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.