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.
Staff presented the following three approaches with regards to the revising of the incremental borrowing rate for subsequent changes in the expected lease term:
- Approach 1: No reassessment of the incremental borrowing rate;
- Approach 2: Reassess by updating for the current incremental borrowing rate for the remainder of the lease term; and
- Approach 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.
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:
- Alternative 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);
- Alternative 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.
- Alternative 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.