Lessor accounting - Lessor performance obligation
After a short discussion the Boards confirmed that under a performance obligation approach the lessor has a single obligation to continue to permit the lessee to use the leased asset over the lease term. Consequently, that performance obligation would be satisfied, and revenues recognised, continuously over the lease term. One IASB member noted that day one gain under this approach should be recognised only when the nature of the transaction is a sale and consequently it is outside the scope of the proposed leases Standard.
One Board member expressed his concerns over the treatment of purchase options under the proposed model and suggested that they be treated as stand-alone options (accounted for separately and not as an extension of the lease term) as they relate to the termination of the right-of-use rather than to the lease term. The staff expressed some concerns about this approach on the interaction with extension options. The staff will provide further analysis of the issue at a following meeting.
On the manufacturer/dealer lessor issue, some Board members felt uncomfortable with no profit/loss recognition upon lease commencement for manufacturers and dealers and suggested derecognition approach for manufacturer/dealer lessor and performance obligation for all other lessor. These Board members thought that such approach better reflects the economic logic of the relationship. Some Board members asked the staff to clarify the issue as well as explore the implication of the proposal on the overall model.
Lessor accounting - Derecognition approach
The Boards explored the derecognition approach to lessor accounting. After a short discussion the Boards rejected the full derecognition approach that resulted in the lessor derecognizing the full carrying amount of the leased asset and recognizing a receivable (a financial asset) and a residual value asset (a non-financial asset).
The Boards continued to explore the partial derecognition approach under which the lessor derecognizes the portion of the asset representing unconditional right to use a portion of the underlying asset for a period of time in return for a receivable and the lessor retains the residual asset representing the lessor`s rights to the underlying asset at the end of the lease term.
One Board member questioned the basis of the derecognition model. He noted that the presented approach (revenue recognition based on the present value of the lease payments and at the same time accounting for cost of sales in the same amount) is inconsistent with the proposed revenue recognition guidance and does not tie to the customer consideration. He noted that the approach assumed that the lessor has no continual performance obligation (that isw, there is the obligation to provide the leased asset, might be obligation to pay taxes, provide maintenance) and therefore might lead to frontloading of revenue.
After a heated discussion the Boards agreed that under both models all other obligations should be recognised and measured either at inception or as they arise in accordance with other Standards. As one Board member noted the model implicitly assumes that the lessor transferred all rights and obligations, though that is not necessarily the case.
Finally, the Boards noted that the derecognition model would place much more focus on the identification of the service component of the contract and identification whether payments for the other obligations are included in the leased payments as the present value of the lease payments might include different elements than those related to the right-of-use asset.
The Boards considered the accounting for arrangements with service and lease components. The Boards debated how to allocate the value attributable to the service component as well as accounting for both components. The Boards noted that the service component would have to be always separated and estimated. The Board asked the staff to consider the accounting for the service component. The Boards also asked the staff to clarify the basis for the decision of separation - that is, which guidance would apply for integral and non-integral types of services (and what is the interaction between the integral characteristic of the service and the distinct function as proposed in the revenue recognition guidance).
Several Board members expressed their concerns with particular aspects of the model - for example, the fact that higher residual value would lead to higher revenue recognition, effects of contingent rentals as well as usage of revaluation model under IFRSs).
The Boards continued their discussion with the definition of the residual asset. The staff suggested that as the lessor would be unable to access the benefits associated with the underlying asset until the end of the lease, the valuation of the residual asset should reflect the time value of money. Several Board members were concerned that such definition would differ from the residual value defined in IAS 16 as well as definition under US GAAP and did not understand how such difference could be justified. Several Board members expressed their concerns that effects of accretion of the value of the residual asset (and accelerated depreciation patterns) might lead to recognition of the day one gain.
In addition several IASB members were concerned that the proposed guidance on valuation of the residual asset would contradict the revaluation guidance under IFRSs. They questioned how different is the revaluation asset from the PPE under IAS 16.
One Board member questioned the usage of discount rate - the nature of the asset risk related to residual asset is different to the credit risk related to the receivable thus potentially leading to different discount rates. The staff noted that in practice a combined rate is being used as separation of the rates in very complicated.
In addition one Board member asked the staff to explore the interactions of the proposed guidance on residual assets with the guidance on investment property.
As the proposal to require re-measurement of the residual asset to fair value did not receive a sufficient support, the Boards considered the alternative of an allocation of the previous carrying amount of the underlying asset that would be frozen at inception and subsequently tested for impairment.
At that point, the Boards asked the staff to explore the implications of that approach and present them on a numerical example. Some Board members doubted the viability of the approach (mechanics of journal entries at the end of the period, potential for lump gains at the end of the lease for very short or very long leases as well as potential for underreporting of income from the leases.) The staff pledged to present examples of application of this model at the Wednesday's meeting.
Treatment of options
The staff proposed the same overall approach to leases with options to extend or terminate as under the performance obligation approach. The majority of the Boards agreed, even though some Board members echoed the arguments for a different treatment for options for lessors and for lessees and suggested separate treatment of options for lessors. On the other hand, other Board members stressed the need for consistency. Finally, the Boards agreed (the IASB with the tightest of margins) that initial measurement of the residual asset recognised by the lessor should be consistent with the assessed leased term (i.e. the longest possible lease term that is more likely than not to occur).
The Boards considered subsequent measurement of leases with options to extend or terminate. Given the consideration of the decision to freeze the cost allocation of residual value at inception, the Boards asked the staff to consider impact of that decision on the subsequent measurement of these options on examples as well as consideration of the different treatment of extending and shortening the expectations of the term.
Consistently with the earlier decision on performance obligation approach, the Boards asked the staff to analyse the broader implications of the purchase options for lessor accounting. The Boards also clarified that given that analysis they would like to consider its impact on the treatment of purchase options on lessee accounting. The staff would provide this additional analysis at a following meeting.
The Boards considered the impact of contingent rentals and residual value guarantees and accounting for subleases on the derecognition approach. The Boards would continue their discussion on leases on their Wednesday meeting when they would cover the remaining aspects of the derecognition model.