Contingent rentals and residual value guarantees
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.
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.