As part of their continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards discussed several topics including:
- Due process considerations (IASB only meeting)
- Lessee accounting: Transition, presentation and disclosure relating to leases where the lessee recognises a single lease expense in its statement of comprehensive income
- Lessor receivable and residual approach: Measurement of the underlying asset if a lease terminates prematurely
- Interim disclosures
- Comment period
The staffs expect that the tentative decisions made at this meeting will be the last decisions to be made before re-exposing the lease accounting proposals, other than those that may arise during the drafting process and a few issues to be discussed by the FASB during a FASB only meeting.
Due process considerations (IASB only)
The IASB Due Process Handbook (the Handbook) includes mandatory and non-mandatory due process steps to be undertaken before the publication of an exposure draft or the issue of a new IFRS or an amendment to existing IFRSs. Highlighting the steps that the Board has undertaken in respect of the Leases revised exposure draft, the IASB staff believed that the Board had complied with all mandatory steps listed in paragraph 112 of the Handbook and all non-mandatory steps listed in paragraph 113 of the Handbook and sought confirmation from the Board that it too believed all necessary steps had been undertaken. Board members were satisfied that all necessary steps had been taken.
Statement of financial position
In July 2011, the Boards discussed presentation in a lessee’s statement of financial position (SFP) for leases accounted for using the interest and amortisation approach. However, given the recent decision to have two separate lease accounting models (an interest and amortisation (I&A) approach) and a straight lease expense (SLE) approach), the Boards were asked to consider the presentation of right-of-use assets and liabilities to make lease payments in a lessee’s SFP for leases for which the lessee recognises a single lease expense in the statement of comprehensive income (SCI) (i.e. SLE).
Regarding the presentation of right-of-use assets, the staffs recommended that the current tentative decision regarding the classification of the right-of-use asset recognised under the I&A approach be applied for the right-of-use asset recognised under the SLE approach such that a lessee would present the right-of-use asset under the SLE approach as if the underlying asset were owned, and that the asset would be separately presented in the SFP or disclosed in the notes to the financial statements. If right-of-use assets are not separately presented in the SFP, disclosures would indicate in which line item the right-of-use assets are included.
One IASB member preferred that preparers not be provided with an option of presenting the right-of-use asset in either the SFP or in the notes. His preference was for inclusion in the SFP. However, his general concern related to increased optionality in the model. Three IASB members supported this view. However, other Board members noted that requiring presentation in the SFP would not be conducive to all entities where leasing is not a significant portion of their business.
With no additional deliberations, both the IASB and FASB tentatively agreed with the recommendation of the staffs.
Regarding the presentation of the lease liability under the SLE approach, the staffs proposed two options: [Option A] requires presentation as a separate line item in the SFP or disclosure in the notes separately. If the liability under the SLE approach is not separately presented in the SFP, the disclosure should indicate in which line item in the SFP the liability is included. [Option B] applies a consistent methodology to Option A but includes the restriction that the liability under the SLE approach should not be presented together with other liabilities that result in interest that is presented as such in the SCI and are paid with cash flows that are presented in the financing section of the statement of cash flows (SCF).
The staffs did not reach a consensus on this topic, with the majority of staffs favouring Option A and a minority of the staffs favouring Option B.
The majority of the Boards agreed that either presenting or disclosing the liability to make lease payments under the SLE approach (Option A) would be useful. They noted that the relationship between interest or finance costs and the liabilities that give rise to that cost can be important to the user’s assessment of that entity’s cost of funding. However, Board members had different views about restricting the presentation of lease liabilities on the SFP. Some viewed cohesiveness across the primary financial statements as important and, thus, recommended preventing the lessee from presenting the lease liability under the SLE approach with other financial liabilities that result in interest or finance costs being presented as such in the SCI and SCF. Others saw no basis for the restriction because all liabilities to make lease payments are measured in the same way. Thus, they did not think that a lessee should be prevented from presenting all lease liabilities together in the SFP.
Another IASB member expressed concern that the staffs were characterising SLE expenses as non-interest baring obligations. She fundamentally disagreed with this view, and noted, if characterised that way in the ballot draft, she would likely provide an alternative view on the proposals.
When put to a vote, both Boards tentatively agreed with the majority staffs’ view, Option A.
Statement of cash flows
In June 2011, the Boards discussed the SCF for lessees for leases accounted for using the I&A approach. However, given the recent decision to have two separate lease accounting models, the Boards were asked to consider the presentation of cash paid in the SCF for leases applying the SLE approach.
The staffs’ analysis noted that for the effects on the SCF to be representationally faithful to the presentation of amounts in the SCI, the cash paid for leases under the SLE approach should be presented in the operating activities section of the SCF. This assessment was primarily based on the definition of operating activities in the SCF described in paragraph 14 of IAS 7 Statement of Cash Flows and the glossary in the FASB Accounting Standards Codification®.
One FASB member reluctantly agreed with the staff recommendation, but noted that current SCF guidance is ‘torturous’ to apply and he would like for his board consider a fundamental review of SCF guidance.
One IASB member questioned whether IAS 7 could be amended to require separate disclosure of cash paid for leases (similar to requirements to disclose cash paid for interest and income taxes). He noted that current proposals will make it difficult for users of the understand cash payments for leases given that certain components are excluded from the statement of financial position (e.g., short-term leases and variable lease payments which are not based on an index or rate or in-substance fixed). Many Board members supported the additional disclosure of cash paid for leases, but preferred that the staffs analyse this proposal before voting. The staffs noted that they would analyse this proposal and possibly provide a future staff paper.
When put to a vote, both Boards tentatively agreed with the staff recommendation.
The staffs then recommended that the right-of-use asset acquired in exchange for a lease liability for which the lessee recognises a single lease expense in its SCI be disclosed as a supplemental noncash transaction disclosure (similar to the tentative decision previously made about the acquisition of right-of-use assets under the I&A approach).
Both Boards tentatively agreed with the recommendations set forth by the staffs, but some concern was expressed that disclosure requirements were duplicative in nature when considered with other disclosures previously discussed. The staffs noted that where disclosures were duplicative, preparers would only be required to disclose the item once.
The Boards considered the disclosure requirements for leases accounted for using the SLE approach given that previous deliberations on disclosure requirements were on the basis of only the I&A approach. Disclosures reconsidered included the maturity analysis, reconciliation of the opening and closing balance of lease liabilities and right-of-use assets and the table of expenses and cash flows related to leases recognised in the reporting period.
Regarding the maturity analysis disclosure, the staffs considered recommending separate maturity analyses for I&A and SLE approach leases; noting that a maturity analysis is already required for I&A approach leases according to current tentative decisions. However, the staffs noted that the main objective of providing a maturity analysis disclosure is to provide additional information about the lessee’s commitments at the reporting date, and the timing of future cash flows associated with those commitments. Because of this, requiring separate maturity analyses would appear less relevant given that all lease liabilities are measured in the same way and future cash flows remain the same regardless of the accounting. Consequently, on balance, the staff did not think the separate maturity analyses would be incrementally useful and recommended that a lessee should disclose one maturity analysis that sets out the undiscounted cash flows relating to all lease liabilities, and that analysis reconciled to the total lease liability.
Based on the fact that the FASB had previously tentatively decided that a lessee should disclose the maturities of contractual commitments related to lease agreements for services and other non-lease components that are not recorded as part of the lease liability (the IASB previously tentatively decided not to require this disclosure), the FASB staff also recommended that preparers not be required to bifurcate the disclosure of the maturity of contractual commitments associated with services and other non-lease components between the two lease types (FASB only).
With no debate, both Boards tentatively agreed with the recommendations set forth by the staff; the last recommendation being a FASB only tentative decision.
Regarding the reconciliation of opening and closing balances of lease liabilities, the staffs recommended requiring a lessee to disclose a reconciliation of opening and closing balances of lease liabilities under both the I&A approach and the SLE approach. The reconciliation would include interest on the unwinding of the discount, thereby requiring that the lessee presents and discloses any accrued interest or accretion on the lease liability together with the liability balance itself.
With little debate, both Boards agreed with the staff recommendation. However, the FASB did direct its staff to bring back a separate paper regarding disclosure implications related to private companies.
Regarding reconciliation of opening and closing balances of right-of-use assets, the staffs recommended requiring a lessee to provide a reconciliation of opening and closing balances of right-of-use assets under both the I&A approach and the SLE approach, by class of underlying asset, consistent with previous tentative decisions reached on right-of-use assets under the I&A approach.
Many FASB members expressed concern of disclosure overload in this area. They noted that a reconciliation of the right-of-use asset under the SLE approach is not necessary because some of the potentially useful information is already provided elsewhere through other disclosures. They also saw the preparation of reconciliations as costly and questioned the need for this information by users – both for leases under the I&A approach and the SLE approach. However, IASB members expressed support for a reconciliation under both lessee approaches. They highlighted the consistency of this disclosure with requirements to reconcile movements in property, plant and equipment (which is not explicitly required under US GAAP although certain key movements require disclosure) and saw this information as useful to users.
Following deliberations, the FASB tentatively decided to reverse its previous tentative decision and not require a reconciliation of opening and closing balances of right-of-use assets for either the I&A or SLE approach. However, the IASB tentatively decided to require disclosure of reconciliations under both the I&A and SLE approach based primarily on the consistency of this tentative decision with current IFRS disclosure requirements for property, plant and equipment.
Finally, regarding disclosure of expenses related to leases recognised in the reporting period, the staffs recommended requiring a lessee to disclose a table of lease expense followed by cash payments. This table would include amortisation expense under the I&A approach, interest expense under the I&A approach, expenses relating to variable lease payments not included in the liability to make lease payments, expenses for those leases in which the short-term practical expedient is applied, lease expense under the SLE approach, principal and interest paid under the I&A approach and cash paid on the fixed portion of the leases under the SLE approach.
Many Board members again expressed concern regarding disclosure overload and the costs to preparers. Most of these Board members saw value in disclosure of variable lease expense given that the amount can vary significantly from period to period and the amounts are not recorded as part of the liabilities (and thus, not reflected in any of the disclosures that relate to liabilities), but felt other disclosures proposed by the staffs were too costly given the benefit provided. When put to a vote, both Boards tentatively agreed that the disclosure should be limited to variable lease expense.
Transition: Measurement of the right-of-use asset
The Boards considered whether, on transition, when applying the SLE approach, right-of-use assets should be measured on the basis of the proportion of the liability to make lease payments at commencement, relative to the remaining lease payment (i.e., the modified retrospective approach as tentatively decided by the Boards in previous deliberations of the I&A approach).
The staffs noted that when the Boards previously tentatively decided to apply the modified retrospective approach at transition, this decision was made in the context of the I&A approach being applied to all leases and, therefore, not in the context of the SLE approach. The Boards decided to change from the simplified retrospective approach proposed in the Leases ED (whereby the right-of-use asset is made equal to the liability at transition) to the modified retrospective approach to address respondents’ concerns about the ‘front loading’ of expenses that would result from the proposals in the Leases ED. In contrast to the I&A approach, the SLE approach results in a straight-line expense pattern in the SCI. Consequently, the Boards’ rationale for changing to the modified retrospective approach is not applicable when considering the single lease expense approach.
The staffs noted that, when applying the SLE approach, if lease payments are even or relatively even over the lease term, the right-of-use asset recognised under a fully retrospective transition approach would be similar to the measurement of the liability to make lease payments on transition. Accordingly, they noted that that permitting lessees to measure the right-of-use asset at the same amount as the liability to make lease payments on transition would be a simplified way to retrospectively apply the new proposals for many leases. When lease payments are uneven, the results of applying the simplified approach (i.e., measuring the right-of-use asset at the same amount as the liability to make lease payments) and a fully retrospective approach may not always be similar. However, the staffs suggested that adjusting the right-of-use asset by the amount of any recognised prepaid or accrued lease payments would provide a similar result to that of a fully retrospective approach. Therefore, the simplified approach in the Leases ED, with possible revision for uneven lease payments, was seen as a way forward.
On the basis of this analysis, the staffs recommended that, at transition when applying the SLE approach, a lessee should be permitted to either recognise a right-of-use asset for each outstanding lease, measured at the amount of the related liability to make lease payments, adjusted for any uneven lease payments, or apply a fully retrospective transition approach.
With no debate, both Boards tentatively agreed with the staff recommendation.
At its May 2012 Financial Instruments: Impairment joint meeting, the Boards discussed the application of the proposed expected credit loss model to lease receivables. At that time, the staffs indicated that the leases team would consider the broader issue of the interaction between the accounting for the lease receivable, the impairment of the lease receivable and the asset underlying the lease, if that asset were to be returned to the lessor before the end of the lease term. Therefore, this meeting served to discuss how the lessor would initially measure the underlying asset when it applies the receivable and residual approach and the lease terminates before the end of the expected lease term, resulting in the lessor reclaiming the underlying asset and re-recognising the underlying asset earlier than expected.
The staffs presented three alternatives for measuring the underlying asset on re-recognition: [Option X] fair value, [Option Y] carrying amount of lease-related assets and [Option Z] revised value. Under Option X, the lessor would derecognise the lease receivable and net residual asset and re-recognise the underlying asset at fair value. The difference between the carrying amount of the lease assets derecognised and the fair value of the underlying asset re-recognised would be recognised as a gain or loss. Under Option Y, the lessor would reclassify the lease receivable and net residual asset as the underlying asset (i.e., the lessor measures the underlying asset at the carrying amount of the lease-related assets). Consequently, this option would never result in a gain being recognised on the residual asset as a result of the lease terminating prematurely. Under Option Z, the lessor would calculate a revised rate implicit in the lease (the rate actually earned on the abbreviated lease) based on the fair value of the underlying asset at the time of premature lease termination. The lessor uses the revised inputs to compute deferred profit on the residual asset had the lessor known that the lessee would prematurely terminate the lease for purposes of determining the net residual asset at the time of repossession. For each option presented, in addition to any impairment testing of the lease receivable during the lease term, the staffs noted that the lessor would measure the impairment allowance for the lease receivable in accordance with the proposed financial instrument impairment guidance immediately before reclaiming the underlying asset. Consequently, because the lessor would no longer receive all of the lease receivable (i.e., the financial asset) at the time that the lease terminates prematurely, the lessor would record any impairment loss by comparing the carrying amount of the lease receivable and the fair value of the portion of the underlying asset related to the lease receivable plus any cash expected on termination.
The staffs recommended Option Y such that, when a lessor re-recognises the underlying asset when a lease terminates before the end of the expected lease term, the underlying asset is measured as the sum of the carrying amount of the lease receivable (after any impairment) and the net residual asset.
In Board deliberations, no support was expressed for Option Z. While some support was expressed for Option X given its relevance and understandability to users of financial statements, others were concerned that this option would result in recognition of deferred profit on the residual asset when the underlying asset is re-recognised, could allow for a net gain from the repossession of the underlying asset and would result in application of a fair value approach contrary to certain entities’ business models.
Many IASB members supported Option Y. They noted that the approach was simple to understand and apply and is consistent with the Boards’ tentative decision not to recognise profit on the residual asset (given that deferred profit on the residual asset is not recognised under this option). However, other IASB members expressed concerns with this approach.
Specifically, one Board member preferred that the lessor reclassify the lease receivable and net residual asset at the time of lease termination without measuring the impairment allowance for the lease receivable in accordance with the proposed financial instrument impairment guidance immediately before reclaiming the underlying asset. Subsequent to the reclassification, he then suggested that the underlying asset should be tested for impairment. His preference was primarily based on simplicity. However, he also noted that economically, a loss should not be reflected for the financial asset (i.e., the lease receivable) when such a loss is offset by appreciation of the underlying asset which can be marketed for re-lease. IASB staff members expressed concerns with this proposal. They noted that the proposal would result in entities bypassing the impairment guidance for a financial asset (thus requiring amendments to IFRS 9 Financial Instruments) and instead subjecting the financial (i.e., receivable) and non-financial (i.e., underlying asset) asset to the non-financial asset impairment guidance in IAS 36 Impairment of Assets (with likely revision to IAS 36 required based on nature of the combined asset). They also noted that deferred profit embedded in a residual asset would mask any impairment of the re-recognised asset. Finally, in responding to certain Board member concerns regarding the economics of recognising an impairment loss when the earnings power of the underlying asset has appreciated, they noted that any recognised loss on the lease receivable reflects the loss on the leased asset which should be considered separately from the potential future earnings potential of the underlying asset.
Another Board member expressed concern that if the fair value of the portion of the underlying asset related to the lease receivable is greater than the carrying amount of the lease receivable, the lessor would not recognise any gain when the underlying asset is re-recognised. He noted this was not consistent with the way that collateral on a financial asset would be measured on initial recognition. However, the staffs’ outreach suggested that the termination of a lease prematurely typically results in a loss for the lessor, rather than a gain. When a loss is recognised, the portion of the underlying asset related to the lease receivable would be measured at fair value, which is consistent with the way that collateral on a financial asset would be measured on initial recognition.
After an extensive debate, the IASB tentatively agreed with the staff recommendation (Option Y).
With no debate, the FASB tentatively agreed with the staff recommendation of Option Y. They noted that this topic had been discussed by their Board as part of an education session.
The Boards discussed whether any of the proposed lessee and lessor disclosure requirements should be required at interim reporting periods.
Evaluating the need for interim disclosures based on the relative significance of leases to the financial statements of an entity, the nature of interim reporting as a condensed update to the previous annual financial statements, the ability to use interim financial statements with annual disclosures to analyse future cash flows and current interim reporting requirements for other items, the staffs recommended that for lessees, no amendments to IAS 34 Interim Financial Reporting (IFRSs only) or Topic 270, Interim Reporting/SEC Regulation S-X, Rule 10-01, Interim Financial Statements (US GAAP only) should be made. This assessment was based primarily on the following considerations:
- Information disclosed in a lessee’s annual financial statements would give a user a good basis for understanding the composition of leases, the future cash flows related to leases and information about the underlying contracts.
- If there is a significant change such that the year-end disclosures are no longer representative of the entity’s current leasing activities, the entity would generally be expected to disclose that change in accordance with the requirements in Rule 10-01 and IAS 34.
With little feedback, the Boards tentatively supported the recommendation set forth by the staffs.
Considering interim disclosure requirements for lessors, the staffs recommended that IAS 34 and Topic 270 should be amended to require a tabular disclosure of the components of lease income. This assessment was based primarily on the fact that the staffs believed a breakdown of lease income at interim periods would be informative to users in assessing future cash inflows from revenue-generating activities, regardless of whether there is a change in trends since year end. The staffs also noted that interim disclosures regarding segmentation of revenue are specifically required in IFRSs and US GAAP, and thus, the incremental costs should not be significant.
The FASB tentatively supported the recommendation of the staffs. However, multiple IASB members expressed concern that the proposals were too prescriptive and should instead require related disclosures only if lease transactions are a significant component of an entity’s business model. One IASB member suggested that the IAS 34 disclosure requirements should be amended such that lease income be disclosed as a single number with a caveat that additional disaggregation of the income figure may be necessary to provide an understanding of the changes in an entity’s performance since the last annual reporting period. The IASB tentatively supported the revision to the staff recommendation. The FASB was asked if they wished to revisit their tentative decision for convergence purposes, but the FASB tentatively decided to retain their earlier vote. Therefore, this represents an area where convergence was not achieved.
Comment period and permission to begin the balloting process
The Boards were asked to decide on the length of the comment period for a revised Leases ED, authorise the staffs to prepare a ballot draft based on the package of tentative decisions and related information discussed during redeliberation of the Leases ED and communicate any intention to present an alternative view to the revised Leases ED.
In accordance with the IASB’s Due Process Handbook and general guidance in the FASB’s Reference Manual, the staffs recommended a comment period of 120 days.
One FASB member suggested that the comment period be a minimum of 120 days so as to avoid a situation where the comment period deadline falls during year end reporting for calendar year entities. Both Boards tentatively agreed with this revision to the staffs’ recommendation, however, the IASB Chair noted that in the international realm, it is difficult to avoid conflicting with year end reporting requirements given that entities operate with different fiscal year end dates.
The FASB Chair asked the staffs when they anticipated issuing a revised Leases ED. The staffs noted that they anticipate issuance by the end of November 2012; timing which is based primarily on the amount of time it took the staffs to issue the 2011 revised exposure draft on revenue recognition following the last decision-making meeting.
The FASB Chair then noted that she would not yet ask the FASB to authorise the FASB staff to prepare a ballot draft given that the FASB will be holding a FASB only meeting next week to discuss remaining FASB only issues on the project. However, she did ask if any FASB members planned to present an alternative view to the proposals once drafted.
Two FASB members noted an intention to dissent, with one additional member uncertain as to whether he would dissent. Reasons for dissention included:
- Concerns regarding the costs of the new proposals relative to the benefits achieved. In particular, this Board member noted that the project failed to achieve one of its key objectives; that being, the removal of a bright-line between lease types.
- Failure to recognise contractual commitments related to variable consideration arrangements. This Board member noted that non-contractual liabilities in the form of contingencies may be reflected in the statement of financial position based on a probability assessment, while contractual liabilities associated with variable components of leases will often be excluded from the statement of financial position which he found difficult to comprehend.
- Concerns over proposed disclosures. Board members expressed a desire for certain additional disclosures including disclosure of cash paid for leases and a comprehensive rollforward of profit and loss and statement of financial position activity during the period.
- Concerns over the lack of convergence on a number of areas. Many of the areas where convergence was not achieved was seen to be the result of existing US GAAP and IFRS guidance creating potential differences in accounting treatment, but this Board member highlighted differences in disclosure requirements arising today as another area of concern.
The IASB Chair did not formally ask for a vote to authorise the IASB staff to prepare a ballot draft on the leasing proposals, but implicitly, it was assumed that the authorisation was provided. Two IASB members noted an intention to dissent, with one additional member uncertain as to whether she would dissent. Reasons for dissention included:
- Concerns regarding the complexity of the proposals.
- Concerns regarding the lack of a conceptual basis for the straight-line expense model for some leases.
- A failure to achieve one of its key objectives of the project; that being, the removal of a bright-line between lease types.
- Concerns regarding the lack of symmetry between the lessor model and the revenue recognition project.
- A belief that many technical issues remain unanswered. Some of the areas specifically highlighted included whether land and buildings are assessed as one unit of account or separately when applying the new lease classification test and implications of impairment on the straight-line expense lease model.