proposal not to exempt very long leases of land from the requirements of lease accounting. One Board member did question whether a lessor would recognise a performance obligation at inception if it has undertaken to pay property taxes (for example) for a certain period of time. The Boards entered into a discussion on whether it will qualify as a performance obligation or as a period cost to the recognised in accordance with IAS 37. It was agreed to further discuss this question offline, however, the staff was requested to link this matter to the previous discussion on what the performance obligation of the lessor is and whether it is possible to have more than one performance obligation.

Lessor accounting for Purchase options

In the light of the Boards' tentative decision for lessee accounting that purchase options should be accounted for in the same way as options to extend or terminate the lease, the Boards deliberated how lessors should account for purchase options. The staff explained that although the Boards tentatively decided that there should be symmetry in the accounting by lessees and lessors, there may be a difference in measurement. However, the staff recommended that lessors should also account for purchase options in the same way as for renewal or termination options.

Some Board members questioned how gains or losses on purchase options will be treated as it is possible under the performance obligation model to recognise a gain on the purchase option prior to the option being exercised. These Board members wanted a part of the performance obligation to be allocated to the purchase option until the option is exercised.

After a short discussion on whether there is a difference between what was tentatively agreed on lessee accounting and what is proposed for lessor accounting, the majority of Board members supported the staff proposal but qualified their support on the basis that there need to be linkage with how the performance obligation is run-off.

Leases – information about total cash rentals paid

At the March 2010 joint meeting, the Boards tentatively agreed that cash payments of interest and principal amounts relating to leases should be presented separately as financing activities in the statement of cash flows. Some Board members noted that information on cash rentals paid are important, especially for users that used to have an operating lease payment included in the calculation of EBITDA. As the lease payments under the new requirements would be split between interest and prinicpal amounts, and would be grouped with interest and principal repayments on other borrowings, it may be difficult to reconstruct the total cash rentals paid.

The staff recommended that the cash rentals paid be disclosed in the roll-forward presented in the notes. The Boards agreed with this proposal.

The Boards were also asked whether they want the interest and principal cash payments on leases to be presented separately from other borrowings. After some confusion as to what was tentatively agreed to at the previous meeting, the Boards confirmed that such separate presented should not be required.

Lessor disclosures

The Boards discussed the disclosure requirements for lessors in accordance with the performance obligation model. The staff presented an analysis of proposed disclosures which have been structure in accordance with the Investors Technical Advisory Committee (ITAC) Disclosure Framework, setting out the requirements for the disclosure of the following:

• the lease disclosure principle;
• the nature of the lease arrangements distinguishing between the leased asset, lease receivable and performance obligation;
• the roll-forward;
• assumptions, uncertaintites and risks; and
• short-term lease arrangements

The Boards tentatively approved the proposed disclosure requirements subject to the following changes:

• with regard to contingent rentals, require the disclosure of the description and carrying amount of contingent rentals instead of the accounting policy; and
• require a level of disaggregation in the roll-forward so that information remains useful to the users.

The staff was also requested to liaise with the Financial Statement Presentation project staff with regards to incorporating a disaggregation principle into the lease disclosure principle, as this principle is broadly based on the principles agreed to in that project.

Lessor accounting – Impairment supplement

As a follow-up on the previous day's session on how to deal with impairment by lessors under the performance obligation model, the staff presented a supplement setting out the proposed flowchart and models for determining impairment, as requested by the Boards.

The flowchart summarised the process for assessing impairment as follows:

• assess whether lease receivable is recoverable in full;
• if it is, then assess whether the underlying asset is impaired using either option A or B as setout in the previous agenda paper;
• if the lease receivable is not recoverable in full, determine whether the lessor will/can repossess the underlying asset;
• if the underlying asset can be repossessed, the lessor may no longer have a performance obligation, in which case the performance obligation is derecognised and lease receivable impaired. The underlying asset is assessed for impairment on a stand-alone basis;
• if the underlying asset cannot be repossessed, the lease receivable as well as the underlying asset needs to be assessed for impairment using either option A or B as set out in the previous agenda paper.

Again, the Boards had a long discussion as to how impairment should be assessed and accounted for, especially whether either the underlying asset or lease receivable or both should be netted off against the performance obligation.

One Board member remarked that in essence the Boards seem to agree on the same approach; however, there seems to be difficulty in articulating the approach. This Board member recommended to withdraw the proposed flowchart and replace it with something that is more simplistic, setting out a pragmatic yet holistic approach.

Discussion at the April 2010 IASB Meeting

First-time adoption of IFRSs

Without substantial discussion, the Board agreed that the same proposed transitional requirements should be applied to all leases for first-time adopters of IFRSs. That is, lease assets and liabilities should be recognised and measured at the present value of the leases payments for all leases and relief for simple finance leases should not be applied to a first-time adopter.

Consequential amendments

The Board considered the consequential amendments resulting from the lease guidance on the business combinations literature. Although the staff was focussing on the issue of the adjustments to the pre-existing intangible asset and/or liability associated with the acquired operating leases, the Board wished to consider the guidance in its entirety. In particular, some Board members were concerned by the requirement to revalue all leases to fair value at the date of acquisition. Those Board members noted that in the deliberations on the leases project the Board concluded that the requirement to use fair value on leases would be onerous and, therefore, questioned the conclusions reached on business combinations guidance.

Finally, the majority of the Board agreed that a specific exception for leases should be developed in the context of business combinations. Some members wanted to discuss the details of the exceptions (for example, related to the question whether the incremental borrowing rate should be reset on acquisition). Nonetheless, as the guidance on business combinations is joint guidance with the FASB, the Board decided to deliberate the issue at a later joint meeting.

The Board considered also the consequential amendments to IAS 40 Investment Properties, especially in the context of the intermediate lessor accounting.

The Board agreed that in the context of an intermediate lessor:

• If an entity elects to use the fair value model, its right-of-use asset classified as an investment property is subsequently measured at fair value in accordance with IAS 40. Therefore, the new lessee accounting requirements on subsequent measurement would not be required.
• If an entity elects to use the cost model, the new lessee accounting requirements for right-of-use assets would be required. Therefore, the requirement under IAS 40 to subsequently measure investment property at depreciated cost using the cost model in IAS 16 Property, Plant and Equipment would be replaced with the new lessee accounting requirements.

In addition the Board confirmed that:

• If the right-of-use asset is measured at cost, changes to the obligation to pay rentals should be accounted for under the proposed new leases requirements, and
• If the right-of-use asset is measured at fair value, the adjustments to the obligation to pay rentals arising from changes in the lease term or changes to estimated contingent rentals would be recognised in profit or loss.

Revaluation of the lessee`s right-of-use asset

The Board briefly discussed the issue of the revaluation of the lessee's right-of-use asset and the methodology of the revaluation. The Board was split on whether the appropriate requirements for revaluation of the right-of-use asset are in IAS 38 Intangible Assets (as that is the nature of the right-of-use asset), IAS 16 Property, Plant and Equipment (as right-of-use asset would be presented within PP&E), or alternatively use the forthcoming fair value measurement guidance. No consensus on methodology was reached. The Board decided to re-discuss the issue at a later meeting.

Nonetheless, the Board agreed in principle to permit revaluation of the lessee's right-of-use asset even if there is not active market in the right-of-use assets. The Board decided to permit a lessee to revalue its right-of-use assets only if the lessee chooses to revalue its owned assets in a class of property, plant and equipment; and to require a lessee to revalue the entire class (as defined in IAS 16) of property, plant and equipment (all owned and leased assets) to which that leased asset belongs if the lessee chooses to revalue its leased assets.

Discussion at the May 2010 Joint IASB-FASB Meeting

Lessor accounting - Lessor performance obligation

After a short discussion the Boards confirmed that under a performance obligation approach the lessor has a single obligation to continue to permit the lessee to use the leased asset over the lease term. Consequently, that performance obligation would be satisfied, and revenues recognised, continuously over the lease term. One IASB member noted that day one gain under this approach should be recognised only when the nature of the transaction is a sale and consequently it is outside the scope of the proposed leases Standard.

One Board member expressed his concerns over the treatment of purchase options under the proposed model and suggested that they be treated as stand-alone options (accounted for separately and not as an extension of the lease term) as they relate to the termination of the right-of-use rather than to the lease term. The staff expressed some concerns about this approach on the interaction with extension options. The staff will provide further analysis of the issue at a following meeting.

On the manufacturer/dealer lessor issue, some Board members felt uncomfortable with no profit/loss recognition upon lease commencement for manufacturers and dealers and suggested derecognition approach for manufacturer/dealer lessor and performance obligation for all other lessor. These Board members thought that such approach better reflects the economic logic of the relationship. Some Board members asked the staff to clarify the issue as well as explore the implication of the proposal on the overall model.

Lessor accounting - Derecognition approach

The Boards explored the derecognition approach to lessor accounting. After a short discussion the Boards rejected the full derecognition approach that resulted in the lessor derecognising the full carrying amount of the leased asset and recognising a receivable (a financial asset) and a residual value asset (a non-financial asset).

The Boards continued to explore the partial derecognition approach under which the lessor derecognises the portion of the asset representing unconditional right to use a portion of the underlying asset for a period of time in return for a receivable and the lessor retains the residual asset representing the lessor`s rights to the underlying asset at the end of the lease term.

One Board member questioned the basis of the derecognition model. He noted that the presented approach (revenue recognition based on the present value of the lease payments and at the same time accounting for cost of sales in the same amount) is inconsistent with the proposed revenue recognition guidance and does not tie to the customer consideration. He noted that the approach assumed that the lessor has no continual performance obligation (that isw, there is the obligation to provide the leased asset, might be obligation to pay taxes, provide maintenance) and therefore might lead to frontloading of revenue.

After a heated discussion the Boards agreed that under both models all other obligations should be recognised and measured either at inception or as they arise in accordance with other Standards. As one Board member noted the model implicitly assumes that the lessor transferred all rights and obligations, though that is not necessarily the case.

Finally, the Boards noted that the derecognition model would place much more focus on the identification of the service component of the contract and identification whether payments for the other obligations are included in the leased payments as the present value of the lease payments might include different elements than those related to the right-of-use asset.

The Boards considered the accounting for arrangements with service and lease components. The Boards debated how to allocate the value attributable to the service component as well as accounting for both components. The Boards noted that the service component would have to be always separated and estimated. The Board asked the staff to consider the accounting for the service component. The Boards also asked the staff to clarify the basis for the decision of separation – that is, which guidance would apply for integral and non-integral types of services (and what is the interaction between the integral characteristic of the service and the distinct function as proposed in the revenue recognition guidance).

Several Board members expressed their concerns with particular aspects of the model – for example, the fact that higher residual value would lead to higher revenue recognition, effects of contingent rentals as well as usage of revaluation model under IFRSs).

Residual asset

The Boards continued their discussion with the definition of the residual asset. The staff suggested that as the lessor would be unable to access the benefits associated with the underlying asset until the end of the lease, the valuation of the residual asset should reflect the time value of money. Several Board members were concerned that such definition would differ from the residual value defined in IAS 16 as well as definition under US GAAP and did not understand how such difference could be justified. Several Board members expressed their concerns that effects of accretion of the value of the residual asset (and accelerated depreciation patterns) might lead to recognition of the day one gain.

In addition several IASB members were concerned that the proposed guidance on valuation of the residual asset would contradict the revaluation guidance under IFRSs. They questioned how different is the revaluation asset from the PPE under IAS 16.

One Board member questioned the usage of discount rate - the nature of the asset risk related to residual asset is different to the credit risk related to the receivable thus potentially leading to different discount rates. The staff noted that in practice a combined rate is being used as separation of the rates in very complicated.

In addition one Board member asked the staff to explore the interactions of the proposed guidance on residual assets with the guidance on investment property.

As the proposal to require re-measurement of the residual asset to fair value did not receive a sufficient support, the Boards considered the alternative of an allocation of the previous carrying amount of the underlying asset that would be frozen at inception and subsequently tested for impairment.

At that point, the Boards asked the staff to explore the implications of that approach and present them on a numerical example. Some Board members doubted the viability of the approach (mechanics of journal entries at the end of the period, potential for lump gains at the end of the lease for very short or very long leases as well as potential for underreporting of income from the leases.) The staff pledged to present examples of application of this model at the Wednesday's meeting.

Treatment of options

The staff proposed the same overall approach to leases with options to extend or terminate as under the performance obligation approach. The majority of the Boards agreed, even though some Board members echoed the arguments for a different treatment for options for lessors and for lessees and suggested separate treatment of options for lessors. On the other hand, other Board members stressed the need for consistency. Finally, the Boards agreed (the IASB with the tightest of margins) that initial measurement of the residual asset recognised by the lessor should be consistent with the assessed leased term (i.e. the longest possible lease term that is more likely than not to occur).

The Boards considered subsequent measurement of leases with options to extend or terminate. Given the consideration of the decision to freeze the cost allocation of residual value at inception, the Boards asked the staff to consider impact of that decision on the subsequent measurement of these options on examples as well as consideration of the different treatment of extending and shortening the expectations of the term.

Consistently with the earlier decision on performance obligation approach, the Boards asked the staff to analyse the broader implications of the purchase options for lessor accounting. The Boards also clarified that given that analysis they would like to consider its impact on the treatment of purchase options on lessee accounting. The staff would provide this additional analysis at a following meeting.

Other issues

The Boards considered the impact of contingent rentals and residual value guarantees and accounting for subleases on the derecognition approach. The Boards would continue their discussion on leases on their Wednesday meeting when they would cover the remaining aspects of the derecognition model.

Lessor accounting - Derecognition approach supplement: Residual asset (freezing residual asset)

During yesterday's discussion on the derecognition approach, the staff was requested to present the Boards with numerical examples on what would happen if the carrying amount of the residual asset does not change after initial measurement, other than for impairment.

The staff presented the Boards with examples illustrating the mechanics of the proposed approach when the underlying asset is released, sold or retained for own use.

While some Board members were comfortable with the examples provided, other Board members questioned the determination of profit on initial recognition. Some of these Board members were concerned that lessors did not get to recognise a profit on initial recognition and that this 'profit' is effectively recognised over the lease term as a higher interest charge. One Board member noted that in order to arrive at the same profit figure that would have been recognised under operating lease accounting, the residual value have to be accreted over the lease term.

The Boards debated that issue around profit recognition and whether it is only a consequence of the derecognition model resulting in a timing difference. The Chairman asked the Boards to vote again on the matter and the Boards re-confirmed their earlier decision to freeze the allocated residual asset and only reassess for impairment when there are indicators of impairment.

Lessor accounting - Derecognition approach supplement: treatment of options

The staff presented the Boards with a supplement setting out the journal entries for an option to terminate a lease earlier than the originally determined lease term, in accordance with the Boards' earlier decision to treat the reassessment as a new derecognition/re-recognition event (Approach A in the agenda papers).

One Board member questioned the mechanics of the example which results in a loss upon reassessing the lease term when no profit has been recognised upon initial recognition. Other Board members noted that the examples presented do not reflect the Boards' earlier decision appropriately and requested the staff to rework the example to reflect the Boards' decision with regards to the residual asset and circulate the supplement again.

Lessor accounting - Derecognition approach: Contingent rentals and residual value guarantees

The Boards considered the accounting for contingent rentals and residual value guarantees under the derecognition approach. Without much discussion on the matter, the Boards tentatively agreed that changes to the receivable arising from contingent rentals based on performance or an index should be recognised in profit or loss as there is no direct correlation between the value of the residual asset and the amounts receivable under contingent rentals.

The Boards then considered how changes in usage-based contingent rentals should be treated. Some Board members were of the opinion that additional usage of the leased asset would lead to a reduction in the residual asset, whereas other Board members did not agree that this will always be the case. It was suggested that a lessor should be able to determine at the commencement of the lease which additional usage would lead to a decrease in the residual asset and which would lead to increase servicing costs. Based on this, only additional usage that does not result in a decrease in the residual asset should be recognised in profit or loss.

Several Board members had sympathy with this view but did not think it was practical to imply in practice. After a short discussion on the matter, the Boards were asked to vote on the following 3 alternatives:

• all usage adjustments are recognised in profit or loss and possible impairment test on the residual asset;
• all usage adjustments are recognised as an adjustment to the residual asset; or
• additional usage that does not result in a decrease in residual asset, is recognised in profit or loss and other usage adjustments are adjusted against the residual asset.

The majority of the FASB members voted in favour of all usage adjustments being recognised in profit or loss, whereas the IASB was evenly split between the 3 alternatives (5 votes each). The IASB members supporting the latter two alternatives then indicated that they don't object to the first alternative. The Boards therefore tentatively agreed that all usage adjustments should be recognised in profit or loss.

The Boards were also asked how changes in the receivable arising from residual value guarantees should be accounted for. The Boards acknowledged that the link between the residual value guarantee and the value of the residual asset is closer than with contingent rentals and usage adjustments. However, the Boards agreed that in the light of their previous decision to freeze the residual asset at initial measurement, changes in the receivable arising from residual value guarantees need to be recognised in profit or loss.

Lessor accounting - Derecognition approach: Accounting for Subleases

The Boards considered how to account for subleases under the derecognition approach. Without much deliberation, the Boards tentatively agreed not to provide different measurement guidance for assets and liabilities under a sublease and that intermediate lessors should present all assets and liabilities arising from a sublease gross on the statement of financial position.

Lessor accounting - Derecognition approach: Presentation

The Boards then deliberated how a lessor's assets, liabilities, revenue and expenses arising from a lease contract should be presented in the financial statements. With regards to presentation in the statement of financial position, the Boards tentatively agreed that, subject to the general presentation and materiality requirements in IAS 1, the lease receivable should be presented separately from other receivables and the residual asset with property, plant and equipment but separately from owned assets on the face and disclosed separately by class of asset.

When discussing the presentation in the statement of comprehensive income, the Boards considered whether to require:

• gross presentation of revenue and cost of sales by all lessors;
• net presentation by all lessors; or
• gross presentation by some lessors (i.e. manufacturers and dealers) and net presentation by others (i.e. financing entities).

Some Board members supported gross presentation by manufacturer and dealer lessors as that would appropriately present the economic reality of the transaction, whereas net presentation by financing entities would be more appropriate especially as they don't have a gross margin to present. The Boards had a short discussion on what the appropriate criteria would be to make the distinction. One Board member suggested allowing management to apply judgement in a way that is similar to how management present financial statements based on the business activities of the entity. Several Board members supported this view subject to the requirement to provide information that is meaningful to the users. The majority of Board members voted for this alternative.

The Boards requested the staff to consider the disclosure requirements for the derecognition of financial assets when formulating the disclosure requirements for lessors under the derecognition approach and provide sufficient explanations if some requirements are considered not appropriate to lessor accounting.

In concluding the session, the Chairman asked the respective Boards to indicate their preference for the performance obligation or derecognition approach in order to provide the staff with some idea on where to focus their efforts. By a large majority the FASB indicate a preference for the performance obligation approach for all lessors, while a majority of the IASB members preferred a hybrid model, where some lessors apply the derecognition approach and others the performance obligation approach. However, the IASB has not yet had time to consider whether the distinction should be drawn between manufacturer and dealer lessors vs. other lessors or the characteristics of the leasing arrangements. The IASB will meet within the next couple of days to define the distinguishing factors.

Discussion at the 1 June 2010 Special IASB Meeting

The Board reviewed (briefly) whether it had complied with the due process steps [as required in the IASB Due Process Handbook based on the steps listed in paragraphs 110-111 ('Comply or explain' approach) of the Handbook] in the leases project. In particular, the Board considered whether the Board had responded sufficiently with respect to the criticism that the leasing model included in the Discussion Paper DP/2009/1 Leases was incomplete because the lessor accounting was not sufficiently developed.

The Board noted that comments received from constituents on DP/2009/1 about lessor accounting had helped the Board to develop approaches to lessor accounting; that before issuing an exposure draft on leases, the Board was conducting significant outreach activities about the project to seek inputs from various constituents, including the lessor industry; and the Board would, during the exposure period and subsequent redeliberations, continue those discussions as they develop a final standard.

The Board concluded that all mandatory due process steps required by the IASB Due Process Handbook for this phase of the project had been performed. In addition, sufficient non-mandatory activities had been undertaken for this stage of the project.

Discussion at the June 2010 Joint IASB-FASB Meeting

Hybrid approach to lessor accounting (Educational session)

The IASB explored a possible hybrid lessor accounting model. No decisions were taken. These issues will be discussed at a joint session with the FASB later in the week. The FASB preliminarily decided to apply the performance obligation approach to all leases, with a possible exception for manufacturers' and dealers' leases.

The staff discussed disadvantages and criticisms of both major models (performance obligation model and partial derecognition model). The staff also presented a variety of approaches with different emphasis placed on those models.

Most of the Board members agreed to scope out short term leases (that is, leases with maximum possible lease term of 12 months) from the leases requirements that would be accounted for by a simplified accrual accounting.

A few Board members expressed support for the staff recommendation to use the partial derecognition approach for all leases except short-term leases and leases of investment property (that might be expanded to some additional leases of real estate). Those Board members agreed that this approach would be consistent with the approach for lessees and would avoid double counting of assets. On the other hand, some Board members disagreed as they believed that this model does not overcome their concerns over the partial derecognition model that were expressed at the May Joint Board meeting. Those Board members continued to express their concerns over the application of the partial derecognition model.

One Board member noted that the presentation of partial derecognition approach would be complex as net gain presentation or presentation of gross revenue and costs of sales would be driven by a business model.

Several other Board members expressed their preference to use the performance obligation approach for leases where the lessor's exposure to the risks associated with the underlying asset is significant. They believed that such approach was conceptually-based and did not need any further exceptions. On the other hand, several other Board members expressed their concerns over this approach as it might be prone to structuring and would draw the line that the leases project should have removed. One Board member questioned whether it would not be preferable to retain the current guidance in IAS 17 Leases.

In the subsequent debate the Board members tried to reconcile the two accounting models. One Board member summarised that there are three items that cause the two model to appear differently in the financial statements – the net presentation of fixed asset, performance obligation and lease receivable under the performance obligation model, non-accretion of interest on the residual asset under the derecognition approach and recognition of gain on lease recognition under the partial derecognition approach when the carrying amount of the underlying asset is less than its fair value.

The Board also discussed the difference between the residual value of an asset under IAS 16 Property, plant and equipment and the proposed treatment of the residual asset under the partial derecognition approach. The staff noted that the residual asset reflect the allocation of the initial fair value of the asset and is not re-measured.

The Board will discuss these issues at a joint session with the FASB later in the week.

Lessor accounting – Transition under a derecognition approach

The Boards discussed possible transition requirements for lessors under the derecognition approach to lessor accounting. The staff noted that the following possible approaches had been rejected as candidates because the boards have previously rejected them when considering transitional provisions for lessee and lessors:

• retrospective application
• prospective application
• retrospective application for outstanding leases only

The staff were unable to decide which of the following should be recommended to the Boards, so both were presented as possible approaches:

• Option A: Apply to all leases outstanding at the date of initial application, but
  • (i) the residual asset is initially measured at a cost allocation based on historical information; and
  • (ii) receivables are measured at the present value of the remaining lease payments discounted using the rate the lessor is charging the lessee in the lease (as of the date the lease arrangement was entered into).

• Option B: Apply to all leases outstanding at the date of initial application, however;
  • (i) the residual asset is initially measured at fair value as deemed cost (a surrogate for cost at the application date); and
  • (ii) receivables are measured at the present value of the remaining lease payments, discounted using the rate the lessor is charging the lessee in the lease (as of the date the lease arrangement was entered into).

The staff stressed that the only real difference was how the entity should measure the residual asset.

A FASB member proposed and other IASB and FASB members refined a third possibility, which would simplify the accounting on transition to a more 'rough and ready' approach based on the remaining useful life of the leased asset. The Board members who supported this approach criticised the 'horrendous' transition provisions proposed by the staff, which was seen as unduly harsh on entities that had not unreasonable accounting now-the asset and related financing liability were in the financial statements.

After a protracted debate, there was not sufficient support for the 'rough and ready' approach and in a subsequent vote, both Boards agreed to adopt Option B, above (IASB: 9 in favour; FASB: 4 in favour).

Lessor accounting – Accounting for arrangements with service and lease components under the derecognition approach

The Boards discussed lessor accounting for a lease with service components under a derecognition approach. The staff explained that if the lessor is unable to identify service components in an arrangement, a concern exists that under the derecognition approach there would be an overstatement of revenue at lease commencement. This is because the lessor would recognise revenue for services before those services have been provided.

The staff considered four possible approaches that could be adopted for the lessor to separate payments between lease and service components when the services are not distinct:

• treating all payments as lease payments;
• treating all payments as payments for services;
• requiring an estimate of future service costs for the allocation of the consideration between service and lease elements; and
• recognising a liability for the costs of future services.

A vigorous and heated debate followed. An IASB member used the example of an office building lease for which the lease payments included heat, light, water, etc. The board member wanted to know whether the obligation to provide these services would be recognised as a liability. (This IASB member would characterise the final bullet above as 'recognising a liability for the obligation to provide future services'.)

Board members disagreed about whether the Leases standard or Revenue Recognition standard would capture the obligation to provide future services – some saw the 'bucket' in revenue recognition as quite large; others thought the 'bucket' in leases would be the large one.

A call for 'first preference' votes was called: the approach requiring an estimate of future service costs for the allocation of the consideration between service and lease elements had the support of a majority of the IASB (9 in favour) but not the FASB (3 opposed).

The chairman closed the debate, promising to revisit the issue, if necessary, after the Boards' discussions of the Performance Obligation Model vs. Partial Derecognition approach on 17 June.

Lessor accounting – Accounting models

In May 2010, the IASB expressed an interest in using a hybrid lessor accounting model. Under a hybrid model, a lessor would use a performance obligation approach to lessor accounting in some situations and a partial derecognition approach in others. The FASB have tentatively decided to adopt a performance obligation approach for all leases. The Boards debated whether the hybrid approach should be adopted for lessors' accounting.

Two possible variants of the hybrid approach were discussed (known as 'D' and 'F'):

• Approach D would use the performance obligation approach for leases for which the lessor's exposure to the risks associated with the underlying asset is significant. (The IASB staff commented that this approach was similar to the existing requirement to classify leases as finance leases or operating leases. The performance obligation approach would apply to leases where the lessor's exposure to the underlying asset is significant (operating leases). The partial derecognition approach would apply to all other leases (finance leases).)

• Approach F would use the partial derecognition approach for all leases except short term leases and leases of certain real estate (including but not limited to investment property as defined in IAS 40). (The IASB staff commented that this approach would avoid the problems associated with short-term leases and investment property leases and would result in the partial derecognition approach for most leases.)

Both approaches had their supporters, and the debate was heated at times. Those supporting the performance obligation approach usually would not accept the partial derecognition approach at all. However, some Board members did not think that either approach advanced lessor accounting significantly.

One Board member thought the approaches were looking at the wrong issue: to him the key issue was accounting for the underlying asset; the right to use that asset was a separate item to be accounted for under revenue recognition. However, this view did not receive support.

Ultimately, the session chairman determined that Approach D (performance obligation) had majority support among both Boards. However, the Boards then seemed to second-guess themselves as they were concerned that Approach D would challenge their decisions on leases with inseparable service elements on the previous day. A discussion ensued in which it became apparent that the IASB actually preferred a different lessor model in some cases – for example in leases involving real estate (both investment property and other real estate leases). This approach would bifurcate the lease payments: the lease element would be accounted for using the leasing standard; the service element using revenue recognition.

The Boards ended in two different places on this issue: the FASB were firmly (4 in favour) in the performance obligation (Approach D) approach. The IASB was firmly (11 in favour) in the bifurcation approach.

The session chairman asked the staff to develop realistic examples of both approaches to lessor accounting using a lease that included inseparable service elements. Those examples would be discussed in July.

One IASB member noted that he would not sign a ballot on the revenue recognition ballot draft while the lease accounting issue remain unresolved. This would mean that he would be unable to sign the ballot as the lease issue would not be resolved until after his term as a Board member expired.

Accounting for purchase options

The staff invited the Boards to reconsider their tentative decisions on accounting for purchase options. They proposed that the Boards adopt one of two fundamental approaches – as the staff was split, they were unable to make a definitive recommendation. Approach A would account for purchase options consistently with the accounting for options to extend or terminate a lease; Approach B would account for purchase options only upon exercise.

Some Board members who supported Approach B wanted bifurcate the option from the lease and account for the renewal option as any other kind of option. Purchase options were seen as fundamentally different from renewal options - a renewal option provided an additional period of a right to use; a purchase option gave access to the underlying asset. These are different in substance and deserved different accounting.

After another vigorous debate, a majority of both Boards (IASB: 10 in favour; FASB: 3 in favour) voted for Approach B. In follow-up votes, both Boards agreed that the option should not be bifurcated (that is, a 'do nothing with it' approach).

Discussion at the June 2010 Joint IASB-FASB Meeting

Application guidance on when to use the performance obligation or derecognition approaches

The Boards discussed the application guidance on when to use the two approaches for lessor accounting.

First, the Boards discussed the timing of the assessment which approach to use. The majority of both Boards agreed that a lessor should be required to determine at inception of the lease whether the lease exposes the lessor to significant risks and benefits associated with the underlying asset and that determination should not be subsequently reassessed. One FASB member suggested that one of the exceptions to the principle should be business combinations. The Boards agreed. Nonetheless, several Board members suggested that reassessment should be performed also in case of significant change in the economics of the contract. The staff clarified that the change in the economics would be accompanied by the change of the lease contract that would automatically trigger reassessment.

Subsequently, the Boards discussed clarification of the terms underlying asset in the context of the assessment. The Boards agreed that the term underlying asset in this context should refer to the asset itself and not to the credit risk. One Board member also noted that the risks and benefits associated with the underlying asset shall be determined at the inception of the lease but assessed over the life of the lease not just at the end of the lease.

Several Board members expressed their concerns over the articulation of the principle and expressed their preference to formulation of the principle based on transfer or retention of the risk rather than creation of exposure (as lessor is already exposed to the risks of the underlying asset).

The discussion focussed on the general criteria of the usage of performance obligation and derecognition approaches. Several Board members questioned the business model criterion and suggested that it could be expressed in a better way as it could lead to structuring opportunities. They also questioned whether risks and rewards were used as a proxy for existence of performance obligation. Some suggested that over the time of the lease performance obligation aspect could be dominant and at the end of the lease the transfer notion is dominant.

The Boards also noted that in the assessment of the risks and rewards the present value of the residual value at the end of the lease period should be considered.

The Boards will continue the discussion on this issue later this week.

After a short discussion, the Boards agreed that residual value guarantees provided by parties other than the lessee should be considered in determining whether a lessor is exposed to significant risks and benefits associated with the underlying asset. The Boards noted that such approach focuses on economics of the lease rather than legal form of the contract.

The Boards also agreed not to provide any additional guidance for the long-term leases of land and noted that the general principles should be applied for all type of contracts (based on significant risks and benefits).

Finally, the Boards considered the set of factors to be considered in determining whether a lessor is exposed to significant risks and benefits associated with the underlying asset. Some Board members expressed their concerns how operational the factors will be as interaction between the criteria to distinguish between the two approaches, short and long term leases and factors to determine between leases and sales/purchases of underlying assets. In addition some Board members expressed their concerns over the complexity of the hybrid approach for lessor and its inconsistency with the proposed guidance for lessees. Even though the Boards agreed in principle with majority of the factors suggested (business model, exposure to risks and benefits associated with the underlying asset at the end of the lease – i.e. lease terms and residual value guarantee, significance of contingent rentals, nature of the underlying asset, relation of fair value of lease payments and fair value of underlying asset and material non-distinct services), the Boards asked the staff to re-consider these factors and articulate them more clearly. The Boards will discuss these conditions later this week.

Revisited: Scope – Purchases/sales of the underlying asset

The Boards re-discussed the criteria for scoping the contracts that meet the criteria for classification as a purchase or sale of an underlying asset out of the new leases standard. Some Board members expressed their concerns that given the decisions taken on the hybrid approach, some criteria for classification as a purchase or sale and related to derecognition approach for lessor would overlap. Some Board members noted that the rationale for scoping of these contracts have been substantially narrowed by the decision to pursue the hybrid approach. Nonetheless, other Board members considered the two set of criteria necessary. In their view, the scope analysis related always to the whole asset and as such would better depict the lending nature of the transaction in some circumstances.

The Boards noted that the economic distinction between derecognition approach and purchase and sale is very small, but could have practical significance. Consequently, the Boards decided to retain the separate criteria for determining whether the contract should be classified as a purchase or sale of the underlying asset. Nonetheless, the Boards decided to retain only the criteria related to title transfer and bargain purchase option, as all other criteria would be already covered by the derecognition approach.

One IASB member asked whether the bargain rental option should not represent a separate criterion as it economically can equal to the bargain purchase option. The staff clarified that this condition would be already covered by the other proposed criteria.

Accounting for Arrangements with Service and Lease Components

The Boards considered accounting for arrangements that contain both service components and lease components.

After a short discussion, in which several Board members expressed their concerns with the appropriate revenue and profit recognition, the IASB agreed that lessor under the derecognition approach to lessor accounting should be required to bifurcate service and lease components in a lease arrangements for both distinct and non-distinct service components. Nonetheless, this proposal was narrowly defeated in the FASB, as three FASB members expressed their concerns over separation of non-distinct services based on practicability concerns and margin considerations. The IASB agreed to do the allocation based on the relative standalone selling prices of the service for both distinct and non-distinct services.

The Boards discussed the allocation of revenue for lessors between the various components. For many Board members it was contradictory to use the relative selling prices of the non-distinct services (as these are usually not separable) and noted that a kind of allocation based on cost-plus-margin approach might be necessary.

Some Board members questioned why the bifurcation is not required for lessees as well if it is possible to require it for lessor accounting. These Board members were concerned by the possible revenue recognition patterns of these contracts. The staff responded that such bifurcation would be too onerous for the lessees due to informational asymmetry.

The Boards continued to consider the accounting for the service component of a lease arrangement under the derecognition approach to lessor accounting, considering two possible approaches: accounting based on proposed revenue recognition requirements or by recognising a separate performance obligation for the service components. The second approach would lead to slightly earlier revenue recognition as well as grossing-up of the statement of financial position. The Boards remained split on the issue, with the IASB preferring to recognise a separate performance obligation, and the FASB preferring to refer to the proposed revenue recognition guidance.

As the Boards were split on the accounting, the Boards decided to ask questions to constituents in the forthcoming exposure draft on these issues (on bifurcation as well as on accounting treatment).

Business Combinations

The Boards discussed the recognition and measurement of the lease assets and liabilities in a business combination. After a short discussion, the Boards agreed that all lease assets and liabilities in business combinations should be measured in accordance with the proposed leases requirements and that an acquirer would measure those assets and liabilities as if the lease arrangement was a new lease arrangement. Based on that decision, the lessee would measure the right of use asset at the present value of remaining lease payments reflecting the acquirer's discount rate (that would equal the initial measurement of lease obligation) and any adjustment for the off-market rate. The lessor, under the performance obligation approach would adjust the initial measurement of the performance obligation (that would equal the initial measurement of lease receivable) for the off-market rate. Under derecognition approach, any adjustment for off market rate would adjust the lease receivable (that would be initially measured at the present value of the remaining lease payments reflecting the acquirer's discount rate).

Additional disclosures

The Boards agreed to add following proposed disclosures relating to the hybrid lessor model to the disclosure section of the forthcoming exposure draft:

• details on the accounting policy on which model(s) that the lessor applies,
• the types of risks/benefits of the underlying asset that the lessor considered when deciding which approach to apply, and
• separately for each type of lessor approach any impairment that occurred.

The Boards also agreed that an entity should disclose the existence and principal terms of any purchase options for the lessee to purchase the underlying asset.

The Boards will continue to discuss leases later in the week.

Application guidance on when to use the performance obligation or derecognition approaches (cont.)

The Boards continued their discussion on the hybrid approach for lessor accounting. After a considerable debate, the Boards remained split on the cut between derecognition approach and performance obligation approach.

In general, the majority of the IASB members preferred more contracts to be accounted using derecognition approach, whereas the FASB members preferred more contracts to be accounted using performance obligation approach. The FASB suggested that contracts that expose the lessor to the risk of significant variability of returns over the lease term should be accounted for using the performance obligation approach, whereas several IASB members preferred a purer derecognition approach.

Finally, the IASB Chairman concluded that any of the discussed distinction criteria would not be operational and suggested that each Board develops a preferred default approach for which a set of exceptions would be developed. The IASB tentatively opted for the derecognition approach to lessor accounting whereas the FASB tentatively opted for performance obligation approach to lessor accounting. The Boards agreed to discuss the default preferred approach at separate sessions and to continue their discussions at a joint session on Thursday.

Preferred default approach to lessor accounting (IASB only)

The IASB discussed the derecognition model as its preferred default approach to lessor accounting. The Board agreed that there exist some leases for which derecognition approach would not be suitable and discussed possible criteria for the exceptions (i.e. criteria for accounting for the lease contracts under the performance obligation approach). Some Board members expressed their concerns focused on application of the performance obligation model to investment property and real estate industry.

After a lengthy discussion, the Board tentatively agreed (subject to further discussion with the FASB and subject to drafting) that the lessor should use the performance obligation approach if the lease term is insignificant (short term) in relation to the useful life of the underlying asset, with the lease term being defined as the minimum contractual term of the lease, and the lessor is exposed to the significant risk of obligation resulting from the non-integral services that could lead to non-performance (with non-performance possibly leading cancellation of the entire lease contract).

The Board discussed other possible criteria for the exception including removal of the asset risk for the lease period, residual value guarantee as well as business model of the lessor. Nonetheless, these criteria did not attracted widespread support among Board members.

The IASB will discuss the criteria for the performance obligation approach at a separate meeting on Thursday. Subsequently, it would discuss possible solutions to the divergent views on lessor accounting jointly with the FASB.

Application guidance on when to use the performance obligation or derecognition approaches (IASB and FASB joint)

The Boards continued their discussion on when to use which approach to lessor accounting. The Boards discussed multiple variants of the model, either separately, or at a joint meeting, before agreeing on a converged solution to lessor accounting.

The Boards agreed that a lessor should account for a lease contract based on whether the lessor retains exposure to significant risks or benefits associated with the underlying asset

1. either during the expected term of the current lease contract; or
2. subsequent to the term of the current lease contract by having the expectation or ability to generate significant returns by leasing that asset multiple times subsequent to the current contract, or
3. by selling the underlying asset.

The Boards also agreed that counterparty credit risk of the lessee should not be considered for this assessment. The Boards confirmed that this assessment should be made at the inception of the lease and not reassessed subsequently.

The Boards agreed that if the lessor retained exposure to significant risks or benefits associated with the underlying asset, the performance obligation approach should be used, otherwise the lessor should apply the derecognition approach.

The Boards agreed to provide additional factors that would indicate that significant risks or benefits associated with the underlying asset during the lease term have been retained. These would include the risks resulting from:

• Significant contingent rentals that are based on the use or performance of the underlying asset;
• Options to extend or terminate the current lease term; or
• Contractual material non-distinct services provided under the lease contract.

The Boards also decided that a lessor should consider whether the term of the lease is short in relation to the useful life of the underlying asset when determining whether the lessor retains exposure to significant risks or benefits associated with the underlying leased asset subsequent to the term of the current lease contract. The Boards noted that in making this assessment the lessor should consider the present value of the residual cash flows at the end of the lease term as well as effect of residual value guarantees provided at inception by the lessee or third parties.

Finally, the Boards concluded that the residual asset should not be re-measured as the asset risk is considered through the lessor's consideration of exposure to risks or returns through sale of the underlying leased asset.

The Boards also noted that the Basis for Conclusion should refer to the business model as a possible indicator of whether the derecognition or performance obligation model for lessor accounting would be appropriate.

Sale and leaseback

The Boards considered implications of the deletion of the reference of 'all but a trivial amount of the risks or benefits associated with the underlying asset' as well as two of the other criteria in determining whether a contract is a purchase or sale of the underlying asset. (Note: that tentative decision was made earlier on Monday).

The Boards decided to reinstate the reference to 'all but a trivial amount of the risks or benefits associated with the underlying asset' but confirmed deletion of the two criteria.

Some Board members still expressed some concerns with the purchase or sale criteria as they believed that these might be potentially confusing with the criteria for using the derecognition approach to lessor accounting.

In relation with sale and leaseback, the Boards decided not to change any proposed guidance, and acknowledged the possible effect that more transactions being accounted for as financings.

Support for the package of decisions

The Boards formally approved the package of decisions in the leases project. Mr. Finnegan indicated that he might present an alternative view related to derecognition and performance obligation approach to lessor accounting.

August 2010: IASB and FASB publish proposals to improve the financial reporting of leases

The accounting under existing requirements depends on the classification of a lease. Classification as an operating lease results in the lessee not recording any assets or liabilities in the statement of financial position (balance sheet) under either International Financial Reporting Standards or US standards (generally accepted accounting principles). This results in many investors having to adjust the financial statements (using disclosures and other available information) to estimate the effects of lessees' operating leases for the purpose of investment analysis.

The proposals would result in a consistent approach to lease accounting for both lessees and lessors—a 'right-of-use' approach. Among other changes, this approach would result in the liability for payments arising under the lease contract and the right to use the underlying asset being included in the lessee's statement of financial position, thus providing more complete and useful information to investors and other users of financial statements.

ED/2010/9 is open for comment until 15 December 2010. Click for:

• IASB press release (PDF 21k)
• Access to the exposure draft (link to IASB website)

Deloitte's IFRS Global Office has published an IFRS in Focus Newsletter – IASB issues Exposure Draft on Lease Accounting (PDF 111k) explaining the proposals in the ED.

Discussion at the October 2010 IASB Meeting

The staff provided the Board with a summary of constituent outreach activities the IASB has performed since the issuance of the exposure draft. The staff has met with over 400 preparers, accounting firms, industry groups, regulators and users in around the world through various mediums including conferences, roundtables, discussion forums, conference call and individual meetings. The staff also highlighted some of the areas frequently raised as concerns, but did not discuss the issues in detail as those issues will be brought back to the board within specific agenda papers after the comment letter process has closed.

Discussion at the January 2011 IASB Meeting

Preliminary comment letter analysis and redeliberation plan

The staff presented a summary of respondents' comment letters to the Boards' exposure draft published in August 2010 as well as feedback received from the various outreach activities undertaken by the Boards during the exposure period.

Overall, most respondents supported the Boards' efforts to jointly develop a single, comprehensive and converged lease accounting model for US GAAP and IFRSs. There was general support for the efforts to address the 'bright-lines' that exist in current lease accounting literature and most respondents supported the recognition of lease obligations and related assets on the lessee's statement of financial statements. However, significant concerns were expressed with regards to the following matters:

• Complexity and cost of implementing the proposals, specifically the initial and subsequent measurement of lease assets and liabilities
• Reduced comparability arising from the level of estimation and judgement required by the proposals
• Definition of a lease and whether all arrangements meeting the proposed definition should be accounted for in accordance with the proposals
• Direction and objectives of the proposals on lessor accounting.

The staff also reported that a number of respondents recommended that further field-testing should be performed on matters such as the differentiation between a lease and a service, which elements of a lease contract should be disclosed rather than recognised and revisions to the current lessor account model.

Some Board members were surprised and also concerned about the lack of responses from users and that it appears that the users could not reach consensus on the need to change the current lease accounting model.

The Boards acknowledged that pressure is being put on the definition of lease and how it is distinguished from a service contract because the ED requires all leases to be recognised in the statement of financial position. Under the current literature, the distinction was not important as the accounting for operating leases and service contracts were basically the same. The Boards were in agreement that the definition of a lease should reflect the position from both the lessee and lessor's perspective.

Many respondents observed that the proposals with regards to the lessor model were less developed than for the lessee model and recommended that the Boards perform significant additional work as part of the due process, including field-testing, before finalising any changes to lessor accounting.

With regards to the lease term, the staff reported that almost all respondents disagreed with the definition as the longest possible term that is more likely than not to occur, with many respondents either supporting the Alternative view in the ED or increasing the threshold for taking into account options to renew to 'reasonable assured' or 'reasonably certain'.

In summary, the main issues for the Boards to redeliberate, are:

• Definition of a lease
• Lessor accounting model
• Lease term
• Variable lease payments
• Profit or loss recognition pattern.

As the definition of a lease is such a pervasive issue that has implications on a number of other mains issues, the Boards would start their redeliberations by focussing on this.

The Boards did not make any decisions during this session.

How to define a lease and how to distinguish it from a service

The Boards had a preliminary discussion during an education session on how to differentiate between a contract that is within scope of the leases standard and one that is accounted for as an executory contract (service).

In order to formulate the underlying principles for the definition of a lease, the Boards were asked to consider the following questions:

1. What is a lease?
2. Are all leases:
• A form of financing?
• Different from executory contracts?
• Should be uniquely accounted for?
3. What is the asset acquired by a lessee? Is it the right-of-use asset or the underlying asset that is subject to the lease?
4. Should the development of the definition of a lease reflect both lessee and lessor perspectives?

Board members were in agreement that the definition of a lease should reflect both the lessee and lessor's perspective and that the definition of a service should be consistent with the Revenue Recognition project. Board members also agreed that the asset acquired by the lessee, is a right-of-use asset and not the underlying asset. A physical asset can be unbundled into its various components and all a lease does is to unbundle the benefits embodied in the physical asset into a right-of-use and a residual value.

With regards to the question on executory contracts, most Board members were in agreement that leases are a subset of executory contracts and that although the Boards are not trying to account for all executory contracts in this project, they are addressing leases. Several Board members were of the opinion that once a lessor has delivered the asset to the lessee, the performance obligation has been satisfied if the lessor is not required to perform any other activities/services.

When discussing whether all leases are a form of financing, several Board members were uncomfortable with the implications of concluding either way. Some Board members acknowledged that in certain cases, the primary objective of a lease is to finance the acquisition of the right-of use asset, whereas in other cases that may not be the case. When asked why the question was put to the Board, the staff explained that respondents have identified certain situations where the profit or loss recognition pattern as proposed in the ED, would not reflect that substance of the lease arrangement. Respondents felt that in some situations the substance would be better reflected by presenting a straight-line rental payment rather than the amortisation of the right-of-use asset and unwinding of the lease obligation.

One Board member suggested an alternative view whereby all leases are recognised in the statement of financial position, but the profit or loss recognition pattern should be different depending on certain factors. The Boards requested the staff to develop criteria and guidance to consider at a future meeting.

No decisions were taken during this session.

Education session on the way forward for lessor accounting model(s)

The Boards discussed how to best approach lessor accounting. The staff presented the comments received on the proposed accounting models. Many constituents noted that the lessor accounting models proposed in the ED are less developed than the lessee accounting model. Some constituents have urged the Boards to perform additional field testing of the new proposals prior to finalising the leases guidance. The staffs presented the following three approaches on how to proceed with lessor accounting:

The staff recommended the approach in (c). The Boards discussed each of these approaches and were in general agreement with a modified (c) approach whereby the Boards will continue redeliberating both lessee and lessor accounting but will not necessarily limit the issues in lessor accounting to those that are critical to both lessees and lessors. Rather, the Boards will consider the implications to the lessor accounting model of any decisions made relating to lessee accounting.

No decisions were taken during this session.

Discussion at the 1-2 February 2011 Special IASB Meeting

As part of the IASB and FASB redeliberations on the proposals in their Exposure Draft, Leases, the Boards plan to discuss the definition of a lease, the lessor accounting model, the lease term, variable lease payments and profit or loss recognition patterns. (A summary of constituent feedback on the Exposure Draft can be found in the Deloitte (United States) publication Heads Up Boards Consider Feedback on Leases ED (PDF 165k)).

How to distinguish between a lease contract and a service contract

During this meeting, the Boards discussed defining a lease and how a lease should be distinguished from a service. The principles in defining a lease under the right-of-use model in the exposure draft include distinction of contracts which specify:

Respondents to the exposure draft had initially indicated that further clarity was needed in application of the above right-of-use model principles in the following environments:

Specified asset:

Right to control the use of a specified asset:

The IASB and FASB staff asked the Boards to consider which factors help determine how the principles of a specified asset and the right to control the use of a specified asset should be applied in determining whether an arrangement contains a lease.

Specified asset:

• Identification: When asked to consider whether specific identification of an individual asset (e.g., asset serial number) was required to satisfy the criterion outlined above, the Boards generally agreed that specific asset identification was not a requirement. The Boards did note that asset specificity would generally be expected to consider the functionality, homogeneity and value of the asset to the lessee in any asset substitution environment. The Boards also questioned whether any contractually specified asset is required to take the form of a specific tangible asset, in contrast to an intangible asset, in which no uniform conclusion was reached.

• Substantive: When asked to consider the substantive terms of an arrangement in the form of customer indifference to use of a pool of assets in satisfaction of lessee requirements, certain members of the Boards noted consideration to the lessee's dependency on specific assets; noting that a termed 'equivalent' asset of consistent functionality, homogeneity and value to the lessee would not result in classification as a service contract when viewed in isolation
• Componentisation: When asked to consider distinction of specified assets when use of a 'specified' asset is componentised for use by multiple parties (e.g., fibre-optic data cable), the Boards were unable to develop a consensus view on whether such componentisation would result in an inability to control physical access to a specified asset.

Control:

• Right to direct the operation: When asked to consider the right to direct the operation, the Boards considered whether the ability to direct the operation required direct performance by the lessee to the contract at all levels of functionality, or whether contract specificity as to the lessee's ability to direct the functionality of the lessor served in fulfilling this requirement. No consensus view was reached on this topic
• Right to control physical access: When asked to consider the right to control physical access, the Boards considered whether restriction of physical access required total unrestricted use of the assets, such that componentised asset use would serve to restrict recognition of a contract as a lease. No consensus view was reached on this topic.

In addition to the above, the Boards considered whether contracts which contain an embedded asset and service elements should be bifurcated and accounted for separately, and if so, how such components should be evaluated when considering value and importance of such elements to functionality; however, a conclusion was not reached on this topic during the respective Boards' meeting.

No tentative decisions were reached during this session. The staff intended to use the information obtained in these discussions in developing formal proposals to bring to the Boards during a future meeting.
 

Discussion at the February 2011 IASB Meeting

Wednesday, 16 February 2011

As part of continual deliberations surrounding the Exposure Draft Leases published 17 August 2010, the Boards considered the accounting for options to extend or terminate a lease, in which the Exposure Draft proposed that an entity should account for options to extend or terminate a lease by defining the lease term as the longest possible term that is more likely than not to occur (see paragraphs B16-B20 of the Exposure Draft), in a definition applicable to both the lessee and the lessor.

In outlining feedback including comment letters and other outreach, the staff noted:

• Many respondents agreed with the Boards that options to extend and terminate leases affect the economics of lease contracts and supported a consistent approach for applying the lease term definition to both lessees and lessors
• Many respondents acknowledged the boards' concerns relating to the structuring risks associated with options to extend and terminate leases
• Many respondents and workshop participants questioned the practical application of the proposals, questioning how the lease term would be determined in situations in which a lease contract includes, for example, month-to-month extension terms/open-ended/'pay-as-you-go' contracts, a right of first refusal, or terms permitting termination by either the lessee and/or the lessor.

Generally, respondents encouraged the Boards to consider whether the objective of the lease term definition is to focus on (1) contractual future lease cash flows, (2) estimating all future lease cash flows or (3) in-substance contractual future lease cash flows.

Based on feedback received from interested parties, the Boards were asked to consider the following topics:

• Initial measurement of options to extend or terminate a lease
• Reassessment requirements associated with options to extend or terminate a lease
• Symmetry between lessee and lessor accounting

Initial measurement of options to extend or terminate a lease

The staff proposed three alternatives to the initial accounting for lease term options:

A majority of the staff recommended Approach C; citing that factors such as past practice and management intent would not influence the determination of a reasonably certain lease term at inception. The staff believed this approach was more objective because it does not depend on the assessment of future business conditions or management intent, which could easily be altered by external economic circumstances. Other staff members external to the above majority cited approval for Approach B, because including all factors that may affect the potential lease term, such as past practice and management intent, would more closely reflect the expected future cash flows associated with the lease, and thus, be more responsive to the needs of the users of the financial statements.

In deliberations on the above three initial measurement approaches, the majority of the Boards (absent three members of the Boards) tentatively approved Approach C, with clarification of the wording applied thereto, as summarised below:

• The use of the reasonably certain threshold applied in Approach C. Multiple members of the Boards debated the use of the term, 'reasonably certain' as a threshold outlined in Approach C; questioning whether this term suggested too high a threshold, and likewise, how this threshold should be viewed in industry practice.

While certain members of the Boards supported the use of the 'reasonably certain' criterion, as it deters judgement on the part of management to manipulate a company's financial position, the majority of the Boards tentatively concluded that any future amendments should consider revised wording to more appropriately define the level of certainty required in recognition of an initial option to extend or terminate. A proposed wording, as agreed by the majority of the Boards, stated that the term 'reasonably certain' should be replaced by the phrase, 'clear economic incentive to exercise the options.' The staff agreed to review such wording at a future meeting.

The tentative decision of application of Approach C was reached after considering:

• Approach C provides more objectivity, as it does not depend on the assessment of future business conditions or management intent
• Approach C is responsive to concerns that it may be misleading to include amounts in the lessee's liability that the lessee has genuine flexibility to avoid because there is no economic incentive to renew
• Approach C would result in more consistent reporting and less volatile financial reporting.

Reassessment requirements associated with options to extend or terminate a lease

The Exposure Draft proposed that lessees and lessors should adjust the lease liability/asset after initial recognition if facts or circumstances indicate that there would be a significant change in the lessee's liability to make lease payments or in the lessor's right to receive lease payments. When such indications exist, the lessee and lessor are required to reassess the length of the lease term.

After receiving respondent feedback that the reassessment is overly complex and burdensome, the staff identified two approaches to subsequent measurement relating to the lease term:

The staff supported Approach A, requiring a reassessment of the lease term on a basis consistent with the initial determination of lease term.

In deliberations amongst the Boards, the Boards tentatively concluded with the view of the staff. One member of the Boards expressed concern that the current language in the Exposure Draft suggests continual reassessment, and as such, it was suggested that the staff provides further clarity that continual reassessment without changes in underlying circumstances in not required.

The tentative decision was reached after consideration by the Boards that requiring reassessment of the lease term provides useful information to users because the lease term is determined on a consistent basis over the duration of the lease contract.

Symmetry between lessee and lessor accounting

The Exposure Draft does not make a distinction between a lessee and a lessor in the way term options are accounted for. However, because the lessee and the lessor may have different information on whether the lessee will extend or terminate the lease, the lessee and the lessor may not determine the same lease term.

In this regard, the Boards considered whether the definition of lease term should be consistent between the lessee and the lessor.

As part of this assessment, the staff highlighted the following reasons that support differences in the accounting for options to extend or terminate a lease between a lessee and a lessor:

• The information known to the two parties of the lease will be asymmetrical
• The lessee is usually the party that holds the option and exercise of the option is usually within the control of the lessee, but outside of the control of the lessor
• For a lessor applying the derecognition approach, reassessment of the lease term results in the recognising revenue and/or reversals of revenue based on a subjective determination by the lessor. Because there is an impact on revenue resulting from a reassessment, the recognition principle for a lessor applying the derecognition approach may need to be more restrictive.

In contrast, the staff highlighted the following reasons that do not support differences in the accounting for options to extend or terminate a lease between a lessee and a lessor:

• Less complex to apply and understand, which may be helpful to users of financial statements
• Easier to account for subleases and related party leases.

Consistent with the tentative decision of Approach C, above, within the initial measurement of options to extend or terminate a lease, the Boards cited that under Approach C, the accounting for the lease term requires both parties to assess the lease term based on the lease contract and the leased asset, rather than business and other factors, and as such, there would usually be symmetrical information available to both parties. As both parties are assessing the same contract at the same time (lease inception) to determine the lease term, it is more likely that the lessee and lessor would determine the same lease term.

As a result, the Boards had unanimously decided that it is appropriate to have a consistent definition of lease term between the lessee and the lessor.

Topics to be discussed at future meetings

The staff intend to discuss the following related topics in a future meeting:

• Accounting for purchase options
• Presentation impact of changes from a reassessment of lease term
• Disclosures regarding options to extend or terminate a lease.

Thursday, 17 February 2011

Distinguishing between leases and services

As part of continual deliberations surrounding the Exposure Draft Leases published 17 August 2010, the Boards considered the following topics given feedback received as part of comment letter and outreach activities:

• Distinguishing between leases and services, including:
• Types of leases
• Principles relating to the definition of a lease including:
• the concept of a specified asset, and
• the concept of the right to control the use of an asset.

Following outreach activities discussed during the January 2011 joint Board meeting, the staff highlighted consideration as to whether there should be more than one lease model for both lessees and lessors, and specifically, the profit or loss effects of the proposed right-of-use model for both lessees and lessors. In this context, the following overriding questions were raised to the Boards:

• Are there different types of leases; a concept unique from the current Exposure Draft which suggests one type of lease?
• If there are different types of leases, should all leases have the same profit or loss recognition pattern or should there be differences in profit or loss recognition?
• If there are different types of leases, what are the indicators that distinguish one type from another?

Types of leases

The staff recommendations as part of this meeting included:

• Tentative acknowledgement that there are two different types of leases, with a plan to establish a targeted approach for outreach on underlying topics derived from this tentative acknowledgement.
• If there are different types of leases, that each type have a different profit or loss recognition pattern for both the lessee and lessor. Specifically, there is a lease that is:
• A finance lease that is akin to an instalment purchase / sale in which the financing element is significant and should be reflected in the pattern of profit or loss recognition of both lessees and lessors. The profit or loss of a finance lease has a profit or loss pattern consistent with the proposals in the Exposure Draft and includes interest expense / income (using the effective interest method), and would usually reflect the lessee consuming the right-of-use asset on a straight-line basis, or
• An 'other-than-finance lease' that is a lease transaction in which the financing element is not considered significant. The profit or loss pattern of an other-than-finance lease is characterised by straight-line recognition consistent with today's US GAAP / IFRS operating lease accounting
• Indicators to make a determination between the two proposed types of leases, including (a) residual asset, (b) potential ownership transfer, (c) length of lease term, (d) rent characteristics, (e) underlying asset, (f) embedded or integral services and (g) variable rent.

The concept of the appropriate presentation for leases will be subject to deliberation at a future meeting.

The Boards, in deliberation of the concept of two different types of leases in the Boards' right-to-use model, tentatively confirmed the staffs' conclusions, including that of targeted outreach activities, highlighting:

• Certain types of leases provide for a financing element which is not significant as the lessee enters into a rental transaction to use the asset rather than a transaction that is similar to financing the acquisition of the asset; in substance, a lease not entered into for the purpose of financing, but rather, to create flexibility, mitigate the risk of ownership and /or outsource activities related to maintenance and administration
• Certain types of leases have varying levels of ancillary services combined in the arrangement which may differentiate the form of a lease
• The distinction of two types of leases is not inconsistent with the Boards' stated purpose of providing users of financial statements with a complete and understandable picture of an entity's leasing activities.

In reaching the above tentative confirmation, the Boards also tentatively confirmed the staffs' views regarding a different profit or loss recognition pattern for both the lessee and lessors, citing:

• Different entities engage in lease transaction for different reasons, including those of a financing nature and other of an other-than-financing nature, as described above.

Multiple members of the Boards suggested further development and discussion regarding the profit and loss recognition patters applied in an effort to provide linkage between the assets and liabilities derived under lease transactions.

In contemplation of the distinction of leases noted above, the Boards considered what indicators should be used to distinguish one type of lease from another; generally concluding that new indicators should be identified independent of those outlined in current standards, although the indicators recommended by the staff, as specified above, consider current guidance in IAS 17 and ASC 840, as well as feedback received from comment letters and outreach activities.

Certain members of the Boards expressed concerns regarding the indicators expressed by the staff including:

• Defining a 'by-exception' model for finance lease classification, whereby indicators outlined herein may be viewed in isolation.
  
  Specifically, multiple members of the Boards expressed reservation that the applicability of one of the indicators for finance lease distinction should not be viewed as conclusive evidence of the appropriateness of a finance lease distinction.
  
  Further, multiple members of the Boards deliberated as to whether two indicator lists should be produced to distinguish indicators to be considered in finance lease distinction, independent of indicators for other-than-finance lease distinction, as well as if a hierarchical approach to the indicators should be provided.

Future deliberation on the above topic will continue at a future meeting.

Principles relating to the definition of a lease

In application of the definition of a lease expressed within the Exposure Draft, as generally consistent with current IFRS and US GAAP literature, and considering feedback from comment letter and outreach sessions, the staff focused its proposals to the Boards on the concepts of specificity of assets and the right to control; considering the following:

• Specificity of an asset
• Should the definition of a lease refer to a specific or specified asset (e.g., uniquely identified asset or an asset of a particular specification)?
• Should the final standard clarify whether an asset can be a portion of a larger asset?
• Should the final standard address assets that are incidental to the delivery of specified services?
• Right to control
• Should the concept of control apply the principles already in IFRIC 4 and ASC Topic 840, but change to the wording of paragraph B4(c) to clarify the principle underlying those words?
• Should the concept of control be consistent with the concept of control included in the revenue recognition Exposure Draft?

The staff recommendations as part of this meeting included:

• No definitive recommendation as to whether an asset should refer to a specific or specified asset. The staff recommended targeted outreach in this area
• No definitive recommendation as to clarifying whether an asset can be a portion of a larger asset, but highlighting two likely approaches: (a) applying current IFRIC 4 and ASC Topic 840 guidance without additional amendment, which clarifies that a physically distinct portion of a larger asset can be a specified asset or (b) clarifying whether a physical or non-physical (e.g., capacity) portion of a larger asset can be a specified asset. The staff recommended targeted outreach in this area
• The inclusion of working regarding assets that are incidental to the delivery of specified services, which is generally consistent with paragraph B1 of the Exposure Draft that 'an entity shall determine whether the contract is, or contains, a lease on the basis of the substance of the contract...'.

Specificity of an asset

The Boards, in response to whether the definition of a lease refers to a specific or specified asset, expressed a relatively split view, with the majority of the Boards supporting that a 'specified asset' should be viewed more broadly as an asset of a particular specification (e.g., copier machines under a leasing arrangement can be substituted with consistent models, assuming no disruption of service). Deliberations underlying this tentative decision considered that a more broad views considers that a customer has received the same benefits and functionality throughout the lease term, while the opposing view highlights that a broad view may result in variances in accounting between the lessor and lessee, whereby a lessor must identify a specific asset to enable practical application of the derecognition model within the Exposure Draft.

The Boards agreed to tentatively confirm the broad 'specific asset' application while taking both approaches for targeted outreach.

In evaluating the concept of whether assets can be a portion of a larger asset, the majority of the Boards confirmed that any amendments should clarify whether a physical or non-physical (e.g., capacity) portion of a larger asset can be a specified asset.

Focusing on the concept of non-physical asset distinction as a lease, the majority of members of the Boards noted that a non-physical portion of a larger asset could be a specified asset, as this was conceptually consistent with the right-of-use model proposed in the Exposure Draft and an approach of viewing an underlying asset as a bundle of rights. The staff expressed concerns about the implications and possible unknown consequences of expanding the application of the definition of a lease to non-physical portions of a larger asset and acknowledged that, for cost / benefit reasons, it may be appropriate to clarify that non-physical portions of a larger asset would unusually not meet the definition of a specified asset. Therefore, the staff recommended that the Boards seek input through targeted outreach on both of the likely approaches set forth by the staff.

The Board confirmed the recommendation of the staff.

In evaluating the concept of assets incidental to the delivery of specified services, such as season tickets to a sporting venue or a cable box provided when a customer contracts to have viewing rights to particular television channels, the Exposure Draft was silent on such examples. The staff provided preliminary draft wording to the definition of a lease to capture assets that are incidental to the delivery of specified services, noting consideration as to the 'incidental' nature of the asset.

Under preliminary draft wording provided by the staff, an asset was considered likely to be incidental to the provision of a service when (a) specification of the asset is determined by the supplier as a mechanism for providing a specified service requested by the customer in the contract; or (b) the asset component of the contract is insignificant in terms of its benefit to the customer when compared to the service components of the contract.

The majority of the Boards agreed with this definition amendment, but noted that the term 'insignificant' should be clarified as whether such an assessment underlies economics or other benefits. A minority of members of the Boards considered whether time should be a component of the definition (e.g., a time charter of one day versus five years), but no consensus was reached.

Right to control

The current definition of a lease within the Exposure Draft raises the concept of a right to control, whereby a contract is said to convey the right to use an asset if it conveys to an entity the right to control the use of the underlying asset during the lease term. Control, in the context of a lease, is considered to provide for either (a) the active ability to operate or control physical access to an asset as well as the right to obtain some output or other utility of the asset; or (b) having the right to obtain all but an insignificant amount of the output or other utility of the asset as long as the pricing is such that the customer is paying for the right to use the asset, rather than for actual use or output.

Comments from respondents around the control provision questioned the following key concepts: (a) how should the 'ability or right to operate' concept be applied when a customer relies on personnel employed by the supplier to receive benefits from use of the specified asset; (b) what does 'output', 'insignificant', 'contractually fixed per unit' and 'current market price' mean within paragraph B4(c) of the Exposure Draft; (c) why would the concept of control applied when a customer obtains the right to control the use of an asset be different from the concept of control applied when a customer obtains control of a good?

In response to the main comments raised, the staff expressed two possible approaches:

• Retain the concept of control already in IFRIC 4 and ASC Topic 840 regarding the right to control the use of a specified asset, but change to the wording of paragraph B4(c) to clarify the principle underlying those words
• Revise the description of control in the lease standard to be consistent with the concept of control included in the revenue recognition Exposure Draft.

The staff recommend a targeted outreach of the above approaches, while also further deliberating any potential unintended consequences of applying the revenue recognition concept to the leasing environment. Certain members of the Board expressed the need for consistency in the use of the term 'control,' while a minority noted the unique nature of the revenue environment to that of the leasing environment.

The proposal provided by the staff provided preliminary draft wording relating to the definition of a lease in this area, including application of the revenue recognition Exposure Draft to the leasing environment.

Relevant deliberations included determination as to whether the entity has the ability or right to operate the asset or direct others to operate the asset in a manner that it determines while obtaining or controlling more than an insignificant amount of the potential cash flows from use of the asset, the ability or right to control physical access to the underlying asset while obtaining or controlling more than an insignificant amount of the potential cash flows from use of the asset, and rights to obtain substantially all the potential cash flows from use of the asset throughout the term of the lease.

The Boards expressed concern that use of the term, 'cash flows' should be broadened to include any benefit derived from use of the assets. The staff will consider revised wording in a future meeting.

The Boards confirmed the staffs' recommendation to field test the above approaches, with a majority preference of consistency between control defined within the revenue Exposure Draft and that of the leasing proposal. The Boards also asked the staff to consider unintended consequences of a consistent modelling within revenue and leasing in this area.

In a subsequent deliberation session held on 17 February 2011 surrounding the Exposure Draft Leases, the Boards considered the following topics given feedback received as part of comment letter and outreach activities:

• Accounting for variable lease payments
• Other variable lease payment considerations:
  • Residual value guarantees
  • Third party residual value guarantees
  • Term option penalties

Accounting for variable lease payments

The Exposure Draft Leases identified that in some leases, the amount of each contractual lease payment is variable rather than fixed. That variability can arise because of features such as, but not limited to, residual value guarantees, penalties for failure to renew, and contingent rentals. The Exposure Draft Leases proposes that at the date of commencement of a lease, a lessee should recognise a liability to make lease payments and a lessor should recognise a right to receive lease payments (lease receivable) in the statement of financial position. Payments arising under a lease include fixed payments as well as all variable payments. The Exposure Draft proposes that an entity should measure the liability to make lease payments and the lease receivable using an expected outcome technique. Expected outcome is the probability-weighted average of the cash flows for a reasonable number of possible outcomes. In addition, the Exposure Draft proposes that a lessor should include variable lease payments in the measurement of the lease receivable only if those payments can be reliably measured.

In assessing feedback from comment letters and outreach activities, users had mixed views on the treatment of variable lease payments, whereby most supported additional information relating to variable lease payments, but views on the appropriate recognition pattern within the financial statements varied. Such views included concern as to judgement applied in measurement of variable lease payments that depend on future performance or usage, as well as the volatility and challenge of measuring reliably variable lease payments using an expected outcome technique.

In consideration of the above, the staff recommendations as part of this meeting included:

• The majority of the staff recommended that variable lease payments should be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable only if those variable lease payments depend on an index or a rate.
• The minority of the staff recommended that all variable lease payments that are "probable" or "reasonably assured/certain" should be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable.
• Disclosures would be required for variable lease payments; however, relevant disclosures will be subject to a future meeting.
• A reliability threshold should be included in the proposal for the measurement of variable lease payments for both lessees and lessors.

Taking each in hand, in evaluating which variable lease payments should be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable, the majority of the staff detailed inclusion only if those variable lease payments depend on an index or a rate; noting the following key advantages:

• May avoid concerns relating to the accuracy or provision of measurement;
• More consistent accounting between the lessor and lessee in cases in which the lessor would otherwise be unable to estimate variable lease payments reliably;
• May better reflect the fact that variable lease payments based on usage or performance provide lessees with flexibility and reduce their business risk.

A minority of the Boards noted that in such an application, the lessee's measurement of the liability and lessor's measurement of lease receivables would not reflect the amounts that an entity has the ability to avoid, whereby such accounting may depict understated lessee obligations and lessor receivables when future cash flows are highly likely to occur. Further, certain members of the Boards were concerned that such an appropriate would create structuring opportunities.

Support from the Boards regarding the above approach cited that such an approach promotes consistency in application and reduces judgement and variability. Further, the approach was believed to capture residual value guarantees and term option penalties (or obligations to retire the leased asset), which is consistent with the definition of minimum lease payments under IAS 17 and ASC Topic 840.

In application of a principle that all variable lease payments that are "probable" or "reasonably assured/certain" should be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable noted the following key advantages:

• May give a more faithful depiction of the rights received by the lessor and the obligations incurred as it may be more reflective of actual cash flows.

A majority of the Boards questioned whether such an approach would lead to highly subjective estimates, and likewise, concerns were expressed over the definition of "probable" or "reasonably assured/certain" as applied in the recommendation. One member of the Boards deliberated as to whether the concept of the "foreseeable future" should be considered in modelling, whereby assessment of probability is limited to the period management considers being "foreseeable" based on budgets and forecast modelling.

Support from the Boards regarding the above approach cited that such an approach addresses the operational and reliability concerns expressed by preparers, while providing more useful information to financial statement users to assess amounts, timing and uncertainty of cash flows.

In final deliberations, the majority of the Boards confirmed, in relation to which variable lease payments should be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable, the following items for inclusion:

• Variable lease payments that depend on an index or a rate;
• Variable lease payments that are "reasonably assured/certain," in which such a term will be defined in a later meeting;
• "In-substance" / "phoney" leases which are provided at off-market terms;
• Elevated disclosure within the notes of contingent rate leasing arrangements, which will be discussed in a later meeting.

In assessing a reliability threshold for inclusion in the proposal for the measurement of variable lease payments for both lessees and lessors, the staff recommended that the initial measurement of the variable lease payments that depend on an index or rate to be based on a prevailing rate (or spot rate), with subsequent update of this rate at each reporting period. This approach was considered to be a practical approach to avoid incomparability between entities.

The majority of the Boards tentatively confirmed the recommendation of the staff, noting the simplicity of the model as compared to use of forward rates and indices. Further, members of the Boards questioned whether forwards rates would result in incomparability and misleading information. Such a conclusion contradicts the Exposure Draft Leases proposal that when determining the present value of lease payments payable, variable lease payments that depend on an index or rate should be determined using readily available forward rates or indices.

Other variable lease payment consideration

The following topics were considered in relation to the recognition and measurement of the lessee's liability to make lease payments and a lessor's lease receivable for other lease payment considerations, absent those general considerations set forth above:

• Residual value guarantees ("RVGs")
• Third party RVGs
• Term option penalties

RVGs

Given a lack of clarity as to whether RVGs should be included in lessee's liability to make lease payments and a lessor's lease receivable, the staff believed it important to clarify that RVGs (that are not from an unrelated party) should be included in the measurement of a lessee's liability to make lease payments and the lessor's lease receivable, similar to current guidance. The full amount of the RVGs would be included in this measurement.

The Boards confirmed such a recommendation, as considered against the variable lease payment definition outlined above, as a RVGs is viewed equivalent to a contingent payment at the end of the lease term, whereby they are linked to the value of the underlying asset and could be misleading to recognise such guarantees separately.

The Boards also tentatively decided that RVGs provided by the lessee (not unrelated third parties) should be included in the measurement of a lessee's liability to make lease payments at the amount that represents the difference between the residual value of the asset and the level of the guarantee. The amount of the residual value guarantee included in the liability to make lease payments will be reassessed. The staff will reach out to constituents to gather feedback on these tentative decisions.

Third party RVGs

The Exposure Draft proposes that the present value of lease payments should not include an estimate of amounts payable under RVGs that are provided by an unrelated third party, which has been objected by a minority as part of comment letter responses received and outreach activities performed. The conclusion expressed in the Exposure Draft Leases is reached because RVGs that are provided by an unrelated third party are not lease payments and are outside of the lease contract. Further, the staff believes that since such third party RVGs solely affect the value of the underlying lease asset and are not arrangements between the lessee and lessor, these should be accounted for as other guarantees.

Given the above, the staff recommended that the Boards confirm the tentative decision reflected in the Exposure Draft Leases that the lessee's liability to make lease payments and the lessor's lease receivable should not include an estimate of amounts payable under RVGs provided by an unrelated third party.

The Boards confirmed such a recommendation.

Term option penalties

Consistent with the proposals for variable lease payments, the Exposure Draft Leases proposes that the present value of lease payments should include an estimate of expected payments to the lessor under term option penalties.

While very few respondents providing feedback on the Exposure Draft Leases commented specifically on term option penalties, of those who responded to this particular proposal, many requested clarification of the term, while others disagreed with use of term option penalties in the measurement of the lessee's liability to make lease payments and a lessor's lease receivable.

Given the above, the staff recommended that if there are term option penalties for non-renewal and the renewal period is not included in the lease term, then those term option penalties should be included in the measurement of the lessee's liability to make lease payments and the lessor's lease receivable (e.g., term option penalties should be included to the extent that it is reasonably certain that the lessee will not extend the lease).

The Boards confirmed such a recommendation on the basis that such a conclusion is consistent with the accounting for options to extend or terminate a lease.

Discussion at the additional 1-2 March 2011 Joint IASB-FASB Meeting

As part of continual deliberations surrounding the Exposure Draft Leases published 17 August 2010, the Boards considered the right of use model in application of lessee accounting, as well as the scope of the leases standard.

Right-of-use model

The purpose of this discussion served to confirm the Boards' tentative decisions to apply a right-of-use ("ROU") model to all lease arrangements, whereby, in accordance with the Exposure Draft, a lessee in a lease arrangement would recognise a ROU asset representing its right to use an underlying asset during the lease term and a liability to make lease payments. Although the Boards are considering all issues from both a lessee and a lessor perspective during redeliberations, the scope of this discussion was limited to lessee accounting under a ROU model, as lessor accounting will be considered in a future meeting.

In outlining feedback including comment letters and other outreach, the staff noted:

• Users generally support applying the ROU model in principle to lessees, noting that most respondents support the recognition of lease obligations and related assets on the lessee's statement of financial position
• Certain users noted that in application of a ROU model, they support a whole asset approach where the lessee would recognise the entire underlying asset during the lease term
• Certain respondents noted that improvements could be made to existence guidance under ASC Topic 840 and IAS 17 as opposed to fundamental reform suggested within the Exposure Draft, as those who do not support a ROU model think that the model leads to the recognition of assets and liabilities for all executory contracts, which they perceived as inappropriately grossing up the statement of financial position.

In assessing feedback received, the staff thinks the principles underlying the proposed ROU model would address many of the problems in existing U.S. GAAP and IFRSs, and in particular, the models to lessees would:

• Reflect the assets and liabilities arising in all leases in the statement of financial position
• Result in the same accounting for the majority of leases on the statement of financial position for purposes of comparability
• Be possible to apply to a wide range of leasing arrangements
• Be consistent with the Boards' conceptual framework (e.g., definition of an asset and a liability).

Based on this information, the Boards tentatively confirmed the staff's recommendation that the ROU model be used for lessees in lease arrangements. The Boards acknowledged that this decision may be modified based on future decisions on the leases project.

Scope of the leases standard

The purpose of this discussion served to discuss the scope of the proposed lease accounting model. This scope of this discussion included possible exclusion for intangible assets, certain items classified as inventory by a lessee, as well other scoping areas including leases to explore for or use natural resources, leases for biological assets, leases of non-core assets, long-term leases of land and service concession arrangements within the scope of IFRIC 12, Service Concession Arrangements. Scoping considerations outside this particular discussion, which will be discussed in a future meeting, include investment properties, the definition of a lease and short-term leases.

The Exposure Draft proposed that an entity shall apply the guidance to all leases, including leases of right-of-use assets in a sublease, except (a) leases of intangible assets, (b) leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources and (c) leases of biological assets.

In application of outreach activity feedback, the staff communicated that the majority of respondents agreed with the proposed scope exclusions in the Exposure Draft, but certain respondents suggested that the Boards clarify whether standard should apply when the underlying asset in the contract is an item classified as inventory (e.g., spare parts), a service concession arrangement and timber (for US GAAP constituents).

As part of this assessment, the following tentative decisions and follow-up activities were noted:

• The Boards tentatively decided that the lease accounting model is not required to be applied to all leases of intangible assets except for the right-of-use assets in a sublease. The FASB requested the staff to bring back the question of whether intangible assets under ASC Topic 350-40, Internal-Use Software, should be in the scope of the leases standard

• The IASB tentatively confirmed that leases of inventory should be in the scope of the lease accounting model, consistent with IAS 17, while the FASB requested the staff do more research to better understand the implications of such a decision given that ASC Topic 840 currently scopes out leases of inventory

• The Boards tentatively decided that an asset is not required to apply the leases standard to leases:
• for rights to explore for or use minerals, natural gas and similar non-regenerative resources
• for biological assets, including timber (US GAAP-only)
• for service concession arrangements within the scope of IFRIC 12 (IFRS-only).

Regarding intangible assets, the staff and the Boards acknowledged that outreach feedback on excluding intangible assets from the scope of the leases standard were mixed, with the majority of respondents agreeing that there was no conceptual basis for excluding intangible assets as stated in paragraph BC36 of the Exposure Draft, and other citing (a) difficulties encountered with bundled arrangements with both tangible and intangible assets, (b) concerns surrounding the implications for lessors and alignment of lessor and lessee accounting models and (c) the lack of guidance available for IFRS preparers if the standard excludes intangible assets within the scope of IAS 17.

The Boards tentatively decided that the leases standard is not required to be applied to all leases of intangible assets, except for right-of-use assets in a sublease, absent implications of ASC Topic 350-40, as outlined above, for the following primary reasons:

• Any consideration of leases of intangible assets should be done separately and comprehensively
• It provides a converged answer as opposed to certain scoping differences currently present in IFRSs and US GAAP
• There is no conceptual basis for excluding leases
• Implications of including intangible assets in the scope of the leases standard are not currently known.

Regarding scope exceptions surrounding inventory, the staff and the Boards acknowledged that certain respondents pointed out that based on the definition and exclusions proposed in the Exposure Draft, certain items classified as inventory by a lessee would be in the scope of the guidance. This fact led many respondents to specifically exclude leases of certain items classified as inventory from the scope, or clarify whether a lease of inventory is within the scope of the Exposure Draft.

The staff further acknowledged that the scope of this feedback appeared to be narrow, focusing on outreach feedback received from arrangements in the airline industry and other heavy manufacturing industries where leases of inventory are present, taking the primary form of spare parts or other operating supplies. With that said, it was not always clear that such items are indicative of the conceptual framework of inventory.

The Boards deliberated surrounding any application of a scope exception in considering the conceptual model of inventory and outreach activity received to date. Ultimately, the IASB tentatively decided that leases of inventory should be in the scope of the leases standard for the following reasons:

• From feedback received, in practice, it appeared that relatively few leases of inventory exist and few arrangements may be accounted for under the leases standards
• Either the definition of a lease or the short-term lease election would appropriately address many arrangements that contain leases of inventory
• It creates a potential inconsistency between the scope of the standard for lessees and lessors.

The FASB requested that the staff perform more research to better understand the implications of such a decision, which will be discussed at a future meeting.

With respect to other scope exclusions, including rights to explore for or use minerals, natural gas and similar non-regenerative resources, biological assets, including timber (US GAAP-only), and service concession arrangements within the scope of IFRIC 12 (IFRS-only), the Boards tentatively decided that an entity would not be required to apply the leases standard.

Such a tentative decision was reached based on the fact that:

• These industries are specialised, whereby accounting practices are diverse and often differ from accounting for other types of assets
• It provides for certain levels of consistency through application of more specific accounting guidance
• There is no conceptual basis for differentiating the above areas from other assets
• It follows feedback received during outreach activities.

Discussion at the March 2011 IASB and IASB-FASB Meetings

As part of its continual deliberations surrounding the Exposure Draft Leases, the Boards considered the following topics:

The Boards made a number of tentative decisions in the conduct of these deliberations; however, such tentative decisions were made in the context of further necessary outreach in the following areas:

• The definition of a lease, as distinguished from the definition of an instalment sale;
• Whether the reassessment for a bargain purchase option should be the same as the reassessment for renewal options, focussed most notably on the linkage of value of the underlying asset.
  • In this assessment, consideration is placed on whether, in a bargain purchase option, we have a significant incentive to extend and the impact of developments in the underlying asset value subsequent to entering into the lease
  • We note that the IASB preliminarily decided that no expected difference in the reassessment indicators would be expected between a bargain purchase option / significant economic incentive option and a renewal option, while the FASB preliminarily decided that a potential difference may be present between a bargain purchase option / significant economic incentive option and a renewal option based on the determination as to whether the option should be assessed on day 1 of the lease or reassessed throughout the lease term;
• Accounting for revisions to the existence of a significant economic incentive to exercise the purchase option, which could lead to a new derecognition/recognition event (for example, what are the dangers if a reassessment were to result in a change from a finance to an other-than-finance lease).

Distinguishing between a lease and a purchase or sale

The purpose of this discussion was to determine whether the leases standard should provide guidance for distinguishing a lease from a purchase or sale.

As a result of the assessment performed by the staff, the staff recommended that guidance should not be provided in the leases standard for distinguishing a lease of an underlying asset from a purchase or sale of an underlying asset.

As outlined within the Exposure Draft,

An entity should not apply [the leases proposals] to the following contracts, which represent a purchase or sale of an underlying asset:

(a)	a contract that results in an entity transferring control of the underlying asset and all but a trivial amount of the risks and benefits associated with the underlying asset to another entity; and
(b)	a lease after the lessee has exercised a purchase option specified in the lease. A contract ceases to be a lease when such an option is exercised and becomes a purchase (by the lessee) or sale (by the lessor).

The application guidance in the Exposure Draft further states that:

• That determination is made at inception and is not subsequently reassessed.
• An entity should consider all relevant facts and circumstances when determining whether control of the underlying asset is transferred at the end of the contract.
• A contract normally transfers control of an underlying asset when the contract automatically transfers title to the underlying asset to the transferee at the end of the contract term.
• A contract normally transfers control of an underlying asset when the contract includes a bargain purchase option. A bargain purchase option is an option to purchase the asset at a price that is expected to be significantly lower than the fair value of the asset at the date that the option becomes exercisable. If the exercise price is significantly lower than fair value, it would be reasonably certain at the inception of the lease that such options will be exercised. An entity that has a bargain purchase option is in an economically similar position to an entity that will automatically obtain title to the underlying asset at the end of the lease term. By exercising its bargain purchase option, the transferee would be able to direct the use of, and receive the benefits from, the whole of the underlying asset for the whole of its life.

Using the above guidelines, and considering feedback received from outreach activities and related internal discussions amongst the staff, the staff noted a view that if the Boards appropriately define a lease in the leases project, then the proposed guidance on this issue would be unnecessary. In such a definition, it would be necessary to provide a clear principle for the definition of a lease, and clear guidance on when to apply the revenue recognition requirements in the revenue recognition project for lessors.

The staff also noted that in the Exposure Draft, the Boards excluded from the scope of the leases standard transactions that include either automatic title transfer or a bargain purchase option. Likewise, the staff noted that the Boards introduced the Exposure Draft guidance to determine which leases are in-substance purchases or sales when the Boards were considering only a performance obligation approach to lessor accounting. Under the performance obligation model, an underlying asset is not derecognised and income is recognised over time, leading to an accounting approach that could be different from sale accounting. However, subsequently, the Boards discussed and proposed two accounting approaches for lessors in the Exposure Draft. To the extent that a derecognition model is retained, the boundary between leases and purchases or sales becomes less relevant. This is because, under the derecognition approach to lessor accounting, the accounting would be similar to the accounting for a sale of an asset (e.g. an underlying asset is derecognised and income may be recognised at the commencement of the lease).

At the 17 February 2011 meeting, the Boards discussed two types of leases for both lessees and lessors and a principle for identifying two types of leases. One indicator the Boards are considering for distinguishing between the two types of leases is potential ownership transfer, the same criteria to distinguish a lease from a purchase or sale in the Exposure Draft. Therefore, if the Boards ultimately decide to introduce two approaches to lessee accounting, the accounting by a lessee for finance type leases would be similar to purchase accounting. Therefore, the staff think that there is no fundamental difference in the accounting for an arrangement accounted for as a purchase or as a finance lease for a lessee.

Consequently, the staff think that criteria to distinguish between a lease and a purchase or sale are not necessary, as a result of the following:

• the final Leases standard would appropriately define a lease;
• the final Revenue Recognition standard would appropriately provide guidance on when to recognise revenue;
• the accounting for a purchase of an underlying asset would be similar to the accounting by a lessee under the accounting for a finance lease (if there are two types of leases for lessees) when applying the final Leases standard; and
• the accounting for a sale of an underlying asset would be similar to the accounting by a lessor under the accounting for a finance lease (if there are two types of leases for lessors) when applying the final Leases standard.

In consideration of the staff's recommendation, the Boards collectively recognised the importance of defining a lease from that of a instalment purchase (sale), as multiple members of both Boards expressed concern with:

• The current definition of leases in the context of accounting for term options, purchase options or other variables in contracts, whereby it is not considered particularly clear whether such variables would ultimate fall within the scope of leases or revenue recognition. Further, if included in the scope of the definition, multiple members of the Boards questioned the significance assessment which should be used in evaluating term options, whereby only significant economic incentives should be included in the relevant assessment. Likewise, members of the Boards questioned whether continual reassessment of significant economic incentives would be required, and to this extent, whether general market movements would result in changed conclusions on whether an incentive is economically significant on a quarterly basis.
• Whether the definition of a lease should be considered as a point-in-time assessment, as opposed to a forward-looking assessment, whereby leasehold improvements, for example, performed during the lease term would require a reassessment of the accounting for a lease. The staff noted an intention that only material changes would result in a reassessment.
• While the revenue recognition model currently present provides for a residual definition, whereby items external to the lease accounting would be expected to fall into the scope of the revenue recognition guidance, concern was expressed around 'failed sales' or other environments which may result in an underlying transaction being accounted for external to both the lease and revenue recognition models.

Noting the above, there was a general concern that the current lease definition did not appropriately consider the right to use aspect of a contract, in conjunction with the control of the underlying component to a contract.

While considering the above, and in conjunction with further discussions regarding the accounting for purchase options, below, the Boards tentatively confirmed the staff's recommendation that the guidance to distinguish between a lease and a purchase should not be carried forward into the final standard. A lease contract should be accounted for in accordance with the leases standard and contracts that represent a purchase or sale of an underlying asset should be accounted for in accordance with other applicable standards (e.g. revenue recognition by lessors, property, plant and equipment by lessees). The Boards recommended that further consideration be placed on the definition of a lease, however, while outreach activities should include the related definition of a lease. Further, outreach should be conducted around evaluation of the lease assessment as a point-in-time assessment, as opposed to a forward-looking assessment.

The purpose of this discussion, in the context of the above discussion regarding distinguishing between a lease and a purchase or sale, was to deliberate on the accounting by lessees and lessors for purchase options included in a lease contract. In this context, the deliberation considered including both options that the lessee has a significant economic incentive to exercise (which would usually include bargain purchase options) and options that the lessee does not have a significant economic incentive to exercise (which would usually include non-bargain purchase options).

Ultimately, the staff expressed mixed views as to whether a purchase option should be accounted for as an ultimate renewal option, or whether a purchase option should only be accounted for upon exercise, with the following distinct views present:

• A majority of staff members think that purchase options are the ultimate renewal option. These staff members note the economic similarities between an option to purchase an underlying asset and an option to extend the lease of an underlying asset. The exercise price of the option should be included in the lessee's liability to make lease payments and the lessor's right to receive lease payments when there is a significant economic incentive to exercise a purchase option ("Approach A" for application purposes herein).
• Other staff members think that purchase options should be accounted for as a termination of the lease contract and the purchase of the underlying asset. The result of this view is that all purchase options would be accounted for only upon exercise, consistent with the proposals in the Exposure Draft. Therefore, lease payments would exclude the exercise price of all purchase options. These staff members highlighted that an option to purchase the underlying asset is a termination of the lease agreement, and results in the purchase/sale of the underlying asset when the option is exercised ("Approach B" for application purposes herein).

In discussing the above approaches, support for Approach A was seen in the following context:

• Provides for the accounting of a purchase option consistent with the accounting for options to extend a lease.
• Acknowledges that the pricing of a purchase option is interrelated with the pricing of other terms in the lease contract; a lease with a bargain purchase option would require larger periodic payments during the lease term. In other words, the pricing of the lease is such that a portion of the periodic lease payments (excluding the exercise price of a purchase option) relate to prepaying for the ownership of the asset.
• The pattern of the lessee's expense would reflect the lessee's expectation that the asset will be purchased and used through the end of its economic life.
• It is consistent with the Boards' decision on lease term option penalties.
• It is consistent with the Boards' tentative decision that lease payments should include amounts expected to be payable under residual value guarantees.

Discussion amongst members of the Boards highlighted the following primary disadvantages to such application, however, as follows:

• Approach A includes an amount that is not part of the ongoing lease payments in the lessee's right-of-use asset and liability for lease payments.
• The purchase price, which is included in the measurement of the lessee's right-of-use asset, would be amortised over the life of the underlying asset. If the purchase option is eventually not exercised, the amortisation of the asset may not reflect the economics of the usage of the right-of-use asset.

Multiple members of the Boards also discussed examples where the lessor applies the performance obligation approach to a lease with a bargain purchase option (for instance, when the option is not a bargain at inception but becomes a bargain subsequently). This could potentially lead to the following disadvantages of Approach A for lessors applying a performance obligation approach:

• It may be inappropriate for a lessor to determine whether the lessee is likely to exercise an option to purchase the underlying asset until the purchase option is exercised. That is, the lessor may not have information to determine that a lessee will exercise a purchase option.
• It is unclear if a lessor applying the performance obligation approach would recognise revenue over the economic life of the asset or the term over which lease payments are made.
• The underlying asset (and its residual value asset) would not be recognised by the lessor if, at the beginning of the lease, it was determined that it there is a significant economic incentive for a purchase option to be exercised. This could lead to the possibility of changes in presentation between periods as dependent upon the definition of significant economic incentive and related market influences on a period-by-period basis.

In discussing the above approaches, support for Approach B was seen in the following context:

• It does not include the exercise price of a purchase option that can be avoided. Therefore, Approach B avoids grossing up the lessee's right-of-use asset and liability for the exercise price of a purchase option that may, or may not, be exercised.
• It avoids the need to "unwind" the accounting if it is later determined that the purchase option is not exercised.

Discussion amongst members of the Boards highlighted the following primary disadvantages to Approach B:

• It excludes the exercise price of a purchase option that the lessee may intend to exercise in the lessee's assets and liabilities. Therefore, Approach B potentially understates the expected cash flows of the lease.
• Under Approach B, a lessee's amortisation expense is front-loaded because it does not reflect that the asset will be purchased and used for the remainder of its economic life.

In deliberation of the above Approaches, the majority of the Boards tentatively confirmed application of Approach A, which applies a consistent modelling to that of renewal options. In reaching such a tentative conclusion, the Boards recommended outreach activities by the staff in the following areas:

• The definition of a lease, as distinguished from the definition of an instalment sale;
• Whether the reassessment for a bargain purchase option should be the same as the reassessment for renewal options, focussed most notably on the linkage of value of the underlying asset.
  • In this assessment, consideration is placed on whether, in a bargain purchase option, we have a significant incentive to extend and the impact of developments in the underlying asset value subsequent to entering into the lease.
  • We note that the IASB preliminarily decided that no expected difference in the reassessment indicators would be expected between a bargain purchase option / significant economic incentive option and a renewal option, while the FASB preliminarily decided that a potential difference may be present between a bargain purchase option / significant economic incentive option and a renewal option based on the determination as to whether the option should be assessed on day 1 of the lease or reassessed throughout the lease term;
• Accounting for revisions to the existence of a significant economic incentive to exercise the purchase option, which could lead to a new derecognition/recognition event (for example, what are the dangers if a reassessment were to result in a change from a finance to an other-than-finance lease).
   

The Boards continued their discussions from the previous day on the leases project. Today their discussions focused on short-term leases.

Accounting for short-term leases

The exposure draft proposed different accounting by a lessee and a lessor for short-term leases. Specifically, a lessee could elect to measure the liability at the undiscounted amount of the lease payments and measure the right of use asset as the undiscounted amount of lease payments plus initial direct costs while a lessor could elect on a lease-by-lease basis not to recognise assets or liabilities from the lease arrangement and instead retain the leased asset on the balance sheet while recognising lease payments over the lease term.

Comment letter respondents were generally supportive of providing simplified accounting for short-term leases; however, a majority of respondents disagreed with the proposals for lessees primarily because they felt the cost relief would not be significant enough.

The Boards considered three alternatives in considering the feedback received:

• Alternative 1: Retain the exposure draft proposals for simplified accounting for short-term leases.
• Alternative 2: Retain the exposure draft proposals for lessors but permit lessees to account for short-term leases in a manner similar to current operating leases (so that the accounting would be symmetrical between lessors and lessees).
• Alternative 3: Eliminate the exception for short-term leases.

An IASB member began the discussions stating he supported alternative 2 so long as sufficient disclosures were provided (such as profit or loss information on short-term lease arrangements, the policy utilised and disclose payments due over the next twelve months). Several other IASB members supported this view as well.

However, other IASB members supported alternative 3, one because he believed introducing a third model for leases would result in additional complexity that would outweigh the benefit provided by the practical expedient while another felt that requiring the disclosures mentioned above would negate any benefit provided by allowing alternative 2. A third IASB member felt that structuring opportunities could also be created under alternative 2 in order to avoid balance sheet presentation, although other Board members mentioned that separate transactions would have to be entered into each period, each of which would be subject to the market risks at that point in time, which they felt would minimise the risk of structuring.

The FASB members were similarly split in views between alternatives 2 and 3. Ultimately, the Boards tentatively decided that the proposed guidance in the ED for the accounting for short-term leases by lessors would be retained and the requirements for lessees would be amended such that short-term leases would not be recognised on a lessee's statement of financial position (i.e., consistent with the current requirements for operating leases). As a result, both lessees and lessors would present the expense or income from short-term leases as lease income or lease expense which is consistent with current operating lease treatment.

Definition of short-term lease

The exposure draft defined a 'short-term lease' as "a lease that, at the date of commencement of the lease, has a maximum possible lease term, including options to renew or extend, of 12 months or less." However, based on the definition of 'lease term' from the Boards' subsequent deliberations, the staff believed the definition of 'short-term lease' should be revisited.

The staff recommended a definition of 'short-term lease' as "a lease that, at the date of commencement of the lease, has a maximum possible term, including any options to renew, of approximately 12 months or less." One IASB member expressed concern with the inclusion of 'approximately' in the definition and questioned the staff on its inclusion. The staff responded that this was added in order to be consistent with some of the terminology in the insurance project but that the staff did not have a strong view on it being part of the definition.

The Boards tentatively decided that the definition of short-term lease should be "a lease that, at the date of commencement of the lease, has a maximum possible lease term, including any options to renew or extend, of 12 months or less". Therefore, in determining whether a lease that includes a renewal option is short-term, a lessee and lessor would not evaluate whether there is a significant economic incentive for the lessee to exercise the option because it is assumed the renewal option would be exercised.

Application of short-term lease guidance

The Boards also discussed how an entity would apply the practical expedient provided for short-term leases (alternative 2 above). The Boards considered three approaches: (1) applying on a lease-by-lease basis, (2) permitting application enterprise wide through an accounting policy election, or (3) requiring application of the practical expedient for all short-term leases.

An IASB and FASB member each proposed a combination of the first two alternatives where an entity would be permitted to apply the practical expedient as an accounting policy election for specific asset classes. This approach was raised in part because of concerns that an entity may have smaller short-term leases for certain asset classes (e.g., photocopier leases) but may have another short-term lease that is more significant and does not wish to apply the practical expedient (e.g., equipment critical to production efforts). This combination received support from both Boards, however, the Board members (both IASB and FASB) representing financial statement users tended to prefer consistency above all else and supported requiring application of the practical expedient to all short-term leases.

Ultimately, the Boards tentatively decided that an entity would apply the short-term lease guidance as an accounting policy election by asset class.

Pattern of Profit or Loss Recognition

Based on the decision to provide the practical expedient so that short-term leases would be accounted for similar to current operating leases, the staff suggested the Boards clarify the pattern over which profit or loss would be recognised. The Boards tentatively decided that lease payments on short-term leases would be recognised on a straight-line basis over the lease term unless another systematic and rational basis is more representative of the time pattern in which use is derived from the underlying asset.

Monday, 21 March 2011

Initial direct costs

The purpose of this discussion was to discuss:

The staff recommended that initial direct costs should be defined consistent with the ED except for the removal of recoverable from the definition. The Staff noted that they believe the notion of recoverable is implicit in the definition and is therefore redundant. The proposed definition of initial direct costs is as follows:

Costs that are directly attributable to negotiating and arranging a lease that would not have been incurred had the lease transaction not been made.

The staff also recommended to retain the guidance in the Exposure Draft that lessees and lessors should capitalise initial direct costs by adding them to the carrying amount of the right-of-use asset and the right to receive lease payments, respectively.

The staff identified the following advantages to affirm the guidance in the Exposure Draft:

The Boards agreed almost unanimously in favour of the staff's recommendation.

Inception vs. commencement

The purpose of this discussion was to discuss:

The staff recommended the following:

The Boards agreed with the staff's recommendation to initially measure the lease assets and liabilities at the date of lease commencement. This decision eliminates the concerns that potential gains and losses could develop between inception and commencement date and that any changes that occur between inception and commencement would be taken into account when initially measuring the assets and liabilities. A few Board members expressed concern over differences in impairment tests pre and post commencement. The Staff noted they intend to bring an impairment paper at a later date.

The Boards disagreed with the staff recommendation on when to set the incremental borrowing rate if that is being used. The tentative decision was to determine the incremental borrowing rate at commencement. Board members noted that determining the incremental borrowing rate at inception would add complexity and could cause entities to use hindsight in determining the rate.

The Boards agreed with the staff recommendation that costs incurred prior to commencement should be accounted for outside the scope of the leases standard. The staff will provide additional guidance on what other guidance will apply.

The boards agreed with the staff recommendation that lease payments made prior to lease commencement will be recognised as a prepayment and at the date the commencement the prepayments will be added to the right-of-use asset.

The staff recommended the following treatment for lease incentives:

The Boards agreed with the recommendation for (a) and (c), however they did not agree with (b). Many Board members expressed concern that a lessee could change their expense recognition by changing what they determine is being reimbursed. Additionally it may be difficult to determine what costs are being reimbursed. Therefore the boards tentatively decided to eliminate (b) and agreed that all payments received from the lessor would be recognised as a reduction of the right of use asset.

Determination of the discount rate in a lease

The purpose of this discussion was to determine how lessees and lessors should determine the discount rate used to initially measure lease payments at present value.

The staff made the following recommendations:

1. The staff recommends that a lessee establish its discount rate using either:

   a)	Its incremental borrowing rate; or
   b)	The rate that the lessor charges the lessee (the rate implicit in the lease), if readily determinable.

   Additionally, the staff recommended that the lessee guidance be clarified that if both rates are available, the lessee is required to use the rate the lessor charges the lessee.

2. The staff recommended that the lessor should establish its discount rate as defined in the ED. That is, a lessor should use the rate that the lessor charges the lessee, which could be the lessee's incremental borrowing rate, the rate implicit in the lease, or, for property leases, the yield on the property.

   Additionally, the staff recommends that the definition of the rate that the lessor charges the lessee be clarified to state that when more than one indicator of the rate the lessor charges in the lease is available, the rate implicit in the lease should be used.

The Boards discussed the recommendations and agreed with the staff's recommendations. Board members discussed if the rates would be different for the two categories of leases, finance or an other-than-finance. They noted it may be more likely in an other-than-financing lease to not know the implicit rate. A board member also clarified that he did not want a lessee to have to go to extreme measures to try to determine the implicit rate, and the staff clarified that is their intention and will try to clarify in drafting.

Tuesday, 22 March 2011

Contracts that contain a lease

The purpose of this discussion was to discuss how to separate a lease, service, and other components within contracts that contain a lease.

The staff recommended that entities should be required to separate lease components from all non-lease components. This approach would account for only the right-of-use of the underlying asset as a lease with all other components (services, executory costs, etc.) accounted for in accordance with the applicable guidance.

The boards agreed with this recommendation.

The boards also discussed how to allocate payments between the lease components and the non-lease components of a contract that contains a lease for lessors.

The staff noted that the comment letters received indicated the importance of the FASB and the IASB to reach the same conclusion for the final standard.

The staff recommended that separate guidance for allocation of payments between the lease and non-lease components not be developed. Rather, the staff recommended that the lease standard refer to the guidance within the revenue recognition standard for allocation between separate performance obligations. This is consistent with what was included in the ED.

The boards agreed with this recommendation.

The boards discussed how lessees should allocate payments between the lease components and the non-lease components of a contract.

The staff recommended that lessees should be required to allocate between lease components and non-lease components based on their relative standalone purchase prices.

The boards agreed with this recommendation.

The staff also recommended that if the purchase price of one component in a contract that contains a lease is observable, a lessee can use the residual method to allocate the price to the component for which there are no observable purchase prices.

The boards agreed with this recommendation.

The staff also recommended that lessees should treat the entire contract as a lease when there are no observable prices for any of the components.

The boards agreed with this recommendation.

Sale and leaseback transactions

The purpose of the discussion was to determine when a sale and leaseback transaction should occur.

The staff recommended that when the sale has occurred, the arrangement would be accounted for as a sale and a leaseback. If a sale has not occurred, then the arrangement would be accounted for as a financing.

The majority of the staff also recommended that an entity should apply only the control criteria in revenue recognition to determine whether a sale has occurred in a sale and leaseback transaction.

The boards agreed with the recommendations.

This decision would remove paragraph B32 from the ED which proposed conditions that normally preclude the seller/ lessee from transferring more than a trivial amount of the risks and benefits associated with the transferred asset at the end of a contract that therefore do not result in a purchase or sale.

The boards also discussed:

The staff recommended that in a sale and leaseback transaction when consideration is at fair value, gains or losses arising from the transaction should not be deferred. When consideration is not at fair value, the assets, liabilities, gains and losses should be adjusted to reflect current market rentals.

The boards agreed with the recommendations.

The boards also discussed whether to apply the partial asset or whole asset approach in a sale and leaseback transaction.

The staff recommended that the seller/ lessee should apply the whole asset approach which is consistent with what was in the ED.

The boards agreed with the recommendations.

The staff recommended that the boards do not prescribe a particular type of lessee accounting model for entities that are participating in a sale leaseback transaction.

The boards agreed with the recommendations.

Discussion at the Special 6 April 2011 IASB meeting

The IASB and FASB staff provided the Board with a one-day education session on the leases project in relation to topics which will be discussed in greater detail during the joint IASB and FASB meetings the week commencing 11 April 2011.

No deliberations were performed as part of this education session, and likewise, no tentative or definitive decisions were reached.

During this meeting, the Boards discussed:

• the definition of a lease
• potential types of leases
• accounting for variable lease payments.

Definition of a lease

Following discussion at a joint meeting of the Boards on 17 February 2011 in which the definition of a lease and the application guidance in the Leases Exposure Draft (ED) relating to that definition were discussed, the staff presented feedback received from targeted outreach in relation to previous decisions of the Boards. Specific discussion points of this targeted outreach considered (1) whether the definition of a lease should refer to a specific or specified asset, or to an asset of a particular specification, (2) whether both a physically distinct portion (e.g., a floor of a building) and a non-physically distinct portion (e.g., capacity portion of a pipeline) of a larger asset can be the subject of a lease and (3) when does a customer have the right to control the use of a specified asset, among other areas.

Specified asset:

Receiving feedback from outreach activities that participants generally did not support the widening of the definition of 'specified asset' (beyond that of a uniquely identified asset), several Board members raised concerns that application of the term, 'specified asset,' as used in the ED to defined leases, to one particular asset, without consideration of substitutability to an asset of consistent specification, would be too specific and would ignore the broad principle of including assets of a particular specification in the definition of a lease given the financing nature of underlying arrangements. Likewise, several Board members expressed concern that limiting the definition to one particular asset would lead to prospective contracts providing verbiage on substitutability in order to receive the preferred accounting consequence, and therefore, it was noted that the concept of control should be considered in future meeting agenda discussions, as discussed in further detail below.

Portions of a larger asset:

Regarding contracts which represent a portion of a larger asset, the staff provided a recommendation that a physically-distinct portion of a larger asset can be a specified asset, but a capacity portion of a larger asset that is not physically-distinct cannot. Similar to the specified asset discussion, above, several Board members noted the significance of the control (e.g., access control) concept in the determination of whether a portion of a larger asset is representative of a lease, which will be discussed in a future meeting.

Right to control:

The staff noted that the majority of staff support an approach that aligns more closely the application of control as applied to leases in the ED, to how it is applied in the forthcoming revenue recognition standard and the consolidation standards, for purposes of consistency in application, while other staff support retaining the proposals regarding the right to control the use of an asset in the ED, with minimal changes to address practice concerns identified in the comment letters and through outreach.

Several Board members commented that the definition of a lease, as applied in the finalisation of the standard, should more directly describe the specific concept of control, and it was noted that this concept would be discussed in further detail in joint meetings of the Boards to be held the week commencing 11 April 2011. Likewise, Board members will deliberate at such time both views receiving support from the staff, as outlined above.

Types of leases

In a February 2011 joint meeting of the Boards, the Boards introduced two different types of leases, which were referred to as finance and other-than-finance leases (although the labelling of such lease types will be considered further in a future meeting). Targeted outreach on this distinction revealed that most respondents were supportive of having two types of leases, but noted certain disadvantages of a two-type model, including added complexity and creation of bright-lines that may allow structuring between types of leases.

Considering this feedback, the staff presented a draft definition to be used in distinguishing finance and other-than-finance leases, as well as supporting indicators in distinguishing between the two; noting, generally, that the assessment should be based on the business purpose of the contract and a review of indicators including the lessor business model, residual asset, potential ownership transfer, length of lease term, underlying asset, variable rent, rent characteristics (e.g., benchmarking of rent payments) and embedded or integral services.

One Board member expressed concern that the assessment for the lessee adds too much complexity to an environment in which the underlying purpose of leasing is generally financing, and therefore, proposed that only one type of lease be recognised for lessee modelling. This same Board member supported two types of leases in lessor accounting given the need to account for different income statement recognition patterns. This concept will be discussed further in a future meeting, in conjunction with assessment as to how the underlying leases would be accounted for both in the income statement and the balance sheet.

Accounting for variable lease payments

The Boards were presented with staff recommendations and outreach feedback regarding the identification of lease payments that are in-substance fixed lease payments but are structured as variable payments in form (e.g., disguised minimum lease payments), following the Boards' tentative decision in February 2011 to require that the lessee's liability and the lessor's receivable include an estimate of disguised minimum lease payments.

The majority of targeted feedback supported the Boards' tentative decision, and as a consequence, the staff presented potential indicators for determining when the lease arrangement contains disguised minimum lease payments.

Several Board member expressed concern that indicators presented by the staff did not address uncertainties; for example, if a lease payment is contingent on a future event (e.g., underlying sales), how would the minimum lease payment be determined for purposes of assessment as to whether the lease is indicative of a disguised minimum lease payment. Other Board members expressed concern of recognising contingent balances on the balance sheet, and noted this as an area to discuss more fully in next week's joint meeting of the Boards.

Considering, specifically, the accounting for variable lease payments, the Board was presented with outreach feedback surrounding the Boards' February 2011 tentative decision that a high threshold ("reasonably assured") would be applied to variable lease payments, whereby variable lease payments should be included in the lessee's liability to make lease payments and the lessor's right to receive lease payments only if they are "reasonably assured." It was noted that the majority of feedback did not support inclusion of such payments in the lease liability or asset, as applicable, even if considered to be reasonably assured. Considering feedback received, the majority of the staff did not recommend retention of the Boards' tentative decision from February 2011. While this topic will be discussed in a future meeting, one Board member questioned whether the Boards were adding unnecessary structure in the accounting for variable lease payments; highlighting that a focus should be directed on disguised minimum lease payments only.

All of the above topics will be subject to deliberation during the joint meeting of the Boards scheduled the week commencing 11 April 2011.

Discussion at the April 2011 IASB meeting

TUESDAY, 12 APRIL 2011

As part of its continual deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards deliberated on the following topics:

Defining a lease

Following discussion at a joint meeting of the Boards on 17 February 2011 in which the definition of a lease and the application guidance in the Leases ED relating to that definition were discussed, the staff presented feedback received from targeted outreach in relation to previous decisions of the Boards. Specific discussion points of this targeted outreach considered (1) whether the definition of a lease should refer to a specific or specified asset, or to an asset of a particular specification, (2) whether both a physically distinct portion (e.g., a floor of a building) and a non-physically distinct portion (e.g., capacity portion of a pipeline) of a larger asset can be the subject of a lease and (3) when does a customer have the right to control the use of a specified asset, among other areas.

Specified asset

Feedback from outreach activities noted that participants generally did not support the widening of the definition of 'specified asset' (beyond that of a uniquely identified asset), with many participants agreeing that the right to substitute an asset is an important aspect of assessment. If a supplier has the substantive right to substitute an asset, a customer, in the view of many respondents, would not control the use of that asset.

Several Board members raised concerns that application of the term, 'specified asset,' as used in the ED to defined leases, to one particular asset, without consideration of substitutability to an asset of consistent specification, would be too specific and would ignore the broad principle of including assets of a particular specification in the definition of a lease given the financing nature of underlying arrangements. Other Board members noted that if a customer recognised a right to use an asset, as discussed in the Leases ED, the asset should be identifiable, and similarly, if a supplier derecognises a right to use an asset, the asset being derecognised needs to be identifiable. As a result, it was considered that the concept of substitutability, as applied in any final standard, should consider the existence of substitutability rights of a supplier, whereby a supplier's ability to substitute assets under an arrangement as a result of practicality and economic feasibility, without requiring the customer's consent, would not result in lease accounting treatment according to the specified asset criterion alone. As a result, the Boards tentatively decided that a 'specified asset,' as defined in the Leases ED, should be defined as an identifiable asset as opposed to an asset of a certain specification. A "specified asset" would be an identifiable asset that is explicitly or implicitly identified in the contract. An asset would be implicitly identified if it would not be practical and economically feasible for the owner to substitute alternative assets in place of the underlying asset during the lease term.

Portions of a larger asset

Regarding contracts which represent a portion of a larger asset, the staff provided a recommendation that a physically-distinct portion of a larger asset (e.g., a floor of a building) can be a specified asset, but a capacity portion of a larger asset that is not physically-distinct (e.g., access to a portion of the capacity of a pipeline) cannot. Several Board members noted the significance of the control concept (e.g., access control) in the determination of whether a portion of a larger asset is representative of a lease, but the Boards tentatively concurred with the staff's recommendation.

Right to control

The Boards discussed two alternative views:

• whether the control concept applied within the definition of a lease should be considered with the forthcoming revenue recognition standard, whereby a customer has the right to control the use of a specified asset if it has the ability to direct the use, and receive benefits from use, of that asset (Approach A)
• whether the control concept proposed in the Leases ED should be retained in which the right to control the use of a specified asset is conveyed if the customer has the ability to direct the use, receive the benefits from use and pays for the right to use the asset, rather than paying a per unit price for the output (Approach B).

The majority of the members of the Boards supported Approach A as a result of considerations to (1) consistency in standard setting, (2) concern that Approach B creates structural opportunities in pricing and (3) the significance of the control principles applied in the revenue recognition proposal as would be applied consistently in the Leases ED. Respective members of the Board discussed the necessity of appropriate draft wording in any final standard issuance to consider all available evidence in the determination as to whether a customer has the ability to direct the use and receive the benefits from use of a specified asset, including control of physical access, involvement in the design of the specified asset and rights to obtain substantially all of the economic benefits.

In circumstances in which the supplier directs the use of the asset used to perform services requested by the customer (similar to the 'separate performance obligations' concept in the revenue recognition project), under the proposal in Approach A, the customers and suppliers would be required to assess whether the use of the asset is an inseparable part of the services requested by the customer (if inseparable, the entire contract would be accounted for as a service contract because the customer has not obtained the right to control the use of the asset) or a separable part of the services provided. Those supporting the concept of separating components in the definition of a lease cited that if an asset is separable from other services provided in a contract, the contract contains at least two separate components; the right to use an asset at the date of commencement of the contract and the other services over the term of the contract, and consequently, recognition principles should be applied accordingly.

Certain members of the Boards expressed concerns regarding the separable decisions outlined above, noting concerns with the identification of appropriate indicators to determine separable components and the potential impact of a large number of service contracts arising out of incidental services which are not determined to be separable. Examples raised by members of the Boards included a copier which includes a service contract, in which separation of elements is not able to be established, or the accounting for time charters. The staff were asked to re-consider draft verbiage provided in any final standard around the "separability" concept, including distinction of unique application environments such as common-area maintenance in the real estate sector.

Ultimately, the majority of the Boards tentatively decided that the description of 'control,' as defined in the Leases ED, should be revised to be consistent with the revenue recognition project while including guidance on separable assets, whereby a contract would convey the right to control the use of the underlying asset if the customer has the ability to direct the use, and receive the benefit from use, of a specified asset throughout the lease term.

Accounting for variable lease payments

The Boards were presented with staff recommendations and outreach feedback regarding the identification of lease payments that are in-substance fixed lease payments but are structured as variable payments in form (e.g., disguised minimum lease payments), following the Boards' tentative decision in February 2011 to require that the lessee's liability and the lessor's receivable include an estimate of disguised minimum lease payments.

Board members discussed:

• Consistency in recognition of estimates amongst this proposed standard and that of current projects surrounding insurance, impairment and revenue recognition
• Concerns regarding determination of a minimum lease amount in contracts which are completely comprised of variable lease payments, where a lack of substantive support exists for estimating prospective payments
• Concerns regarding the recognition of underlying lease assets or liabilities which extend beyond the foreseeable future of a company's projections lending to significant variability in the balance sheet each year
• Consideration of a recognition model which reflects only unavoidable amounts.

As a result of this assessment, the majority of the Boards tentatively decided that the asset and liability recognised under a lease contract should exclude variable lease payments except for those that are considered disguised minimum lease payments. Disguised minimum lease payments are those payments in a lease contract that are structured such that the variable payments are in-substance fixed. Many Board members acknowledged that the exclusion of variable lease payments (except disguised minimum lease payments) is a practical expedient because contingent rentals represent an unconditional obligation at lease commencement. These Board members noted the practical concerns with recognition of a 'reasonably assured' estimate of potential variable cash flows. This tentative decision reverses the Boards' previous tentative decision that included a high threshold for all variable payments. The Boards asked the staff to consider any practical guidance available from accounting firms in the identification of disguised fixed minimum lease payments for purposes of practical guidance to provide in any final standard issuance.

WEDNESDAY, 13 APRIL 2011

As part of its continual deliberations surrounding the Leases ED, the Boards deliberated on the following topics:

• Types and classification of leases
• Initial and subsequent measurement and presentation of lessee accounting
• Initial and subsequent measurement and presentation of lessor accounting
   

Types and classification of leases

In a February 2011 joint meeting of the Boards, the Boards introduced two different types of leases (absent short-term leases), which were referred to as finance and other-than-finance leases (although the naming convention of such lease types will be considered further in a future meeting). Targeted outreach on this distinction revealed that most respondents were supportive of having two types of leases, but noted certain disadvantages of a two-type model, including added complexity.

Considering this feedback, the staff presented a draft definition to be used in distinguishing finance and other-than-finance leases, as well as supporting indicators in distinguishing between the two; noting, generally, that the assessment should be based on the business purpose of the contract and a review of indicators including the lessor business model, residual asset, potential ownership transfer, length of lease term, underlying asset, variable rent, rent characteristics (e.g., benchmarking of rent payments) and embedded or integral services.

Several Board members expressed concern that the assessment of two unique lease types added too much complexity to an environment in which the underlying purpose of leasing, from a lessee perspective, is generally financing, and therefore, proposed that only one type of lease be recognised for lessee modelling. Likewise, Board members were concerned with creating new bright-lines for structuring purposes and developing appropriate conceptual arguments to support different classifications of leases.

Several Board members, however, noted unique classifications of leases would provide results which are more consistent with current business models and would allow for differentiating the profit and loss recognition pattern to the underlying economics of the lease transactions and relevant levels of asset risk and reward; both under a lessor and lessee accounting model.

As a result, the Boards tentatively decided that two types (classifications) of lessee and lessor accounting models exist; a finance and other-than-finance lease (although naming convention will be re-evaluated in a future meeting).

In distinguishing whether a lease should be accounted for as a finance lease or an other-than-finance lease, the Boards considered classification criteria, including a determination based on the business purpose for the lease transaction and the transfer of substantially all of the risks and rewards of ownership, but several Board members expressed concern as to the operationality of such a determination. The majority of the Boards discussed a preference to base distinction in classification according to the transfer of substantially all of the risks and rewards of ownership, and noted a preference to continue application of the IFRS guidance as outlined in IAS 17, paragraphs 7 - 12. One Board member expressed concern that any final standard, in application of IAS 17's classification criteria, should also include outreach assessment around items external to current IAS 17 indicators, including bundled services and variable rent.

The Boards tentatively decided that the determination of whether a lease is a finance or other-than-finance lease should be based on the existing indicators in paragraphs 7-12 of IAS 17.

Lessee accounting

The Boards analysed approaches for the initial and subsequent measurement and presentation of both other-than-finance and finance leases in the financial statements of a lessee.

Other-than-finance leases

The Boards deliberated on multiple approaches regarding how a lessee should initially and subsequently measure and present an other-than-finance lease. A minority of Board members supported a right of use asset that would be amortised on a straight-line basis through other comprehensive income (OCI). These members highlighted that application of an OCI presentation would serve to specifically highlight the nature of such modelling application to users of the financial statements, while providing comparability for all lease transactions within the income statement and statement of financial position, but the majority of the Boards expressed concern with presentation within OCI given that the purpose of OCI has not been clearly defined and is often criticised as being a placeholder to reflect items that would otherwise cause unwanted volatility in earnings.

Another minority of Board members preferred application of a right of use asset and liability to make lease payments that were linked at inception of the lease and amortised independently of the measurement of the liability for lease payments, believing it better reflected the consumption of benefits over the lease term and the time value of money. A majority of the Boards rejected this approach based on the application of an effective annuity depreciation over the term of the lease which was inconsistent with current guidance.

After exploring these possibilities, the Boards considered approaches which reflect the utilisation of benefits by allocating costs of an asset over its useful life in a way that reflects both the consumption of economic benefits and the time value of money, while also reflecting lease payments in a manner consistent with underlying IAS 17 guidance. One member suggested that for other-other-finance leases, both the liability to make lease payments and the right-of-use asset should be initially measured at the present value of lease payments. The liability to make lease payments should be measured using the effective interest method and amortisation of the right-of-use asset should be based on the difference between the straight-line amount and the interest expense amount. The Boards tentatively decided to apply the above model.

The Boards also tentatively decided that recorded expenses under the above model should be presented in a single-line item (as opposed to reflection of amortisation and interest expense as separate line items) by lessees as operating (rent) expense within profit or loss for all other-than-finance leases. This conclusion was reached given the principles underlying an other-than-finance lease.

Finance leases

The staff recommended that the Boards confirm the proposals in the Leases ED for the initial and subsequent measurement of assets and liabilities arising for a lessee in a finance lease, as summarised above.

The staff presented, given feedback received in outreach activities, an effective interest and a fair value method for subsequent measurement of the liability to make lease payments under finance leases. The Boards, considering that an effective interest method is consistent with the principle of a finance lease and conceptually consistent with other borrowing or financing activities that a lessee would enter into, noted that interest expense would represent useful information about the financing component of a finance lease. Board members noted that a fair value approach would be costly and inconsistent with the initial measurement of the liability to make lease payments and the subsequent measurement of many other non-derivative financial liabilities. Thus, the Boards tentatively agreed that the final standard require the lessees in a finance lease to measure the liability to make lease payments at the present value of lease payments, while the subsequent measurement of a liability to make lease payments should be measured using the effective interest method.

The Boards also considered the measurement of the right-of-use asset on a systematic basis in accordance with IAS 38 Intangible Assets, as compared to a straight-line expense for the lessee. Board members noted that the former was consistent with the amortisation of a lessee's owned assets and other non-financial assets and is also consistent with the initial measurement of the right-of-use asset at cost. Thus, the Boards tentatively decided that the right-of-use asset should be initially measured at the present value of lease payments, with subsequent measurement using a systematic and rational amortisation/depreciation method.

Lessor accounting

The Boards discussed approaches for the initial and subsequent measurement and presentation of both other-than-finance and finance leases in the financial statements of a lessor.

Other-than-finance leases

Board members discussed presentational requirements in an other-than-finance lease. While the Boards were unable to reach a tentative decision as to whether the lease receivable and lease contract liability should be presented on a net basis or whether the lessor should follow current operating lease accounting treatment (no receivable and liability would be recognised), the Boards tentatively decided that lease receivables and lease contract liabilities should not be presented on a gross basis, as originally presented in the Leases ED, given that it results in double counting of the lessor's assets and the carrying amount of the lessor's receivables and the underlying assets are supported by the same set of cash flows. Consequently, if the underlying asset were viewed in isolation, it could be argued to be impaired.

The Boards will discuss this issue in a future meeting, as no further decisions were reached regarding the above topic or the underlying presentation and measurement of other-than-finance leases in lessor accounting.

Finance leases

For finance leases (previously referred to as the derecognition approach in the Leases ED), the Boards discussed the initial and subsequent measurement of assets and liabilities recognised by a lessor for finance leases. The staff explained that a lessor could account for the underlying asset for finance leases in two ways; by derecognising the entire carrying amount of the underlying asset or derecognising only a portion of the carrying amount of the underlying asset (e.g., the right-of-use portion that was transferred to the lessee).

Several members of the Boards immediately rejected a 'full' derecognition approach to lessor accounting (e.g., derecognising the entire underlying asset) because of concerns that the lessor would recognise a gain / profit on initial recognition of the lease contract equal to the difference between the carrying amount of the underlying asset and its fair value even when only a portion of the underlying asset has been transferred (does not faithfully depict the transfer of benefits to the lessee). Opposing views noted that all material risks and rewards should be transferred in a finance lease, so would the residual portion of the underlying asset that has not been transferred be material.

Other Board members cited the complexity of a partial derecognition approach, while also citing outreach responses which suggested that a partial derecognition approach (1) did not provide users with useful information on the level of residual asset risk and (2) the residual asset should not be considered an item of property, plant and equipment given that it is not an asset that the lessor uses or intends to use in its business.

The Boards will discuss this issue in a future meeting, as no tentative decisions were reached regarding the above topic or the underlying presentation and measurement of finance leases in lessor accounting. Such discussion is expected to consider measurement of the lessor's lease receivables, including receivable securitisation environments which may suggest a fair value measurement of lease receivables, while also considering the measurement of residual assets.

Discussion at the special 11-12 May 2011 IASB-FASB meeting

The IASB held an education session in preparation for next week's joint meeting. The FASB staff joined the meeting by teleconference. No decisions were made by the Board at this meeting.

Distinguishing between lease accounting approaches

The IASB discussed whether to include certain elements and indicators with the guidance in paragraphs 7-12 of IAS 17 to distinguish between finance and other-than- finance leases. The staff discussed a definition of an other-than-finance lease and proposed to include a specific definition (rather than just the inverse of a finance lease). Most Board members supported an enhanced definition but some felt uncomfortable with the staff's proposed wording. Many Board members also acknowledged that they don't agree with having two types of leases. The Board also discussed the indicators and again there was disagreement about the specific indicators that should be applied to determine the type of lease. Some Board members expressed concern that the indicators will be applied as bright-lines like today.

Lessee Accounting – other than finance lease

The IASB discussed the other than finance lease model for lessee accounting with a focus on how the right-of-use asset should be depreciated. Several IASB members expressed concern about the operationality of the model and others questioned the conceptual basis of depreciating an asset using an annuity approach. Some Board members thought that other comprehensive income should be used to address the difficulties in the model. Also, some Board members expressed a view that the cut for determining the type of lease should be based on the nature of the asset (e.g., equipment versus real estate). A majority of IASB members indicated that they would drop the other-than-finance lease approach entirely. These IASB members would favour a single approach for lessee accounting where the profit and loss would be recognised on an accelerated basis consistent with the exposure draft.

Lessor Accounting: Finance leases – measurement and presentation

The IASB discussed different aspects of the measurement and presentation of finance leases, with a particular focus on the measurement of the residual value and the presentation of the lease receivable and residual assets. Specifically, the IASB discussed whether the entire asset should be derecognised and whether residual asset should be recognised at a discounted amount and subsequently accreted over the lease term using the rate the lessor charges the lessee. Also, in relation to presentation, the IASB discuss whether a lessor should present the lease receivable and the residual asset together as one amount in the statement of financial position as an investment in leased assets. The lessor should also disclose in the notes to the financial statements, the portion of that investment in leased assets that relates to the residual asset.

Lessor Accounting – other than finance lease

The IASB discussed three possible approaches relating to lessor accounting: (1) performance obligation approach with net presentation, (2) retain current operating lease accounting and (3) derecognition approach. The IASB had expressed mixed views with some supporting retaining current operating lease accounting while a slight majority supported the derecognition approach. The FASB staff indicated that the FASB appeared to support either the performance obligation approach or retain current operating lease accounting.

Discussion at the May 2011 IASB Meeting

IASB-FASB Joint Meeting

As part of its continual deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards deliberated on the following topics:

• Lessee accounting approach
• Lessor accounting in other-than-finance leases
• Lessor accounting in finance leases
• Contract modifications or changes in circumstances
• Options in a lease
• Discount rates in a lease

The Boards made a number of tentative decisions or took informal votes on the following:

Short-term Leases

The Boards discussed short-term leases and took an informal vote that would have eliminated the short-term lease exemption tentatively developed during the March 2011 Board meetings. However, the Boards decided to discuss short-term leases at a future meeting.

Lease Term

At a previous Board meeting, the Boards tentatively decided that "lease term" should be defined for the lessee and lessor as the non cancellable period for which the lessee has contracted with the lessor to lease the underlying asset, together with any options to extend or terminate the lease when there is a significant economic incentive for an entity to exercise an option to extend the lease, or for an entity not to exercise an option to terminate the lease.

In the May 2011 joint Board meeting, the Boards tentatively decided that in determining whether there is a significant economic incentive, lessees and lessors should consider contract-based factors, asset-based factors and entity-specific factors for both the initial and subsequent evaluation. Contract-based factors are terms that are written into the lease contract that could create a significant economic incentive to exercise an option at the date of commencement, or subsequently if there is a change in the lease contract. Examples of contract-based factors include the requirement of the lessee to pay a substantial penalty for terminating the lease earlier than the contractual lease term, the obligation of the lessee to incur material costs to restore the asset prior to returning it to the lessor and the existence of a bargain renewal or purchase option. Asset-based factors relate to the characteristics of the underlying leased asset that exist either at lease commencement or subsequently that could create a significant economic incentive to exercise an option. Examples of asset-based factors include the existence of significant leasehold improvements installed by the lessee during the lease term that will have significant value at the time when the option becomes exercisable and the importance of the geographic location of the asset. Entity-specific factors would include historical practice of the entity, management intent and common industry practice. Market-based factors such as fluctuations in the market rental or asset values would not be considered by the lessee or lessor.

The Boards tentatively decided that a lessee would adjust its right-of-use asset when there are changes in lease payments due to a reassessment and a lessor that applies the derecognition approach would adjust the lease receivable and the carrying amount of the residual asset.

Distinguishing Between Lease Types

The Boards tentatively decided that if the final standard were to include two types of leases for lessees and/or lessors, the underlying principle in distinguishing between the type of lease would be based on whether substantially all the risks and rewards of the underlying asset have transferred from the lessor to the lessee. In making this determination, the Boards tentatively decided that the indicators in IAS 17 Leases should be used while adding fair value and variable rental indicators. The Boards tentatively decided to not add an indicator based on embedded or integral services.

Lessee Accounting

The Boards tentatively decided there should be one type of lease for lessee accounting consistent with the exposure draft. The lessee would recognise a right-of-use asset and a liability to make lease payments at the present value of the lease payments. The right-of-use asset would be amortised/depreciated using a systematic and rational method and the liability to make lease payments would be amortised using the effective interest method. Therefore, the expense recognition pattern would be on an accelerated basis for all leases. As part of this discussion, the Boards considered whether to retain the current short-term lease exemption of 12 months, expand it beyond 12 months or eliminate it from the final standard. The Boards took an informal vote that would have eliminated the short-term lease exemption. However, the Chairman of the IASB indicated that the vote to eliminate the short-term lease exemption was not a formal vote and the Boards will discuss, at a future meeting, whether:

• to include a short-term lease exemption or a discussion regarding materiality in the final standard;
• to require the right-of-use asset and liability to make lease payments be discounted for all leases; and
• to require the service component be separated from the lease component for all leases.

Lessor Accounting

The Board discussed lessor accounting for "other-than-finance" leases and considered three approaches: (1) the performance obligation approach with net presentation, (2) current operating lease accounting and (3) the derecognition approach. The IASB voted in favour of the derecognition approach and the FASB voted in favour of current operating lease accounting. The IASB's vote would result in all leases being accounted for using the derecognition approach while the FASB's vote would result in two models for lessor accounting. The Chairman of the IASB indicated that this is not considered a formal vote and requested the Board advisors and project team meet to discuss a possible way forward.

Because of the disagreement on the accounting for "other than finance" leases, the Chairman of the FASB decided it would be best to assume for purposes of further discussing lessor accounting that the lease would not transfer substantially all the risks and rewards of ownership. The Chairman of the FASB indicated that the Boards would take an informal vote on various issues to assist the staff in developing the staff papers on lessor accounting. The Boards supported the following:

• a partial derecognition approach;
• the use of an allocation methodology to measure the residual under a partial derecognition approach;
• accretion of the residual value over the lease term; and
• separate presentation for the lease receivable and residual asset in the statement of financial position.

Reassessment of the Discount Rate in a Lease

The Boards tentatively decided that the discount rate should not be reassessed on a periodic basis when there is no change in lease payments. The discount rate would be reassessed when there is a change in lease payments due to a change in the assessment of whether the lessee has a significant economic incentive to exercise an option to extend a lease or to purchase the underlying asset. The discount rate would also be reassessed when there is a change in lease payments due to the exercise of an option that the lessee did not have a significant economic incentive to exercise. If reassessment is necessary, the discount rate would be revised using the spot rate at the reassessment date and applied to the remaining lease payments, including the remaining payments on the initial lease plus the payments due to the extension period or upon exercise of the purchase option.

Contract Modifications or Change in Circumstances After the Date of Inception of the Lease

The Boards tentatively decided that the final leases standard would include guidance for accounting for modifications to the contractual terms of a contract or changes in circumstances after the date of inception of the lease. The guidance would clarify that:

• a substantive change to the existing contract would result in the accounting for the modified lease as a new lease;
• a change in circumstances that would affect the assessment of whether a contract is, or contains, a lease would result in a reassessment by the lessee and the lessor as to whether the contract is, or contains, a lease and may result in the lessee and lessor applying or ceasing to apply the leases standard;
• a change in circumstances that would affect the "classification" of the lease (if applicable) should not result in a reassessment by the lessee or lessor.

Lessee Accounting Approach

The Boards redeliberated on their April 2011 joint meeting tentative decision that there should be two accounting approaches by lessees (finance and other-than-finance, although all Board members requested that a new naming convention to other-than-finance leases).

The majority of both Boards expressed an interest in applying one lessee accounting model, as originally proposed in the Lease ED, as opposed to application of two lease accounting models, in commenting that all leases appear to have some financing element. Likewise, in application of two lease accounting models, these Board members expressed concern as to the ultimate application of presentation in an other-than-finance environment in considering accounting alternatives including use of other comprehensive income to achieve a straight-line profit or loss recognition pattern (assuming a constant pattern of consumption), an annuity approach which was rejected in an early Board meeting, undiscounted measurement approach or maintaining current operating lease accounting.

A minority of the Boards proposed to retain two lessee accounting models to distinguish the principle of the transfer of substantially all risks and rewards of ownership, with varying views on application of accounting approach. The majority of Board members who preferred a two lease accounting model for lessees preferred an annuity based approach assuming the Boards could resolve the different patterns of recognition of leased assets over the lease term.

With general discussion focussed on application of one type of lease for lessee accounting, one Board member discussed potential disclosure requirements surrounding such a model. Specifically, this Board member cited targeted outreach which noted that users were interested in understanding the straight-line recognition of lease charges for other-than-finance leases, and therefore, he requested that application of one type of lease require disclosure of interest, depreciation and cash commitments, as distinguished by the class of the underlying transaction (e.g., equipment and buildings). Multiple Board members supported this proposal.

As a result, the Boards tentatively decided there should be one type of lease for lessee accounting consistent with the Leases ED. The lessee would recognise a right-of-use asset and a liability to make lease payments at the present value of the lease payments. The right-of-use asset would be amortised/depreciated using a systematic and rational method and the liability to make lease payments would be amortised using the effective interest method. Therefore, the expense recognition pattern would be on an accelerated basis for all leases. The Boards asked the staffs to bring back analysis on relevant disclosures surrounding this tentative decision in a future meeting.

Given the Boards' tentative decision for one lessee accounting model, one Board member proposed that the Boards revisit the scope of practical expedients to using the right-of-use model for lease arrangements as proposed in the Leases ED. Specifically, this Board member, citing historic decisions that short-term leases (i.e., a lease that, at the date of commencement of the lease, has a maximum possible lease term, including any options to renew or extend, of 12 months or less) would not be recognised on a lessee's statement of financial position, requested that the Boards consider increasing the scope of items subject to the right-of-use model exception (e.g., applying current operating lease requirements for leases of up to 24 months or more). While some Board members supported this proposal as a practical expedient, other Board members expressed a desire to eliminate the exception for short-term leases completely as the underlying purpose of the leases project was to put risks and rewards on the statement of financial position. These Board members also expressed concern with a bright-line contract length as the basis for exemption in reporting.

The Boards took an informal vote on retaining the short-term leases exemption, with the majority of the Boards voting to eliminate the short-term lease exemption. However, the Boards decided to discuss short-term leases at a future meeting, including whether to include a short-term lease exemption or a discussion regarding materiality in the final standard; to require the right-of-use asset and liability to make lease payments be discounted for all leases; and to require the service component be separated from the lease component for all leases.

Lessor Accounting Approach

The Boards then discussed the lessor accounting model in other-than-finance leases in considering three potential approaches: (1) the performance obligation approach with net presentation, (2) current operating lease accounting and (3) the derecognition approach.

Several IASB members, citing the most-recent deliberations on one lessee accounting model, outlined a preference to apply one model in lessor accounting for all leases, and therefore, preferred the derecognition approach with consistent application in finance and other-than-finance leases.

Opposing views, primarily expressed by the FASB members, noted that targeted outreach expressed a desire for the lease project to be consistent in principle with the revenue recognition project, and such Board members felt that application of the derecognition approach was inconsistent with the revenue recognition project, although one IASB member noted that the derecognition approach was consistent with the revenue recognition project as recognition was determined in line with performance transfer.

Another FASB member noted that the lessor and lessee accounting approaches should not necessarily be aligned, as he expressed a view that the underlying business models for lessors and lessees were unique, and therefore, he preferred retention of two lessor accounting models with other-than-finance leases accounted for under current operating lease accounting.

When put to an informal vote, the IASB voted in favour of the derecognition approach and the FASB voted in favour of operating lease accounting. Given the divergence on this issue, the Chairman of the IASB requested the Board advisors and project team meet to discuss a possible way forward.

Because of the disagreement on the accounting for "other than finance" leases, the Chairman of the FASB decided it would be best to assume for purposes of further discussing lessor accounting that the lease would not transfer substantially all the risks and rewards of ownership. This line of inquiry served as a hypothetical series of questions taken by way of an informal vote to assist the staff in developing staff papers on lessor accounting for a future Board meeting (given that the Boards were divided on application of one lessor accounting model or two, as discussed above), as all staff papers developed in advance of this meeting presumed a two model approach.

In an environment in which the lease would not transfer substantially all the risk and rewards of ownership, both Boards supported:

• a partial derecognition approach, consistent with the proposal in the Leases ED, as opposed to recognition of full derecognition in all lessor accounting transactions, given that the partial derecognition approach is viewed by many to be consistent with the right-of-use approach applied by lessees and any day-one gain recognised for the portion of the underlying asset transferred arguably more faithfully depicts the transfer of benefits from the lessor to the lessee (as a note, many Board members indicated that they would be supportive of a full derecognition approach if a lease transfers substantially all risks and rewards of ownership);
• the use of an allocation methodology to measure the residual under a partial derecognition approach given that it was considered to more faithfully depict the economics of the lease transaction (recognition of profit only on the portion of the underlying asset transferred to the lessee in the form of the right-of-use);
• accretion of the residual value over the lease term to reflect the time value of money on the amount initially recognised for the residual asset (avoids delaying recognition of gains solely from the time value of money), and likewise, since such application is considered to be consistent with how the lease is typically priced and maintains a historical-cost basis for measurement of the residual asset; and
• separate presentation for the lease receivable and residual asset in the statement of financial position.

The above informal votes were reached without significant debate, absent the presentation for the lease receivable and residual asset in the statement of financial position, in which several IASB members supported the combined presentation of the lease receivable and the residual asset. Board members supporting separate presentation noted that the lease receivable and the residual asset provide for different risks and variability, while other Board members believed that recognition of the receivable, residual and deferral of the day one gain (where applicable) could be recorded collectively on the face of the statement of financial position and disaggregated in the notes. The latter position was expressed out of concern that inclusion of residual assets in property, plant and equipment would yield unique presentation of revaluation adjustments when accreting the residual asset, yield less useful information about the amount of cash flows expected from the residual asset at the end of the lease term and cause confusion in separately presenting assets arising from one underlying asset.

In conjunction with the above discussion, the Boards discussed the initial measurement of lease receivables (e.g., measure all lease receivables at the present value of lease payments, discounted using the rate the lessor charges the lessee plus any initial direct costs incurred by the lessor; or measure lease receivables at fair value). Many Board members questioned the basis for scoping lease receivables out of the financial instruments standard for measurement purposes. The Boards asked the staff to consider the implications of applying financial instruments standard to lease receivables, including implications surrounding embedded derivative exemptions, in bringing back this issue in a future meeting.

Distinguishing Between Lease Types

The Boards redeliberated on how to distinguish between lease types if it is ultimately determined that the final standard will include two types of leases for lessees and/or lessors. The underlying principle continues to be based on whether substantially all the risks and rewards of the underlying asset have transferred from the lessor to the lessee, but the staffs presented potential indicators including fair value, variable rent and embedded / integral service indicators. The Boards did not want to establish a bright line for fair value indication, as outlined in US GAAP, but the Boards tentatively decided that fair value should be considered in indicator. Likewise, while Board members noted that significance should be considered, Board members felt that variable rent should be an indicator for consideration in distinguishing lease types. Board members were opposed to the inclusion of embedded or integral services as an indicator for consideration, however, as they felt it conflicted with revenue recognition guidance where the inability to distinctly identify components to a transaction led to the entire transaction being treated as a service.

Contract Modifications or Changes in Circumstances

The Boards then discussed how to account for changes after the date of inception of the lease. The staffs provided feedback from outreach activities, in conjunction with assessment of current guidance. Without much debate, absent one Board member questioning the threshold for determining contract modification or changes in circumstances, the Boards agreed that the modifications to contract terms after the date of inception should be reflected in the accounting for contracts to avoid structuring opportunities.

Thus, the Boards tentatively decided that the final leases standard would include guidance for accounting for modifications to the contractual terms of a contract or changes in circumstances after the date of inception of the lease, and the guidance would clarify that (1) a substantive change to the existing contract would result in the accounting for the modified lease as a new lease; (2) a change in circumstances that would affect the assessment of whether a contract is, or contains, a lease would result in a reassessment by the lessee and the lessor as to whether the contract is, or contains, a lease and may result in the lessee and lessor applying or ceasing to apply the leases standard; and (3) a change in circumstances that would affect the "classification" of the lease (if applicable) should not result in a reassessment by the lessee or lessor.

Options in a Lease

Historic Board meetings have defined the "lease term" for the lessee and lessor as the non cancellable period for which the lessee has contracted with the lessor to lease the underlying asset, together with any options to extend or terminate the lease when there is a significant economic incentive for an entity to exercise an option to extend the lease, or for an entity not to exercise an option to terminate the lease. In this meeting, the Boards considered potential indicators for defining whether there is a significant economic incentive for an entity to exercise an option.

The staffs presented four specific potential factors for consideration as indicators in the assessment of a significant economic incentive; contract-based, asset-based, market-based and entity-specific. Contract-based factors are terms that are written into the lease contract that could create a significant economic incentive to exercise an option at the date of commencement, or subsequently if there is a change in the lease contract. Examples of contract-based factors include the requirement of the lessee to pay a substantial penalty for terminating the lease earlier than the contractual lease term, the obligation of the lessee to incur material costs to restore the asset prior to returning it to the lessor and the existence of a bargain renewal or purchase option. Asset-based factors relate to the characteristics of the underlying leased asset that exist either at lease commencement or subsequently that could create a significant economic incentive to exercise an option. Examples of asset-based factors include the existence of significant leasehold improvements installed by the lessee during the lease term that will have significant value at the time when the option becomes exercisable and the importance of the location of the asset. Entity-specific factors would include historical practice of the entity, management intent and common industry practice.

While the Boards generally agreed that contract and asset-based indicators should be considered, many Board members expressed uncertainty regarding the inclusion of market-based or entity-specific factors. With the former, Board members noted that market-based factors may lend to significant variability, where market variances may lead to subsequent reversals from period-to-period. These Board members considered that the inclusion of this factor should be limited to only 'permanent' changes in market valuation, but the Boards expressed concern in practical application. Others expressed a view that assurance of permanent market price changes could only be obtained near the end of the lease term, and therefore, would allow for this indicator in the last months of a lease. Many felt this led to variability without significant benefit to users of the financial statements, and thus, the Board tentatively decided market-based factors such as fluctuations in the market rental or asset values would not be considered by the lessee or lessor.

In considering entity-specific factors, many Board members expressed concern over the inclusion of management intent and historic practice as possible indicators, as intent could be abused as past practice did not ensure comparability. Other Board members noted that this should be considered an indicator, although the assessment should not be exclusively based on management intent. Instead, they cited the importance of considering the needs of an entity. As a result, the Boards tentatively decided that in determining whether there is a significant economic incentive, lessees and lessors should consider entity-specific factors for both the initial and subsequent evaluation.

Discount Rate in a Lease

Following previous decisions by the Boards as to the determination of the discount rate in a lease, the Boards discussed whether there are circumstances that would require a lessee or a lessor to reassess the discount rate used to measure the present value of lease payments.

The staffs presented feedback under the Leases ED which did not permit a change in the discount rate after inception of a lease unless lease payments are contingent on variable reference interest rates. Without significant debate, the Boards tentatively decided that (1) the discount rate should not be reassessed on a periodic basis when there is no change in lease payments; (2) the discount rate would be reassessed when there is a change in lease payments due to a change in the assessment of whether the lessee has a significant economic incentive to exercise an option to extend a lease or to purchase the underlying asset; (3) the discount rate would also be reassessed when there is a change in lease payments due to the exercise of an option that the lessee did not have a significant economic incentive to exercise. If reassessment is necessary, the discount rate would be revised using the spot rate at the reassessment date and applied to the remaining lease payments, including the remaining payments on the initial lease plus the payments due to the extension period or upon exercise of the purchase option, although the Boards noted an intention to discuss the rate at a future meeting.

Discussion at the 31 May - 2 June 2011 IASB Meeting

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards deliberated on the following topics:

• Lessee accounting: subsequent measurement
• Lessee accounting: residual value guarantees (RVGs)
   

Lessee accounting: Subsequent measurement of foreign exchange differences

As the Leases ED did not provide specific guidance on how a lessee should account for the effects of foreign exchange relating to the measurement of a liability to make lease payments and a right-of-use asset, and following respondent feedback to the Leases ED which requested clarity as to whether the effects of subsequent changes in the exchange rate would require recognition in profit or loss, consistent with the principles of IAS 21 The Effects of Changes in Foreign Exchange Rates and Topic 830 Foreign Currency Matters, or as a change in the carrying amount of the right-of-use asset, the Boards tentatively decided, with little deliberation, to confirm that changes in the liability to make lease payments as a result of foreign exchange differences would be recognised in profit or loss.

One IASB member expressed concern with reflection of foreign exchange differences relating to future periods in the current period profit and loss, as he preferred bifurcation of foreign exchange differences between those derived from current or prior periods and those relating to future periods (for reflection as a change in the carrying amount of the right-of-use asset). Other Board members, while not disputing the tentative decision, expressed concern with reflection of foreign exchange guidance within the leases standard. Specifically, certain Board members preferred that relevant guidance on foreign exchange activity be applied in the foreign exchange rate standards, which the staffs will consider in future standard drafting.

Lessee accounting: Impairment of a lessee's right-of-use asset

Considering that the impairment models in IFRSs and US GAAP are not currently converged, the Boards deliberated on the proposal in the Leases ED to follow the existing impairment models in IFRSs and US GAAP when assessing impairment of the right-of-use asset. The staffs presented outreach feedback which noted that many supporting impairing the right-of-use asset as proposed in the Leases ED, while others requested a converged solution. With little deliberation, the Boards acknowledged that retention of the proposals in the Leases ED would not result in a converged solution, but they noted that the consistency and comparability that would result in using the same impairment model for leased and owned assets would outweigh the disadvantage of divergence. Thus, the Boards confirmed the right-of-use asset would be evaluated for impairment in accordance with IAS 36 Impairment of Assets (IFRSs only) or Topic 350 Intangibles – Goodwill and Other (US GAAP only).

Lessee accounting: Revaluation of a lessee's right-of-use asset (IASB-only)

As an IASB-only issue, given that for preparers following US GAAP, the Leases ED did not allow revaluation of the right-of-use asset, the Boards deliberated on the proposals in the Leases ED that:

• revaluation of a lessee's right-of-use asset would be permitted if a lessee revalued all owned assets in the underlying asset's class of property, plant and equipment, but would not be required, even if the rest of the asset class was revalued
• if a lessee revalues its right-of-use assets, it would be required to revalue the entire class of assets to which the underlying asset belongs
• revaluation would be required to be performed in accordance with IAS 38 Intangible Assets; however, an active market would not be required to revalue right-of-use assets.

The IASB staff noted that a minority of respondents to outreach expressed concern with the Board's proposals in the Leases ED, with some respondents expressing a desire for a converged solution to that of US GAAP and others requesting that right-of-use assets be treated as their own class for purposes of revaluation.

With little debate, the IASB tentatively decided to permit revaluation of the right-of-use asset in accordance with the principles of IAS 38 Intangible Assets if a revaluation policy is applied to owned assets of the same class consistent with the proposed guidance in the ED. While this will not result in a converged solution, the Board previously decided that the consistency and comparability that would result in using the same revaluation model for leased and owned assets in IFRSs would outweigh the disadvantage of divergence with US GAAP. Likewise, the prohibition would be difficult to justify as the right-of-use asset is subject to existing guidance for amortisation and impairment, and existing IFRS guidance currently allows revaluation for non-financial assets.

Lessee accounting: Residual value guarantees

The Boards deliberated on subsequent measurement and reassessment of RVGs for lessees. With little debate, the Boards tentatively decided that amounts expected to be payable under RVGs included in the measurement of the lessee's right-of-use asset would be amortised on a systematic basis from the date of commencement of the lease to the end of the lease term or over the useful life of the underlying asset, if shorter. If a pattern cannot be readily determined, a straight-line amortisation method would be used.

Many Board members, however, expressed concern over how to distinguish RVGs and variable lease payments (e.g., contingent rent) in light of the Boards' previous tentative decision that variable lease payments should not be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable unless the variable lease payments are 'disguised minimum lease payments'. While this question speaks more to the measurement of RVGs than to the amortisation, one Board member highlighted that RVGs may be derived from underlying asset usage (such as an automobile lease in which the RVG varies according to kilometres driven), and it was not clear whether this would be considered a RVG or a variable lease payment. Thus, the Boards directed the staffs to research distinguishing characteristics between RVGs and variable lease payments for discussion at a future meeting.

The Boards then considered the reassessment of RVGs following Leases ED proposals which noted that lessees should reassess the carrying amount of the liability to make lease payments arising from each lease if facts or circumstances indicate that there would be a significant change in the liability since the previous reporting period. The staffs, citing little respondent feedback on this issue other than practical application challenges from a cost-benefit perspective, proposed to retain the reassessment requirement in order to provide relevant and timely information to users of financial statements on expectations of the lessee's liability in conjunction with providing consistency with previous tentative decisions requiring reassessment of options.

The Boards tentatively decided that lessees should reassess amounts expected to be payable under RVGs when events or circumstances indicate that there is a significant change in the amounts expected to be payable under RVGs. The Boards tentatively decided not to include indicators, such as contract-based, asset-based or entity-based factors, in the final standard for purposes of defining whether reassessment should occur, but rather, proposed application of a general significant change threshold for application by preparers.

Finally, the Boards deliberated on accounting for changes in the expected amounts payable under a RVG as a result of reassessment, including retention of proposals in the Leases ED or requiring all changes be recognised in profit or loss. With little debate, the Boards decided that changes to the lessee's liability to make lease payments arising from current or prior periods would be recognised in profit or loss, while changes relating to future periods would be recognised as an adjustment to the right-of-use asset (consistent with Leases ED). The allocation for changes in estimates of RVGs would reflect the pattern in which the economic benefits of the right-of-use asset will be consumed or was consumed; however, if the pattern cannot be reliably determined, an entity would allocate changes in estimates of RVGs to future periods. Such a conclusion is based on assessment that the above decision better reflects the economics of many leases. One Board member, however, noted that the above decision was inconsistent with earlier tentative decisions on subsequent measurement of foreign exchange differences. Another Board member highlighted that the proposal for RVGs is consistent with decommissioning guidance, however.

Discussion at the June 2011 IASB Meeting

MONDAY, 13 JUNE 2011

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards deliberated on the topic of the lessor accounting model.

The Chairman of the IASB decided that it would be best to assume, for purposes of discussing further the lessor accounting model, application of the derecognition approach as prescribed in the Leases ED. The Chairman of the IASB asked the Boards to take an informal vote on various issues to assist the staff in developing future staff papers on lessor accounting under a derecognition model. The Boards generally supported recognition of the residual asset as an allocation of the underlying asset's previous carrying amount (i.e., allocation based on the proportion of the underlying asset's fair value that is the subject of the lease).

The Boards supported the staff exploring the following topics in relation to the above model:

• accretion of the residual asset over the lease term
• recognition of profit or loss upon transfer of the right-of-use asset
• derecognition of a portion of the underlying asset.

Lessor accounting

As part of the May 2011 Board meeting, the Boards asked the staff to explore possible lessor accounting approaches; specifically considering whether to apply a single lessor accounting model and, if so, what the model would be, or whether to retain the current operating and finance lessor accounting models while distinguishing between leases that transfer substantially all the risks and rewards of ownership.

In deliberations, prior to a formal vote as to a preference for a single lessor accounting model or two lessor accounting models (i.e., derecognition model for a lease that transfers substantially all the risks and rewards of ownership and the current operating lease model when a lease does not transfer substantially all risks and rewards), the Boards decided that it would be best to assume, for purposes of discussing further the lessor accounting model, application of the derecognition approach. Under such an approach, noting the lessor's two rights arising from a lease contract take the form of the lease receivable and the residual asset, the Boards agreed, as generally consistent with other financial assets of a similar nature, that the lease receivable should be initially measured at the present value of the lease payments, discounted using the rate charged in the lease, and subsequently measured at amortised cost using the effective interest method.

However, in considering the above model, the Boards expressed a few key concerns, including:

• whether to recognise the residual asset as an allocation of the underlying asset's previous carrying amount or whether to measure the residual asset at the present value of the estimated residual value of the underlying asset at the end of the lease term
• whether to recognise profit or loss upon transfer of the right-of-use asset
• what is the appropriate methodology for subsequent measurement of the residual (i.e., accrete to rate defined in lease or accrete to estimated residual value)
• how to account for the lease of a portion of an underlying asset.

Initial measurement of the residual asset

In initially measurement of the residual asset, the majority of the Boards expressed a view consistent with that of the Leases ED that measurement should be an allocation of the previous carrying amount of the underlying asset, as calculated based on a proportion of the underlying asset's fair value that is the subject of the lease (e.g., cost of underlying – [(cost x lease receivable) / fair value of underlying]). These Board members expressed a preference of avoiding subjectivity in measurement of the residual (and potential variability in the financial statements) which would be present if preparers were asked to estimate the future fair value of the residual. However, other Board members expressed concern that the above allocation measurement provides an "artificial" number (i.e., undefined number). These Board members contend that the valuation of the residual asset, representative of the right to an underlying asset at some point in the future, should initially be measured at the present value of the estimated residual value of the underlying asset at the end of the lease term. By way of an informal vote, Board members supported application of an allocated residual valuation model, but in doing so, expressed concerns in profit and loss recognition at lease commencement.

Initial profit recognition

In modelling of the above derecognition model, Board members expressed concern over recognition of "day 1 profit", if applicable (e.g., the difference between the fair value of the underlying asset and the carrying amount at lease commencement), when the lessor has not transferred substantially all of the risks and rewards of ownership of the underlying asset to the lease or the estimate of the residual value of the underlying asset is not a reliable prediction of what the underlying asset will be worth at the end of the lease term (which could create variability in profit and loss in future periods).

In relation to this concern, multiple alternatives were suggested by individual Board members including:

• recognition of profit only when substantially all the risks and rewards of ownership of the underlying asset have transferred, in which recognition of profit would be confined to the recognised residual asset until such point that substantially all the risks and rewards of ownership have transferred; or
• recognition of profit only to the degree prescribed by the concept of transfer outlined in the revenue recognition project (e.g., recognition of the residual should be limited to circumstances in which the underlying asset is reliably predictable).

Other Board members expressed a preference to recognise profit or loss as the right-of-use asset is transferred given that the lessor has performed by making the underlying asset available to the lessee and the lessee controls the right-of-use asset. These Board members note that the lessor is generally able to obtain or calculate reliable residual value estimates as this valuation is considered in the underlying pricing of the lease agreement. Further, these Board members note that the risk of reporting excessive profits at lease commencement would generally be limited to situations in which the residual value is expected to fall below the amount initially allocated to the residual asset (based on the above informal decision) or the lessor concludes at lease commencement that the lessee has a significant economic incentive to exercise a purchase or extension option which eventually is not exercised.

Based on the above discussions, the Boards requested the staff to explore further the recognition of profit at lease commencement as compared to deferral alternatives noted above.

Subsequent measurement of the residual asset

Following constituent feedback to the Leases ED, in which the Leases ED proposed that the allocated carrying amount of the residual asset would not be remeasured or adjusted apart from impairment, the Boards considered whether the residual asset should be accreted over the lease term. While Board members generally supported accretion of the residual in order to avoid volatility in profit and loss over the lease term, many Board members supported accreting the residual asset to estimated fair value at the end of the lease term, while the staff proposed that the residual asset be accreted over the lease term using the rate charged in the lease. The Boards asked the staff to reconsider the accretion methodology for discussion in a future meeting.

Lease of a portion of the underlying asset

As highlighted above, the Boards expressed concerns with recognition of profit at lease commencement when the underlying or residual asset is not reliably predictable. The Boards noted that unreliable predictions of fair value may often be present when the underlying asset to be leased is a portion of a larger asset (e.g., lease of individual stores in a shopping mall or lease of a floor of a building).

Board members deliberated possible alternatives to applying the lessor accounting model when the fair value of the underlying asset is unreliable, including applying current operating lease accounting, applying a modified receivable and residual approach (i.e., application of the derecognition model as set forth above in which the residual asset would be initially measured as the difference between the present value of the lease receivable and the carrying amount of the underlying asset, with no day 1 profit, if applicable, and the residual asset would be subsequently accreted on a constant effective yield basis) or applying the receivable and residual approach set forth for the lease of an entire underlying asset as set out above.

Multiple Board members highlighted a preference to retain consistency in the lessor model (for both leases of an entire asset or a portion of an asset), whereby application of a derecognition model would be applied (either under a modified or 'standard' receivable and residual approach) for both. While many agreed with this view, some Board members were concerned with the measurement of a residual asset in a componentised environment. Specifically, these Board members noted the challenges in bifurcating residual assets if a derecognition model is used (especially when considering common area environments; for example, in the lease of individual stores in a shopping mall, how would a preparer bifurcate the residual asset component of the air conditioning unit to all lessees in the mall), and therefore, preferred application of the current operating lease accounting in these environments. In an informal vote, the majority of the Boards supported application of the modified derecognition approach set out above for leases where the fair value of the underlying asset is not reliably measurable (e.g., when the underlying asset is a portion of a larger asset).
 

TUESDAY, 14 JUNE 2011

Islamic (Shariah-compliant) leases

As part of its continuing deliberations surrounding the Leases ED, the Boards discussed lessor issues in Islamic, or Shariah-compliant, leases.

The Director of International Activities of the IASB summarised to the Boards that Islamic accounting standards are less accepting of the concepts of time value of money and recognition of interest in a financing environment. Likewise, in lease transactions in which a transfer of ownership of the underlying asset exists at the end of the lease term, Islamic accounting standards generally mandate that the right-of-use and ultimate transfer of ownership be accounted for as separate transactions even if the two transactions are arranged in conjunction with each other (i.e., closely related). As a result, Islamic law generally treats all leases as operating leases assuming Shariah-compliance (i.e., financing or capital leases are not generally recognised in Shariah-compliant financial statements). As a result, the Director of International Activities of the IASB posed the question to the Boards as to whether it is appropriate to consider this environment in contemplation of the lessor accounting model.

In initial deliberations, it was noted that Islamic leases, as currently presented in the financial statements of Shariah-compliant institutions, may be in conflict with current principles in paragraph 36 of IAS 17 Leases, which outlines requirements for arrangements to be treated as finance leases (it was noted that Shariah-compliant institutions have considered legislation by local or national standard setters in preparation of financial statements as opposed to specific IFRSs as issued by the IASB). As such, the Boards considered whether current lease accounting deliberations for the lease project would cause unique practice issues which have not existed in the past. On deliberation, it was noted that current deliberations would not be expected to yield unique issues from current guidance.

Given the difficulty in addressing unique theological or social issues such as these, and considering that current lease project deliberations are not expected to yield additional issues from that which are evident in current practice (to which Shariah-compliant institutions have been able to "resolve" through local standard setters), the Boards noted that the above findings would not result in any change in the tentative decisions reached to date on the leases project.

WEDNESDAY, 15 JUNE 2011

As part of its continuing deliberations surrounding the Leases ED, the Boards deliberated on the topics of subleases and short-term leases.

Subleases

The staff sought the Boards' affirmation of their views in the Leases ED that a head lease should be accounted for as a separate transaction. However, the staff recommended that the Boards clarify that an intermediate lessor does the following:

• As a lessee in a head lease arrangement, it would account for its lease with the head lessor, including the measurement of the right-of-use asset, in accordance with the decisions to date for all leases
• As a lessor in a sublease arrangement, it would account for its lease with the sublessee in accordance with the decisions to date for all lessors.

Likewise, while the Boards continue to deliberate the lessor accounting model, if the Boards decide that there should be two approaches to lessor accounting, to determine the lease classification, the staff recommended that the principles and indicators used to define other leases (i.e., non-subleases) would be applied by the intermediate lessor as a lessor in the sublease arrangement to the right-of-use asset (instead of the underlying asset) it recognises from the head lease.

With little debate, the Boards tentatively decided to confirm the recommendations set forth by the staff.

Short-term leases

At the 15 March joint Board meeting, the Boards tentatively decided to allow operating lease treatment for short-term leases by lessors; reaffirming the proposals in the Leases ED with some differences in the definition of short-term leases and how the accounting may be elected. Based on subsequent deliberations on the lessee and lessor accounting models, the staff sought the Boards confirmation of a short-term lease exception.

Citing respondent feedback around this practical expedient, in which the majority of respondents requested cost relief for short-term leases, the majority of the Boards expressed a preference for a short-term exception from reporting leases within the statement of financial position.

The Chairman of the IASB noted that the short-term exception is currently defined as a lease that, at the date of commencement of the lease, has a maximum possible lease term, including any options to renew or extend, of 12 months or less. He noted that the decision to apply a 12 month model was based on an assessment of materiality (i.e., leases which have a maximum possible lease term of 12 months or less are not material). However, given different business models, the Chairman of the IASB expressed concern that defining short-term leases exclusively on lease term length might lead to material transactions being held off-balance sheet. Thus, he requested that a time component be considered in conjunction with a materiality assessment (whereby material leases of a maximum duration of 12 months or less would require capitalisation under the right-of-use approach). Many Board members agreed with this view, while others expressed concern that a materiality assessment would yield divergent practice in application, and likewise, audit requirements in assessing materiality would dictate preparers performing a detailed assessment of all leases applying the practical expedient, which would dilute the cost benefit the short-term exception served to provide.

Additionally, multiple Board members expressed a desire to have specific disclosure surrounding those leases applying the short-term exception (such as disclosure of the annual rent expense with discussion as to whether the annual rent expense is representative of what is expected to be recurring), although the Boards noted that such disclosure requirements would be considered as part of the overarching assessment of presentation and disclosures at a future date. In a vote, the majority of both Boards tentatively decided that short-term leases, unless material (which will be defined in a subsequent meeting), would not be recognised on a lessee's statement of financial position (i.e., consistent with the current requirements for operating leases), but additional disclosure (to be determined at a later date) would be required surrounding non-capitalised leases. A specific assessment as to whether short-term leases would be defined as a maximum possible lease term of 12 months or less (or a longer or shorter period) was not specifically discussed in the conduct of these deliberations.

The Boards also deliberated on whether the short-term exception should be an election. While a significant majority of the IASB voted to make the exception a policy election, the majority of the FASB preferred to require presentation to avoid comparability differences. When questioned as to whether FASB Board members would object to the exception being an election, the majority of the FASB did not object.

Discussion at July 2011 IASB Meeting

WEDNESDAY, 20 JULY 2011 (IASB-FASB)

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards deliberated on the topics of the lessor accounting model, accounting for variable lease payments and embedded derivatives.

Lessor accounting

As part of the June 2011 Board meeting, the Boards asked the staff to explore possible lessor accounting approaches; specifically considering whether to apply a single lessor accounting model and, if so, what the model would be, or whether to retain the current operating and finance lessor accounting models while distinguishing between leases that transfer substantially all the risks and rewards of ownership. The Boards also provided the staff with informal votes on a number of key topics in relation to possible lessor accounting model approaches.

Lessor accounting model

Continuing from discussions as part of the May and June joint Board meetings, the Boards considered two approaches for the lessor accounting model: (1) a dual-model approach consisting of current operating lease accounting for 'other-than-finance' leases and the 'receivable and residual' approach for 'finance' leases (akin to current capital leases) ("dual-model approach") and (2) the 'receivable and residual' approach for all leases ("single-model approach").

The 'receivable and residual' approach would include the following elements:

• initially measure the lease receivable at the present value of lease payments discounted using the rate charged in the lease, and subsequently measure the lease receivable at amortised cost using the effective interest method
• initially measure the residual asset on an allocated cost basis (i.e., based on the proportion of the underlying asset's fair value that is the subject of the lease) and subsequently accrete the residual asset using the rate charged in the lease
• recognise profit at lease commencement for any difference between (i) the previous carrying amount of the underlying asset and (ii) the sum of the lease receivable and the residual asset recognised, subject to the profit being reasonably assured (see discussion of this concept below)
• recognise interest income on the receivable and residual asset over the lease term.

The staff provided feedback from constituent outreach, in which a clear majority of IFRS constituents preferred a single-model, while US GAAP constituents were relatively split between a single- or dual-model approach. The majority of the staff preferred the single-model approach given its consistency with the lessee single-model approach and the fact that the spectrum of lease contracts was not considered to be uniquely different so as to justify two unique model approaches. However, a minority of staff expressed a preference for a dual-model approach given the key economic differences of different lease transactions. These individuals reconciled having a single lessee model (as opposed to a dual-model for lessors) by acknowledging that there is a threshold difference for revenue recognition (lessor) as compared to liability recognition (lessee).

The Boards reviewed practical examples of both approaches and noted that the 'receivable and residual' approach, when compared to current operating lease accounting, provided for accounting which better reflected the pricing of the contract (e.g., constant rate of return on investments), provided users with better information about risks by separately recognising the receivable and residual asset and provided a more accurate depiction of the economics of the transaction within a company's statement of financial position.

As a result, the Boards tentatively agreed to apply a single-model approach for lessors.

The Boards were asked to consider whether the 'receivable and residual' approach could be used in all leasing environments. Specifically, the Boards were asked to consider the following possible scope exceptions:

• Investment property measured at fair value: Leases ED, as issued by the IASB, proposed that a lessor should apply IAS 40 Investment Property to leases of investment properties that are measured at fair value.
  
  Given the unique aspects of investment property modelling including the fact that investment properties typically take the form of an appreciating asset, significant constituent support was provided for this scope exception, as many constituents noted a more appropriate reflection of an investment property lessor's business is for the lessor to measure the entire investment property at fair value and recognise lease income over the lease term on a straight-line (or more systematic) basis. Likewise, constituents noted the practical difficulties in applying the 'receivable and residual' approach to investment properties given multi-tenant properties limiting the availability of fair value information for individual units within one building.
  
  For this reason, the staff recommended retaining the Leases ED scope exclusion such that leases of investment property measured at fair value (either in accordance with IAS 40 or the final FASB Investment Properties standard once completed) would be excluded from the scope of the lessor accounting approach. For those leases, the lessor would recognise lease income over the lease-term on a straight-line (or other more appropriate systematic) basis.
  
  One Board member suggested that the scope of the exception be extended beyond those investment properties applying IAS 40 to include other assets that are measured at fair value, but there was little support for this proposal from other Board members.
  
  With little deliberation, the Boards agreed with the staff recommendation
   

• Short-term leases (defined as a lease that, at the date of commencement of the lease, has a maximum possible lease term, including any options to renew or extend, of 12 months or less): Following a similar scope exception confirmed for the lessee accounting model as part of the 13-15 June 2011 joint Board meeting, the Boards decided that the proposed guidance in the Leases ED would be retained such that short-term leases would not require recognition under the 'receivable and residual' approach (i.e. could be accounted for consistent with the current requirements for operating leases). This scope exception would be elective by asset class. Disclosure surrounding short-term leases will be discussed separately
   

• Impractical to determine the carrying amount of a leased portion of an asset: The staff highlighted that application of the 'receivable and residual' model requires information about the carrying amount of the asset that is the subject of the lease (and fair value of that asset if profit is to be recognised at lease commencement). If the lessor has entered into numerous lease contracts for physically-distinct portions of a single larger asset, the staff noted that it might be impractical for the lessor to allocate a portion of the total carrying amount of the asset to each leased portion (in addition, it is likely to be difficult to fair value each leased portion of the larger asset). Thus, the staff proposed a scope exception from applying the 'receivable and residual' model if it is impractical to determine the carrying amount of a leased portion of an asset.
  
  Many Board members expressed concern with this proposal, as they noted it allows for significant management judgement so as to impair comparability. These Board members also questioned the practical difficulties in obtaining necessary information to apply the 'receivable and residual' approach. As a result, the Boards tentatively decided not to allow for a scope exception to the 'receivable and residual' approach based on practicality.

Profit recognition under a 'receivable and residual' approach

The Boards were asked, in applying the 'receivable and residual' approach (discussed above), if a lessor should recognise profit on the right-of-use asset transferred to the lessee at lease commencement (i.e. the difference between the fair value of the underlying asset and the carrying amount at lease commencement), or defer profit recognition over the lease term unless the lease agreement transfers substantially all of the risks and rewards of ownership of the underlying asset.

The staff proposed that profit should be recognised to the extent that profit is reasonably assured in an attempt to limit variability in profit or loss when the lessor has not transferred substantially all of the risks and rewards of ownership of the underlying asset to the lease or the estimate of the residual value of the underlying asset is not a reliable prediction of what the underlying asset will be worth at the end of the lease term. Reasonably assured would be designed to be generally consistent with the use of the term in the revenue recognition project.

The staff noted the appropriateness of initial profit recognition in that, at lease commencement, the lessor has performed by making the underlying asset available for use by the lessee and, in exchange, has a lease receivable. Likewise, the staff noted that recognition of any manufacturing / dealer profit at lease commencement is derived from services performed in advance of entering into the lease.

Both Boards generally agreed with the staff's recommendation; however, such agreement was based on the ability to adequately define the term reasonably assured. Specifically, the Boards considered examples outlined by the staff, including uncertainties in: estimating the residual value at the end of the lease term; allocating payments made by the lessee into lease and non-lease components; and determining the fair value of the underlying asset at lease commitment. The staff identified all three of these environments as areas in which the right-of-use asset transferred would not be reasonably assured.

Board members expressed concerns related to the consistency of the 'reasonably assured' concept to that outlined in the revenue recognition model and the confusion of the concepts of reasonably estimated and reasonably assured.

While these concerns are inter-related, specific concerns expressed by Board members included:

• Reasonably assured, as applied in the revenue recognition project, outlined three specific criteria in determining recognition timing. The nature of these criteria were more akin to a revenue recognition model as opposed to a leasing model, in the view of particular Board members, and thus, consistent application of the concept across projects did not seem like an appropriate response. However, other Board members noted the importance of retaining consistent terminology across projects to avoid confusing constituents
• Examples outlined by the staff in applying the reasonably assured concept suggested that any uncertainties (e.g., estimates) triggered deferral of profit recognition. Certain Board members cited guidance in paragraph IN16 of the Revenue from Contracts with Customers exposure draft, which notes that would not be required to defer revenue recognition if revenue is determined to be reasonably estimated (i.e., the entity has experience with similar types of contracts and the entity's experience is relevant to the contract because the entity does not expect significant changes in circumstances). Thus, the Boards saw the staff as being overly conservative in applying the reasonably assured concept when compared to the revenue project. The staff noted its intention was to allow for profit recognition at lease commencement if profit is reasonably estimated.

After debate, the Boards tentatively agreed with the staff recommendation that at lease commencement, a lessor should recognise profit on the right-of-use asset transferred to the lessee if that profit is reasonably assured. If the profit on the right-of-use asset transferred is not reasonably assured, a lessor would apply the 'receivable and residual' approach outlined above except that the lessor would initially measure the residual asset as the difference between the carrying amount of the underlying asset and the lease receivable. The lessor would subsequently accrete the residual asset using a constant rate of return to an amount equivalent to the underlying asset's carrying amount at the end of the lease term as if it had been subject to depreciation.

However, in the above decision, the Boards asked the staff to provide draft wording for application of reasonably assured in advance of final drafting of the standard. Many Board members preferred that the application guidance consider the definition of reasonably assured outlined in the revenue recognition project (i.e., consistent principle), but provide criteria which were appropriate for a leasing environment, while also applying the reasonably estimated concept.

Accounting for variable lease payments

In April and June 2011, the Boards tentatively decided that variable lease payments should not be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable unless those payments represent:

• variable lease payments that are structured in such a way that they are in-substance fixed lease payments (commonly referred to as "disguised minimum lease payments")
• the portion of a residual value guarantee expected to be paid by the lessee, or
• an index or rate derived payment, in which case indices or the prevailing (spot) rate at lease commencement would be used for calculating the variable lease payments.

As part of this Board meeting, the Boards were asked to discuss the measurement of variable lease payments that depend on an index or a rate within the lessee's liability to make lease payments and the lessor's right to receive lease payments. This discussion was derived from clarification requested by constituents as to how to apply a spot rate to the initial measurement of variable lease payments that depend on an index or a rate; specifically considering an environment in which a daily spot rate does not exist (e.g. when the lease payments are linked to an annual rate of inflation) or the index is a scale rate (e.g. lease payments are linked to a consumer price index (CPI) formula – such as a rate of 125 at the lease commencement date). In these environments, constituents were questioning whether the spot rate was indicative of: an annual rate of inflation of zero or CPI rate of 125, respectively; a rate based on the most recent annual rate of inflation; or a rate based on a historical average.

In considering this environment, the staff recommended clarifying the previous tentative decision by stating that variable lease payments that depend on an index or rate should initially be measured based on the index or rate that exists at the date of commencement of the lease (as opposed to stating measurement in accordance with the spot rate since a spot rate does not always exist). As an example, for a lease tied to CPI, a CPI of 100 at lease commencement would result in applying a CPI of 100 throughout the remaining lease term. The measurement of the lessee's liability would exclude any estimation of future rates / indices.

A minority of the Boards expressed a desire to apply a more reliable rate if one is available (i.e. a rate that more appropriately reflected the economics of the transaction). Specifically, these Board members noted that the spot rate is likely not indicative of a future rate prediction, and thus, for example, if a forward rate existed, they preferred the use of the forward rate. However, multiple Board members expressed concern with applying with applying any methodology other than that proposed by the staff, as these Board members felt that the staff proposed a practical expedient that limited structuring opportunities. Further, these Board members noted the complexity that may be added in applying a methodology other than that proposed by the staff. As such, the Boards tentatively agreed that variable lease payments that depend on an index or rate should initially be measured based on the index or rate that exists at the date of commencement of the lease.

The Boards then considered whether reassessment and subsequent measurement of variable lease payments that depend on an index or rate is necessary.

While a minority of the Boards noted the added complexity / time burden of reassessing each lease each period, other Board members did not identify this as an overly complex or time intensive task. They noted the benefits of requiring reassessment, including timely delivery of more relevant information to users of financial statements given that it reflects current economic decisions and consistency with the requirement to reassess options to extend or renew a lease and the accounting for foreign exchange differences.

As such, the Boards tentatively agreed to require reassessment of variable lease payments that depend on an index or rate.

Finally, as a result of the above decision, the staff asked the Boards how to account for changes in the expected amount of such payments; recommending the following:

• For lessees:
  • recognise in profit or loss to the extent that such changes relate to the current period
  • recognise as an adjustment to the right-of-use asset to the extent that those changes relate to future periods
• For lessors:
  • recognise as an adjustment in the expected amount of the right to receive lease payments in profit or loss.

Many Board members, while agreeing with the framework, were unclear as to how to distinguish current and future period adjustments in the lessee accounting model. The staff noted that they will bring this issue back in a future discussion.

Another Board member cited concern with the lessee approach in an environment in which profit is deferred based on the reasonably assured concept outlined above. This Board member requested the staff to consider an environment in which profit is constrained in amending the above application proposal (i.e. can you always say take to profit or loss). The staff will bring this issue back in a future discussion.

Embedded derivatives

The Boards were asked to consider whether entities would be required to assess whether their lease contracts include embedded derivatives which would be bifurcated and accounted for in accordance with the guidance on financial instruments, as is currently required under both IFRSs and US GAAP.

The staff outlined little constituent feedback in this area given that the Leases ED did not provide guidance on embedded derivatives in lease contracts nor did it request feedback from constituents in this area. Staff analysis highlighted that retaining the embedded derivative assessment requirement would provide users with timely information regarding risks related to embedded derivatives, limit structuring opportunities and provide fair value information in relation to lease payments.

The Boards strongly supported retaining current guidance requiring assessment as to whether host lease contracts contain embedded derivatives in providing fair value measurement of assets and liabilities relating to lease contracts. They expressed that:

• guidance on embedded derivatives and the closely related criteria were originally introduced to prevent abuse, and this risk remains unchanged. More specifically, one Board member noted that it is needed to prevent structuring opportunities in structuring a derivative as a lease
• variances would exist between the measurement approach (proposed above) and fair value measurement.

While the Boards supported requiring assessment as to whether host lease contracts contain embedded derivatives, one Board member expressed a desire to provide clarity in any final standard as to the appropriate accounting guidance to apply in accounting for embedded derivatives considering the scope of IFRS 9 Financial Instruments and IAS 39 Financial Instruments: Recognition and Measurement is limited to financial instruments as opposed to a lease liability.

THURSDAY, 21 JULY 2011 (IASB-FASB)

As part of its continuing deliberations surrounding Leases ED, the Boards deliberated on the topics of the lessee presentation and disclosure.

The Boards made a number of tentative decisions during these deliberations, as follows:

Statement of Cash Flows:

• The allocation of principal and interest of cash paid for lease payments within the statement of cash flows would be made in accordance with current applicable IFRS or US GAAP requirements.
• The cash paid for variable lease payments excluded from the measurement of the right-of-use asset and the liability to make lease payments would be classified as an operating cash flow.
• The acquisition of a right-of-use asset in exchange for a lease liability would be disclosed in an additional non-cash disclosure in the statement of cash flows.
• The cash outflows for short-term leases not included in the liability to make lease payments would be included in the operating section of the statement of cash flows.

Statement of Financial Position:

• The leases standard would require that lease assets and lease liabilities be separately presented in the statement of financial position or notes to the financial statements. If not presented on the face of the statement of financial position, the amounts disclosed in the notes would indicate in which line item in the statement of financial position the relevant assets and liabilities are presented.
• The presentation of the right-of-use asset would be classified in a consistent manner to classification had the entity owned the asset.
• The Boards would not clarify in the final standard whether the right-of-use asset recognised by the lessee represents a tangible or intangible asset; instead describing the asset’s nature.

Disclosures:

The Boards discussed certain disclosure requirements from the Leases ED and tentatively decided on the following:

• Retain the requirements in the Leases ED to reconcile the beginning and ending balances of right-of-use assets by underlying asset type and the liability to make lease payments, absent a requirement to disaggregate the reconciliation of the lease liability by underlying asset type
• Include a requirement to disclose a maturity analysis of undiscounted amounts to be paid that are included in the liability to make lease payments
• Include a requirement to disclose time bands for the maturity analysis of liabilities to make lease payments for a minimum annual disclosure of the first five years and the total of the amounts for the remaining years
• FASB requirement: Disclose separately in the maturity analysis undiscounted contractually obligated fixed amounts related to leases that have not yet commenced. The IASB was not supportive of this disclosure requirement.
• Consistent with the Leases ED, not require disclosure of discount rates used to calculate the liability to make lease payments
• Retain the disclosure requirements in paragraphs 73(a)(ii) – 73(a)(iii) of the Leases ED (i.e., disclosing the basis and terms on which contingent rentals are determined and the existence and terms of options, including renewal and termination). The staff intend to provide aggregation guidance and / or illustrations of the proposed disclosures
• Remove the requirements in the Leases ED to disclose (a) the existence and principal terms of any options for the lessee to purchase the underlying asset and (b) initial direct costs incurred on a lease
• Include a requirement to separately present or disclose interest expense and interest paid related to leases
• Consistent with the Leases ED, include a requirement to separately present interest and amortisation (i.e., not combined and presented as lease expense)
• Include a requirement to disclose rental expense incurred under short-term leases during the reporting period, with a qualification note that indicates if there are circumstances or expectations present that would indicate that the entity’s short-term practices would result in a material change in the next reporting period
• Disclosures relating to some arrangements that are no longer determined to contain a lease (as a result of consequential amendments to non-lease guidance) would be outside the scope of the leases standard.

Statement of Cash Flows

The staff discussed the presentation for lessees of cash paid for leases in the statement of cash flows and other supplemental cash flow disclosures. Leases ED proposed that a lessee shall classify cash payments for leases as financing activities in the statement of cash flows and present them separately from other financing cash flows. However, the staff identified four issues with cash flow requirements for lessees based on constituent feedback and past Board tentative decisions. These issues included:

• Interest – Should the cash paid for leases that is classified as a financing activity include amounts for interest?
• Variable lease payments – Should amounts for variable lease payments be classified as financing activities in the statement of cash flows?
• Supplement information – Should there be an explicit statement that a right-of-use asset capitalised during the period should be reported in supplementary cash flow information as a non-cash transaction?
• Short-term leases – Should the accounting treatment of short-term leases determine the classification of the associated cash flows?

Interest:

Many Board members expressed concern with mandating the classification of interest paid for leases since this decision is outside of the scope of the leases project. However, specifying the classification of the principal portion of the liability to make lease payments would be appropriate because similar liabilities are classified in this manner in current practice.

Other Board members focused on the need to provide clarity to users as to all cash components of leases by way of an aggregated disclosure. Given that staff recommendations included bifurcation of principal and cash payments in the statement of cash flows, these Board members expressed the need for one disclosure specifying all cash components of a lease, including fixed principal, variable lease payments and interest.

The Board was asked to consider whether the principal and interest should be bifurcated in the statement of cash flows. While the FASB tentatively decided that the principal and interest should be bifurcated, the IASB tentatively decided not to bifurcate payments. The FASB Chair then asked if the IASB would be opposed to allocation of principal and interest of cash paid for lease payments in accordance with current applicable IFRS or US GAAP requirements. The IASB did not oppose this view.

Variable lease payments:

The staff noted, as a result of previous tentative Board decisions, the value of the right-of-use asset and the liability to make lease payments should only include amounts for variable lease payments that are index based (in addition to disguised fixed payments). Since the liability to make lease payments does not include other variable lease payments, the staff outlined that there is no settlement of a financing liability by the lessee when those variable lease payments are made, and therefore, it would be inappropriate to include those cash flows in the financing section of the statement of cash flows. However, given that users would like information about variable lease payments, based on outreach performed, the staff recommended that cash paid for variable lease payments excluded from the measurement of the right-of-use asset and the lease liability to make lease payments be classified as an operating activity. Period expenses arising from variable lease payments that were not included in the measurement of the right-of-use asset and liability to make lease payments should be presented separately in profit or loss or disclosed in the notes to the financial statements.

Many Board members were concerned with presenting fixed payments in one section of the statement of cash flows (i.e., financing), while presenting variable lease payments in another section (i.e., operating). Another Board member saw it as ‘penalising’ to include variable lease payments in operating cash flows since operating cash flows are a focal point for investors. However, other Board members saw variable lease payments as unique from fixed payments, as such variable payments (which were not included in the right-of-use asset) are often based on performance results, such as variable rent payments based on sales during the quarter. These Board members saw variable payments as more akin to period costs and an operating cash flow.

The Boards tentatively agreed that cash paid for variable lease payments excluded from the measurement of the right-of-use asset and the liability to make lease payments would be classified as an operating cash flow. However, the Boards also tentatively decided that period expenses for variable lease payments not included in the right-of-use asset and corresponding liability, along with fixed principal payments, would be disclosed in the notes to the financial statements under a comprehensive disclosure.

Noncash information:

With little debate, the Boards tentatively agreed that the acquisition of a right-of-use asset in exchange for a lease liability would be disclosed in an additional non-cash disclosure in the statement of cash flows.

Short-term leases:

With little debate, the Boards tentatively agreed that cash outflows for short-term leases not included in the liability to make lease payments would be included in the operating section of the statement of cash flows, as there is not a settlement of the liability to make lease payments. The Boards confirmed that this decision was limited to lessees who took the Board’s practical expedient from reporting short-term leases within the statement of financial position.

In making all of the above decisions, the FASB Chair expressed a desire to have user feedback on these decisions to ensure coherency. Likewise, another Board member asked that the staff bring back a separate paper to provide a comprehensive disclosure which would highlight both expenses and cash flows for lessees and where recognised in the financial statements.

Statement of Financial Position

The staff discussed the presentation for lessees’ right-of-use assets and liabilities to make lease payments in the statement of financial position. Based on comment letter feedback, the staff identified the following issues for discussion by the Boards:

• Disaggregation of right-of-use assets and liabilities to make lease payments
• Presentation of the right-of-use asset
• Characterisation of the right-of-use asset

The Boards considered whether the final lease standard should require that lease assets and lease liabilities be separately presented in the statement of financial position or notes to the financial statements. All Board members agreed that these assets and liabilities have unique measurement attributes and are viewed differently than other assets in certain circumstances (e.g., bankruptcy), and consequently, preferred separate presentation.

Thus, the Boards tentatively agreed that the leases standard would require that lease assets and lease liabilities be separately presented in the statement of financial position or notes to the financial statements. If not presented on the face of the statement of financial position, the amounts disclosed in the notes should indicate in which line item in the statement of financial position the relevant assets and liabilities are presented in. The Boards noted that preparers should follow applicable guidance prescribed in other standards in determining if presentation on the face of the statement of financial position is required.

In considering the presentation of the right-of-use asset, the staff asked the Boards to consider whether the right-of-use asset should be presented in its own asset class and not as part of property, plant and equipment in the statement of financial position. The Boards noted that the right-of-use asset should be presented such that the economic benefits arising from both leased and owned assets are shown similarly (i.e., the nature of the future economic benefit the entity will receive from the lease of an asset during the lease term and the function the asset serves is similar to that of owned assets, and therefore should be presented consistently).

In order to show how the asset is being used by the entity, the Boards tentatively agreed that the presentation of the right-of-use asset would be classified in a consistent manner to classification had the entity owned the asset (if a building if owned, then it would be classified as a building when leased).

Finally, the Boards discussed whether the right-of-use asset should be considered a tangible or intangible asset. This was considered to be a crucial issue in regulated industries, such as financial institutions, given consideration to regulatory capital and taxation. In deliberations, the Boards considered the relevant presentation to be indicative of a regulatory issue and it was not the position of the Boards to dictate presentation for regulatory capital purposes. One Board member noted that the Boards should define exactly what the right-of-use asset is and leave it to regulators to determine presentation for regulatory assessment. Thus, consistent with current guidance in IAS 17 and ASC Topic 840, the Boards decided it was not necessary to clarify whether the right-of-use asset recognised by the lessee represents a tangible or an intangible asset.

Disclosures

The Boards discussed a number of lessee disclosure requirements, including that of disclosure requirements for short-term leases. As part of these deliberations, the staff presented the following recommendations to the Boards based on analysis performed:

• Retain the requirements in the Leases ED to reconcile the beginning and ending balances of right-of-use assets by underlying asset type and the liability to make lease payments, absent a requirement to disaggregate the reconciliation of the lease liability by underlying asset type
• Include a requirement to disclose a maturity analysis of undiscounted amounts to be paid that are included in the liability to make lease payments
• Retain the time bands for the maturity analysis of liabilities to make lease payments proposed in the Leases ED (i.e., annually, for the first five years and the total of the amounts for the remaining years)
• Disclose separately in the maturity analysis undiscounted contractually obligated fixed amounts related to leases that have not yet commenced
• Consistent with the Leases ED, not require disclosure of discount rates used to calculate the liability to make lease payments
• Retain the disclosure requirements in paragraphs 73(a)(ii) – 73(a)(iii) of the Leases ED (i.e., disclosing the basis and terms on which contingent rentals are determined and the existence and terms of options, including renewal and termination). The staff intend to provide aggregation guidance and / or illustrations of the proposed disclosures
• Remove the requirements in the Leases ED to disclose (a) the existence and principal terms of any options for the lessee to purchase the underlying asset and (b) initial direct costs incurred on a lease
• Include a requirement to separately present or disclose interest expense and interest paid related to leases
• Consistent with the Leases ED, include a requirement to separately present interest and amortisation (i.e., not combined and presented as lease expense)
• Include a requirement to disclose rental expense incurred under short-term leases during the reporting period, with a qualification note that indicates if there are circumstances or expectations present that would indicate that the entity’s short-term practices would result in a material change in the next reporting period
• Disclosures relating to some arrangements that are no longer determined to contain a lease (as a result of consequential amendments to non-lease guidance) would be outside the scope of the leases standard

In deliberation of all of the above recommendations, the Boards expressed the following primary concerns:

• One Board member noted the importance of requiring disclosure of the range of discount rates used to calculate the liability to make lease payments, as it provides information about the cost of leased capital.
• One Board member preferred requiring disclosure of purchase options on leased assets as it provides information about lessee flexibility in future commitment obligations.
• One Board member preferred requiring disclosure of the fair value related to provisions of arrangements that are accounted for as a lease, similar to that required for debt, but other Board members noted that the removal of the disclosure of optionality limits the usefulness of a fair value disclosure.
• Multiple Board members expressed a desire to have the time band disclosure for the maturity analysis of liabilities to make lease payments provide for a minimum five-year time band. Specifically, preparers should consider whether an extended time band disclosure is necessary for users to its financial statements.
• Many Board members expressed concern regarding inclusion of a time band disclosure which would exclude variable lease payments, short-term leases and non-lease (executory) costs. Significant Board debate occurred on this topic, as certain Board members wanted all future cash commitments included, while others felt the inclusion of all future cash commitments, including executed contracts in which the lease term has not yet commenced, would result in significant estimates on the part of management (comparability issue) and enhance the burden which the Board was attempting to alleviate with previous tentative decisions (e.g., short-term lease exemption and variable lease payment recognition).
• Many Board members were concerned that disclosures would be disaggregated throughout the financial statements. Thus, they preferred the existence of one aggregated disclosure that highlights all expenses incurred and cash paid in relation to lease arrangements.

In consideration of all of the above deliberations, the Boards tentatively agreed with all of the staff recommendations, absent the following:

• Instead of specifying retention of a five-year time band for the maturity analysis of liabilities to make lease payments proposed in the Leases ED, the Boards decided to require a minimum time band of five-years and thereafter, but preparers would consider if an elongated time band is required to assist users in understanding future commitments (if significant commitments are more than five-years out).
• The Boards were split on requiring disclosure of committed cash flows related to services of the lessee (i.e., a maturity analysis of the undiscounted contractually obligated fixed amounts related to leases that have not yet commenced), with the FASB supportive of this disclosure and the IASB not supportive of this disclosure. The FASB noted that this is a required disclosure of the US Securities and Exchange Commission, and thus, is included in the front-half of the financial statements (unaudited). However, FASB members voted to include this disclosure in the back half of the financial statements as an audited disclosure.

Discussion at September 2011 IASB Meeting

MONDAY, 19 SEPTEMBER 2011 (IASB-FASB)

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards discussed the potential inclusion of inventory within the scope of the leasing standard, the applicability of financial asset guidance to the right to receive lease payments, lessor subsequent measurement issues and lessor accounting for residual value guarantees.

Scope - inventory

The Boards discussed whether a right-of-use asset under a lease arrangement could simultaneously also meet the definition of inventory and whether assets such as non-depreciating spare parts, operating materials and supplies associated with the leasing of another underlying asset (generally characterised as 'inventory' in existing practice) should be excluded from the scope of the leases standard.

The staffs provided their analysis indicating that, for lessors, they did not think that a lessor could have inventory out on a lease. Likewise, for lessees, the staffs did not think that a right-of-use asset subject to a lease agreement could also meet the definition of inventory. As such, the staffs, summarising examples and outreach activities with preparers and accounting firm constituents to discuss current arrangements marketed or labelled as 'leases of inventory', concluded that few, if any, transactions would meet the definition of a lease as tentatively defined at the April 2011 joint meeting (and would therefore not be subject to the final lease guidance). Further, those that do meet the definition of a lease would not be for an underlying asset that simultaneously meets the definition of inventory. Thus, the staffs concluded that an underlying asset subject to a lease arrangement could not simultaneously also meet the definition of inventory provided in IFRSs or US GAAP. As such, the staffs recommended that no scope exclusion for non-depreciating spare parts and other similar assets should be provided within the final lease standard given a lack of assessed need.

One IASB member provided an example of a lease of equipment in which the lessee receives spare parts with a right to return those parts if not used (i.e., a put option on spare parts). The IASB member noted that the revenue project would classify the put option as a lease. However, the above staff analysis would conclude that the put could not be a lease. Several Board members saw the revenue and leasing guidance to be asymmetrical, but expressed that the put option was effectively a purchase of the spare parts given control maintained by the lessee, and thus, did not object to the staffs' conclusion that an underlying asset subject to a lease arrangement could not simultaneously also meet the definition of inventory. The IASB member asked that specific guidance be placed in the standard for the put option example.

With few additional comments, the Boards tentatively decided that no scope exclusion would be provided for inventory given that no practical examples of lease arrangements that could simultaneously meet the definition of inventory were uncovered.

Applicability of financial asset guidance to the right to receive lease payments

The Boards discussed the potential application of existing financial asset guidance regarding initial and subsequent measurement (IFRS 9 and IAS 39 for IFRSs and Topic 825 Financial Instruments for US GAAP) to a lessor's right to receive lease payments.

The staffs recommended that the initial and subsequent measurement of the lease receivable should be excluded from the scope of IFRS 9 / IAS 39 and Topic 825, consistent with current guidance (i.e., no fair value option). In reaching this conclusion, the staffs noted that both the performance obligation and derecognition approaches included in the Leases ED proposed that the lease receivable be measured at amortised cost using the effective interest method, and few constituents expressed concern with this proposal.

Many Board members supported the staffs' recommendation. They noted that removing the scope exception for lease receivables from IFRS 9 and Topic 825 provided disadvantages such as: (a) fair value measurement would be inconsistent with the Boards' measurement of the lease receivable if the contract includes variable payments or options, (b) reassessment of the fair value each period would be complex and (c) fair value measurement could result in a Day 1 gain or loss.

However, two concerns were expressed with the staffs' recommendation. One Board member noted an inconsistency in the application model. Specifically, financial asset guidance was being used for impairment and derecognition; however, the staff recommendation was to exclude financial asset guidance for initial and subsequent measurement of the same assets. While he noted that this is consistent with treatment today, he expressed a desire to further consider the impairment of lease receivables as part of the impairment project for consistent application.

Another Board member, with support from many Board members, felt that a fair value option should exist in an environment in which lease receivables are held for sale at lease inception (e.g., securitised receivables). Given the nature of these receivables, fair valuing the receivables was seen to provide an appropriate measurement basis. However, the Board member was concerned with recognition of Day 1 gain or loss for the difference between the initial measurement of the lease receivable under the proposed guidance and the fair value of that receivable. The Board member preferred to adjust the residual asset to eliminate Day 1 gain or loss. A few Board members expressed concern with over-complicating the model in an environment in which the fair value option was not seen to be significant. However, the Board member noted that the current scope of the leases project could yield significant fair value differences given the exclusion of options from the recognised lease receivable which would be subject to fair value measurement. The Boards requested that the staffs perform further research on this issue.

With little deliberation on other staff proposals, the Boards tentatively decided that the lease receivable would be excluded from the scope of existing financial asset guidance for initial and subsequent measurement and a fair value option of general lease receivables would be prohibited.

Lessor subsequent measurement issues

Subsequent measurement, including impairment

The staffs presented feedback received from constituents regarding subsequent measurement of the right to receive lease payments and impairment (of the lease receivable and residual asset). The staffs noted that most respondents agreed with the proposals in the Leases ED (or did not comment). Those that did express concerns were generally US GAAP constituents who recommended clarification as to whether the impairment model for assessing the residual asset should be based on the impairment model for intangible assets or property, plant and equipment. Others recommended specific impairment guidance within the leases standard for the residual asset, rather than referring to existing guidance.

With little deliberation, the Boards tentatively decided that a lessor should subsequently measure the right to receive lease payments using the effective interest method, consistent with the proposals in the Leases ED and the measurement of other financial instruments.

In discussing impairment of the lease receivable and residual asset, one Board member expressed discomfort in concluding on the impairment model given that the impairment project is still being debated by both Boards. The staffs acknowledged this concern and expressed an intention to test the impairment model on leased assets once a tentative decision is reached on that project.

Other Board members considered possibilities for developing an impairment model for the residual asset, including referring to existing non-financial asset impairment guidance and developing unique impairment guidance for the residual asset in the leases standard. One FASB member, seeking a converged solution, proposed that US GAAP follow the IAS 36 Impairment of Assets model. However, other FASB members were concerned with this proposal since the IAS 36 model introduces concepts unique to US GAAP. Similarly, many FASB members were concerned with introducing a unique impairment model for leases.

While IASB members supported an IAS 36 model for impairment of the residual asset, FASB members were roughly split (4-3) on applying the property, plant and equipment impairment model or the intangible asset impairment model, with a slight majority preferring the property model given the nature of the residual asset appearing more akin to a tangible asset. Both Boards tentatively decided that the lease receivable would be assessed for impairment in accordance with IAS 39 and Topic 310, with little debate.

Variable lease payments

At the July 2011 meeting, the Boards tentatively decided that a lessor should reassess the measurement of lease payments that depend on an index or rate at the end of each reporting period. The Boards also tentatively decided that a lessee should recognise changes in those lease payments in profit or loss to the extent that those changes relate to the current reporting period and as an adjustment to the right-of-use asset to the extent that the changes relate to future reporting periods. However, the Boards did not decide how a lessor should reflect changes in the measurement of lease payments that depend on an index or a rate.

At this meeting, the Boards reversed their previous decision and tentatively decided that any changes relating to reassessment of variable lease payments that depend on an index or a rate be recognised immediately in profit or loss by a lessor. No specific discussion was provided in relation to the lessee model as part of this discussion.

Revaluation of the residual asset (IASB only)

With little debate, the IASB tentatively decided that revaluation of the residual asset would be prohibited. This was based on the fact that revaluation of the residual asset would be inconsistent with the IASB's decision regarding initial measurement and the decision against fair value measurement throughout the leases standard.

Lessor accounting: residual value guarantees

The Boards discussed how a lessor should account for RVGs provided by a lessee, a related party or a third party. As Board members recommended that the leases standard should provide guidance on the accounting by lessors for RVGs, discussions generally considered whether:

• Approach A: the lessor would include RVGs in the initial measurement of the lease receivable measured at the amounts expected to be payable under the guarantee, or
• Approach B: the lessor would not recognise RVGs before they are due from the guarantor (but considering the existence of RVGs when assessing the residual asset for impairment).

A few Board members supported Approach A as they felt it provided more transparency about the lessor's investment in the lease and results in recognition of the impact of the RVG at the time in which the gain economically occurs. However, many Board members supported Approach B since Approach A was seen as resulting in recognition of a larger gain on remeasuring the RVG than the amount of loss recognised on impairment of the residual asset. These Board members acknowledged that Approach B would generally result in deferring recognition of RVGs until the end of the lease as any impairment in the residual would be offset by a RVG, but supported Approach B given the mixed-measurement model being employed in lessor accounting. Thus, the Boards tentatively decided that the lessor would not recognise RVGs before they are due from the guarantor.

WEDNESDAY, 21 SEPTEMBER 2011 (IASB-FASB)

As part of its continuing deliberations surrounding the Leases ED, the Boards discussed the presentation of a lessor's lease receivable and residual assets (collectively, lease assets) in the statement of financial position, classification of cash received for lease payments by a lessor in the statement of cash flows, as well as lessee transition requirements.

Presentation: Lessor statement of financial position

The Boards discussed the presentation of a lessor's lease receivable and residual assets in the statement of financial position. The Boards discussed three alternatives for presentation: (1) presenting lease assets under a single caption in the statement of financial position, (2) requiring presentation of the residual asset as it would be presented at expiry of the lease or (3) not specifying the line items for presentation of the residual assets and the lease receivable.

Many Board members expressed a belief that presenting the lease receivable and residual assets together is a more meaningful presentation, given that it provides users with an aggregated view of contractual cash flows to be generated from the lease asset and the value of the leased asset at the end of the lease term. Likewise, it summarises the lessor's total interest in an asset to which it has legal title.

Other Board members expressed a preference for a 'business model' presentation of the residual asset (i.e., requiring presentation of the residual asset as it would be presented at expiry of the lease). These Board members noted that allowing entities to present the residual asset consistent with the way the entity would present the residual asset at expiry of the lease would be consistent with the Boards' tentative decision that a lessee would present the right of use asset as if it owned the underlying asset and would allow for different industries and entities to present information in a meaningful way to relevant financial statement users. Similarly, a few Board members expressed a preference to not prescriptively require presentation of the residual assets and the lease receivable given that application in certain industries may result in misleading results.

However, many Board members expressed concern with requiring presentation of the residual asset as it would be presented at expiry of the lease or not specifying the line items for presentation of the lease assets given that it would negatively impact comparability. Thus, when put to a vote, the Boards tentatively decided lease assets should be presented under a single caption in the statement of financial position (to improve comparability), absent potential disaggregation in the statement of financial position.

The Boards then discussed disaggregation of amounts related to leases either in the statement of financial position or within the notes to the financial statements. Board members generally agreed that lease receivables and the residual asset should be disaggregated at some level in the financial statements given that residual assets and lease receivables have different risks (asset versus credit risk) and the nature of the assets are dissimilar.

With little debate, the Boards tentatively decided that disaggregation of the lease receivable and residual assets in the statement of financial position should not be required unless aggregated presentation distorts the view of users of the financial statements. Thus, the final leases standard would require that the residual assets and the lease receivable be separately presented either in the statement of financial position or disclosed in the notes to the financial statements. However, lessors would be required to apply the guidance provided in IAS 1 (IFRSs only) and SEC regulations (US GAAP only), as well as management judgements in determining whether disaggregation is required in the statement of financial position.

Classification: Lessor statement of cash flows

The Boards discussed the classification of cash received for lease payments by a lessor in the statement of cash flows. The Leases ED, which proposed that the lessor should classify the cash receipts from lease payments as operating activities in the statement of cash flows, resulted in feedback from many constituents as to inconsistency with presentation of cash inflows for loans receivable as investing activities. Thus, based on this feedback, the Boards considered:

• presenting all cash received for lease payments as operating activities, or
• presenting all cash received for lease payments as operating activities unless certain conditions are met (if the entity makes an up-front cash payment for legal title to an asset, the purchase of title to the asset is directly linked to that entity becoming the lessor of the asset and that payment to purchase the asset is an investing activity, then inflows should be classified as investing activities).

Board members generally supported presentation of all cash received for lease payments as operating activities as they saw this presentation to be a simplification of the accounting model which would eliminate diversity in practice.

However, the FASB Chair expressed concern with classifying all cash received for lease payments as an operating activity given potentially contradicting guidance for securitised receivables. Many Board members agreed with this concern. Thus, the Boards tentatively agreed that all cash received for lease payments should be classified as an operating activity, except those cash flows relating to securitised receivables (in which existing guidance would apply).

Lessee transition issues

The Boards discussed transition requirements and disclosures for lessees upon adoption of the proposed leases' requirements. However, no decisions were made during these discussions as Board members requested that comprehensive transition proposals be provided covering both lessees and lessors before any vote is taken on the topic.

The staffs presented three proposals to the Boards for general transition requirements:

• Modified full retrospective approach: The modified full retrospective approach was considered to be generally consistent with the requirements of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors and Topic 250 Accounting Changes and Error Corrections, where entities would be required to calculate the carrying amount of all outstanding leases as if those leases had always been accounted for in accordance with the proposed requirements. However, certain transitional reliefs were proposed by the staffs
• Modified retrospective approach: The modified retrospective approach uses key inputs at the date of initial application to approximate the transitional impact as opposed to applying inputs as if those leases had always been accounted for in accordance with the proposed requirements. Furthermore, certain transitional reliefs were proposed by the staffs
• Optional full retrospective approach: Entity option to apply either of the above alternatives.

Many Board members expressed concern that the modified full retrospective approach may be too onerous for financial statement preparers, which was consistently communicated by constituents during project outreach. However, other Board members noted that a number of the tentative decisions reached during redeliberations would be expected to make 'full retrospective application' less onerous. Other Board members questioned the value of full retrospective application to users of the financials. These Board members believed that the modified retrospective approach provided sufficient information to users of the financials.

Finally, a number of Board members questioned whether the transition guidance for lessees should be consistent with transition guidance in the revenue recognition project as well as the lessor accounting model. With this, many Board members expressed a desire to defer voting on lessee transitional requirements until a comprehensive transition proposal is provided which includes both the lessee and lessor accounting models, including considerations to subleases. As such, voting was deferred on this topic.

Discussion at October 2011 IASB Meeting

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED) the boards discussed several lessor and lessee related topics including:

(1)	The proposed receivable and residual approach
(2)	How the receipt of variable lease payments impact the subsequent measurement of the residual asset
(3)	Lessor presentation in the statement of comprehensive income
(4)	Fair value requirement for lease receivable held for sale
(5)	Transition requirements for both lessee and lessor.

Receivable and residual approach

Decisions

• Initially measure the residual asset as an allocation of the carrying amount of the underlying asset. The initial measurement of the residual asset comprises two amounts: (a) the gross residual asset, measured at the present value of the estimated residual value at the end of the lease term discounted using the rate the lessor charges the lessee, and (b) the deferred profit, measured as the difference between the gross residual asset and the allocation of the carrying amount of the underlying asset.
• Subsequently measure the gross residual asset by accreting to the estimated residual value at the end of the lease term using the rate the lessor charges the lessee. The lessor would not recognise any of the deferred profit in profit or loss until the residual asset is sold or re-leased.
• Present the gross residual asset and the deferred profit together as a net residual asset.
• The Boards also tentatively decided that there should be no distinction between when profit is or is not reasonably assured in accounting for a lease contract by a lessor.
• The FASB and the IASB tentatively decided that a lessor's lease of investment property would not be within the scope of the receivable and residual approach. Instead, for such leases the lessor should continue to recognise the underlying asset and recognise lease income over the lease term.

Discussion

The boards had tentatively decided on the receivable and residual approach ("R&R") at prior meetings. The staff has received input on these decisions from outreach they performed. The staff summarised the outreach which reflected concern regarding the reasonably assured/not reasonably assured criteria, including difference between leases and revenue recognition, auditability of the criteria, and the perceived option to elect a model. Based on the outreach the staff recommended certain modifications to the R&R approach.

The boards discussion first focused on how to measure the residual asset and how to subsequently accrete the residual asset. The staff presented 4 options:

Approach A – Initially measure the residual asset by determining what the future depreciated carrying amount would be at the end of the lease term as if it were not subject to lease accounting and then discount this based on the rate the lessor charges the lessee. The residual asset is subsequently accreted.

Approach B – initially measure the residual asset as the present value of the estimated fair value at the end of the lease term. The residual asset is subsequently accreted.

Approach C – Initially measure the residual asset at an allocation of the carrying amount. The residual asset would not be subsequently accreted.

Approach D – Initially measure the residual asset at the present value of the estimated fair value at the end of the lease term. Additionally the manufacturing profit of the underlying asset is allocated between the receivable and the residual asset. The profit associated with the residual asset is deferred until the underlying asset is sold or re-leased.

The boards were split between approach A & D or retaining the previous decisions. Several board members preferred approach D because it would result in consistent interest income recognition between a manufacturer and a financial institution and a consistent balance of the residual asset at the end of the lease term. Other board members were concerned that there needed to be a constraint on profit recognition. After a lengthy discussion a majority of board members voted for approach D.

The other significant decision was regarding the staff's recommendation to provide a scope exception from the proposed lessor accounting for a lessor's lease of multiple leases of physically distinct portions. These lessors would apply current operating lease accounting. The Boards agreed that the proposed R&R approach would result in many operational challenges for these lessors. Additionally other board members believed that there were different economics with these arrangements. However, the boards were concerned with trying to define multi-tenant properties. Therefore they tentatively decided to provide the scope exception for investment properties as defined in IAS 40 and the proposed FASB's Investment property entity project.

Variable lease payments and the measurement of the residual asset

Decisions

• If the rate the lessor charges the lessee does not reflect an expectation of variable lease payments, the lessor would not make any adjustments to the residual asset with respect to variable lease payments.
• If the rate the lessor charges the lessee reflects an expectation of variable lease payments, the lessor would adjust the residual asset on the basis of its expectation of variable lease payments by recognising a portion of the cost of the residual asset as an expense when variable lease payments are recognised in profit or loss. Any difference between actual and expected variable lease payments would not result in any further adjustment to the residual asset with respect to variable lease payments.

The boards had concerns about the staff's recommended approach to account for variable lease payments and the subsequent measurement of the residual asset. The biggest concern was the complexity of the proposal. Other board members were concerned with the inconsistency this would create with the lessee model. The boards were initially split in their votes (IASB in favour of the staff's recommendation and the FASB opposing). However the FASB board members changed their vote so that there would be convergence in this decision.

Presentation statement of comprehensive income

Decisions

• The accretion of the residual asset as interest income
• The amortisation of initial direct costs as an offset to interest income
• Lease income and lease expense (for example, revenue and cost of sales) in the statement of comprehensive income either in separate line items (gross) or in a single line item (net), on the basis of which presentation best reflects the lessor's business model
• A lessor should separately identify income and expenses arising from leases by either separate presentation in the statement of comprehensive income or disclosure in the notes to the financial statements. If disclosed, the notes should reference the line item in which the income is presented.

Fair value requirement for lease receivables held for sale

Decisions

• Should not measure a lease receivable at fair value, even if part or all of that receivable is held for the purpose of sale
• Should apply existing derecognition requirements (in IFRS 9 Financial Instruments, or FASB Accounting Standards Codification® Topic 860, Transfers and Servicing) to lease receivables, but allocate the carrying amount of a lease receivable on the basis of its fair value excluding any option elements and variable lease payments that are not transferred
• Should apply the disclosure requirements in IFRS 7 Financial Instruments: Disclosures, and Topic 860 for transferred lease receivables.

Lessee transition

Decisions

• The Boards tentatively decided that for capital/finance leases existing at the beginning of the earliest comparative period presented, a lessee would not be required to make any adjustments to the carrying amount of lease assets and lease liabilities and should reclassify those lease assets and lease liabilities as right-of-use assets and liabilities to make lease payments.

The Boards tentatively decided that for operating leases existing at the beginning of the earliest comparative period presented, a lessee should:

• Recognise liabilities to make lease payments at transition measured at the present value of the remaining lease payments, discounted using the lessee's incremental borrowing rate as of the effective date for each portfolio of leases with reasonably similar characteristics. The incremental borrowing rate for each portfolio of leases should consider the lessee's total leverage, including leases in other portfolios.
• Recognise right-of-use assets equal to the proportion of the liability to make lease payments at lease commencement calculated on the basis of the remaining lease payments.
• Record to retained earnings any difference between the liabilities to make lease payments and the right-of-use assets at transition.
• A lessee could also choose to apply the requirements in the proposed lease standard retrospectively in accordance with IAS 8 or ASC 250.

The boards also tentatively decided to provide the following reliefs when adopting the lease standard:

• An entity is not required to evaluate initial direct costs for contracts that began before the effective date
• An entity may use hindsight in comparative reporting periods including the determination of whether or not a contract is or contains a lease.

Lessor transition

Decisions

• The Boards tentatively decided that for finance/sales-type and direct finance leases existing at the beginning of the earliest comparative period presented, a lessor would not be required to make adjustments to the carrying amount of the assets associated with those leases.

For operating leases existing at the beginning of the earliest comparative period presented, the Boards tentatively decided that a lessor should:

• Recognise a right to receive lease payments, measured at the present value of the remaining lease payments, discounted using the rate charged in the lease determined at the date of commencement of the lease, subject to any adjustments required to reflect impairment.
• Recognise a residual asset consistent with the initial measurement of the residual asset under the receivable and residual approach, using information available at the beginning of the earliest comparative period presented.
• Derecognise the underlying asset.
• A lessor could also choose to apply the requirements in the proposed lease standard retrospectively in accordance with IAS 8 or ASC 250.

Several board members favoured full retrospective approach to adopt the proposed lease standard. However, there was concern about the cost of this approach therefore the boards tentatively decided on providing an option between the modified approach and full retrospective.

The FASB board also noted that these decisions did not change the previous decisions relating to leverage leases.

Discussion at 1 November 2011 Special Joint IASB-FASB Meeting

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards discussed: (1) disclosure requirements for lessors, (2) transition accounting for both lessees and lessors and (3) transition accounting for sale and leaseback transactions. The Boards made a number of tentative decisions, including the following:

Lessor accounting: Disclosures

A lessor should disclose:

• lease income generated from the entity's leasing activities (in tabular form) disaggregated by (a) profit recognised at lease commencement, (b) interest income on the lease receivable, (c) accretion of the residual asset, (d) variable lease income for amounts not initially recorded in the lease receivable and (e) short-term lease income.
• fixed-price purchase options which exist on underlying leases.
• information about variable lease payments and lease term options included in paragraph 73(a)(ii) – 73(a)(iii) of the Leases ED (i.e., disclosing the basis and terms on which contingent rentals are determined and the existence and terms of options, including renewal and termination options).
• a reconciliation between the beginning and ending balances of the lease receivable and residual asset.
• a maturity analysis of undiscounted cash flows that are included in the lease receivable, with reconciliation to the amounts reported in the statement of financial position for the lease receivable. Time bands for the maturity analysis should, at a minimum, include each of the first five years following the reporting date and the total of the amounts for the remaining years.
• how it manages its exposure to the underlying asset, including:
• its risk management strategy;
• the carrying amount of the residual asset that is covered by residual value guarantees and the unguaranteed portion of the carrying amount of the residual asset; and
• whether the lessor has any other means of reducing its exposure to residual asset risk (e.g., buyback agreements with the manufacturer from whom the lessor purchased the underlying asset or options to put the underlying asset to the manufacturer).

However, disclosure would not be required for:

• initial direct costs incurred in the reporting period and included in the lease receivable.
• the fair value of the lease receivable or the residual asset.
• the range or the weighted average of discount rates used to calculate the lease receivable.

Transition: Other considerations

• The transition exception in FASB Accounting Standards Codification (ASC) Topic 840-10-25 Leases (formerly Emerging Issues Task Force (EITF) Issue 01-8 Determining Whether an Arrangement Contains a Lease) would not be retained in the final standard (FASB only).
• No transition guidance would be provided in the final leases standard for short-term leases, investment property measured at fair value, subleases, useful lives of leasehold i