As part of its continual deliberations surrounding the Leases ED, the Boards deliberated on the following topics:
- Types and classification of leases
- Initial and subsequent measurement and presentation of lessee accounting
- Initial and subsequent measurement and presentation of lessor accounting
The Boards made a number of tentative decisions in the conduct of these deliberations, as summarised below:
Types of leases and distinguishing lease types
Lessee accounting model, other-than-finance leases
Lessee accounting model, finance leases
Lessor accounting model, other-than-finance leases
Types and classification of leases
In a February 2011 joint meeting of the Boards, the Boards introduced two different types of leases (absent short-term leases), which were referred to as finance and other-than-finance leases (although the naming convention of such lease types will be considered further in a future meeting). Targeted outreach on this distinction revealed that most respondents were supportive of having two types of leases, but noted certain disadvantages of a two-type model, including added complexity.
Considering this feedback, the staff presented a draft definition to be used in distinguishing finance and other-than-finance leases, as well as supporting indicators in distinguishing between the two; noting, generally, that the assessment should be based on the business purpose of the contract and a review of indicators including the lessor business model, residual asset, potential ownership transfer, length of lease term, underlying asset, variable rent, rent characteristics (e.g., benchmarking of rent payments) and embedded or integral services.
Several Board members expressed concern that the assessment of two unique lease types added too much complexity to an environment in which the underlying purpose of leasing, from a lessee perspective, is generally financing, and therefore, proposed that only one type of lease be recognised for lessee modelling. Likewise, Board members were concerned with creating new bright-lines for structuring purposes and developing appropriate conceptual arguments to support different classifications of leases.
Several Board members, however, noted unique classifications of leases would provide results which are more consistent with current business models and would allow for differentiating the profit and loss recognition pattern to the underlying economics of the lease transactions and relevant levels of asset risk and reward; both under a lessor and lessee accounting model.
As a result, the Boards tentatively decided that two types (classifications) of lessee and lessor accounting models exist; a finance and other-than-finance lease (although naming convention will be re-evaluated in a future meeting).
In distinguishing whether a lease should be accounted for as a finance lease or an other-than-finance lease, the Boards considered classification criteria, including a determination based on the business purpose for the lease transaction and the transfer of substantially all of the risks and rewards of ownership, but several Board members expressed concern as to the operationality of such a determination. The majority of the Boards discussed a preference to base distinction in classification according to the transfer of substantially all of the risks and rewards of ownership, and noted a preference to continue application of the IFRS guidance as outlined in IAS 17, paragraphs 7 - 12. One Board member expressed concern that any final standard, in application of IAS 17's classification criteria, should also include outreach assessment around items external to current IAS 17 indicators, including bundled services and variable rent.
The Boards tentatively decided that the determination of whether a lease is a finance or other-than-finance lease should be based on the existing indicators in paragraphs 7-12 of IAS 17.
The Boards analysed approaches for the initial and subsequent measurement and presentation of both other-than-finance and finance leases in the financial statements of a lessee.
The Boards deliberated on multiple approaches regarding how a lessee should initially and subsequently measure and present an other-than-finance lease. A minority of Board members supported a right of use asset that would be amortised on a straight-line basis through other comprehensive income (OCI). These members highlighted that application of an OCI presentation would serve to specifically highlight the nature of such modelling application to users of the financial statements, while providing comparability for all lease transactions within the income statement and statement of financial position, but the majority of the Boards expressed concern with presentation within OCI given that the purpose of OCI has not been clearly defined and is often criticised as being a placeholder to reflect items that would otherwise cause unwanted volatility in earnings.
Another minority of Board members preferred application of a right of use asset and liability to make lease payments that were linked at inception of the lease and amortised independently of the measurement of the liability for lease payments, believing it better reflected the consumption of benefits over the lease term and the time value of money. A majority of the Boards rejected this approach based on the application of an effective annuity depreciation over the term of the lease which was inconsistent with current guidance.
After exploring these possibilities, the Boards considered approaches which reflect the utilisation of benefits by allocating costs of an asset over its useful life in a way that reflects both the consumption of economic benefits and the time value of money, while also reflecting lease payments in a manner consistent with underlying IAS 17 guidance. One member suggested that for other-other-finance leases, both the liability to make lease payments and the right-of-use asset should be initially measured at the present value of lease payments. The liability to make lease payments should be measured using the effective interest method and amortisation of the right-of-use asset should be based on the difference between the straight-line amount and the interest expense amount. The Boards tentatively decided to apply the above model.
The Boards also tentatively decided that recorded expenses under the above model should be presented in a single-line item (as opposed to reflection of amortisation and interest expense as separate line items) by lessees as operating (rent) expense within profit or loss for all other-than-finance leases. This conclusion was reached given the principles underlying an other-than-finance lease.
The staff recommended that the Boards confirm the proposals in the Leases ED for the initial and subsequent measurement of assets and liabilities arising for a lessee in a finance lease, as summarised above.
The staff presented, given feedback received in outreach activities, an effective interest and a fair value method for subsequent measurement of the liability to make lease payments under finance leases. The Boards, considering that an effective interest method is consistent with the principle of a finance lease and conceptually consistent with other borrowing or financing activities that a lessee would enter into, noted that interest expense would represent useful information about the financing component of a finance lease. Board members noted that a fair value approach would be costly and inconsistent with the initial measurement of the liability to make lease payments and the subsequent measurement of many other non-derivative financial liabilities. Thus, the Boards tentatively agreed that the final standard require the lessees in a finance lease to measure the liability to make lease payments at the present value of lease payments, while the subsequent measurement of a liability to make lease payments should be measured using the effective interest method.
The Boards also considered the measurement of the right-of-use asset on a systematic basis in accordance with IAS 38 Intangible Assets, as compared to a straight-line expense for the lessee. Board members noted that the former was consistent with the amortisation of a lessee's owned assets and other non-financial assets and is also consistent with the initial measurement of the right-of-use asset at cost. Thus, the Boards tentatively decided that the right-of-use asset should be initially measured at the present value of lease payments, with subsequent measurement using a systematic and rational amortisation/depreciation method.
The Boards discussed approaches for the initial and subsequent measurement and presentation of both other-than-finance and finance leases in the financial statements of a lessor.
Board members discussed presentational requirements in an other-than-finance lease. While the Boards were unable to reach a tentative decision as to whether the lease receivable and lease contract liability should be presented on a net basis or whether the lessor should follow current operating lease accounting treatment (no receivable and liability would be recognised), the Boards tentatively decided that lease receivables and lease contract liabilities should not be presented on a gross basis, as originally presented in the Leases ED, given that it results in double counting of the lessor's assets and the carrying amount of the lessor's receivables and the underlying assets are supported by the same set of cash flows. Consequently, if the underlying asset were viewed in isolation, it could be argued to be impaired.
The Boards will discuss this issue in a future meeting, as no further decisions were reached regarding the above topic or the underlying presentation and measurement of other-than-finance leases in lessor accounting.
For finance leases (previously referred to as the derecognition approach in the Leases ED), the Boards discussed the initial and subsequent measurement of assets and liabilities recognised by a lessor for finance leases. The staff explained that a lessor could account for the underlying asset for finance leases in two ways; by derecognising the entire carrying amount of the underlying asset or derecognising only a portion of the carrying amount of the underlying asset (e.g., the right-of-use portion that was transferred to the lessee).
Several members of the Boards immediately rejected a 'full' derecognition approach to lessor accounting (e.g., derecognising the entire underlying asset) because of concerns that the lessor would recognise a gain / profit on initial recognition of the lease contract equal to the difference between the carrying amount of the underlying asset and its fair value even when only a portion of the underlying asset has been transferred (does not faithfully depict the transfer of benefits to the lessee). Opposing views noted that all material risks and rewards should be transferred in a finance lease, so would the residual portion of the underlying asset that has not been transferred be material.
Other Board members cited the complexity of a partial derecognition approach, while also citing outreach responses which suggested that a partial derecognition approach (1) did not provide users with useful information on the level of residual asset risk and (2) the residual asset should not be considered an item of property, plant and equipment given that it is not an asset that the lessor uses or intends to use in its business.
The Boards will discuss this issue in a future meeting, as no tentative decisions were reached regarding the above topic or the underlying presentation and measurement of finance leases in lessor accounting. Such discussion is expected to consider measurement of the lessor's lease receivables, including receivable securitisation environments which may suggest a fair value measurement of lease receivables, while also considering the measurement of residual assets.