• 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

Background

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 amortized 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 recognized 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 upfront 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 recognized 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 amortization/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.