• 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

Timetable

• Click for IASB Project Timetable

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 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 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.

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 derecognizing the full carrying amount of the leased asset and recognizing 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 derecognizes 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.