Lessor accounting - Derecognition approach supplement: Residual asset (freezing residual asset)
During yesterday's discussion on the derecognition approach, the staff was requested to present the Boards with numerical examples on what would happen if the carrying amount of the residual asset does not change after initial measurement, other than for impairment.
The staff presented the Boards with examples illustrating the mechanics of the proposed approach when the underlying asset is released, sold or retained for own use.
While some Board members were comfortable with the examples provided, other Board members questioned the determination of profit on initial recognition. Some of these Board members were concerned that lessors did not get to recognise a profit on initial recognition and that this 'profit' is effectively recognised over the lease term as a higher interest charge. One Board member noted that in order to arrive at the same profit figure that would have been recognised under operating lease accounting, the residual value have to be accreted over the lease term.
The Boards debated that issue around profit recognition and whether it is only a consequence of the derecognition model resulting in a timing difference. The Chairman asked the Boards to vote again on the matter and the Boards re-confirmed their earlier decision to freeze the allocated residual asset and only reassess for impairment when there are indicators of impairment.
Lessor accounting - Derecognition approach supplement: treatment of options
The staff presented the Boards with a supplement setting out the journal entries for an option to terminate a lease earlier than the originally determined lease term, in accordance with the Boards' earlier decision to treat the reassessment as a new derecognition/re-recognition event (Approach A in the agenda papers).
One Board member questioned the mechanics of the example which results in a loss upon reassessing the lease term when no profit has been recognised upon initial recognition. Other Board members noted that the examples presented do not reflect the Boards' earlier decision appropriately and requested the staff to rework the example to reflect the Boards' decision with regards to the residual asset and circulate the supplement again.
Lessor accounting - Derecognition approach: Contingent rentals and residual value guarantees
The Boards considered the accounting for contingent rentals and residual value guarantees under the derecognition approach. Without much discussion on the matter, the Boards tentatively agreed that changes to the receivable arising from contingent rentals based on performance or an index should be recognised in profit or loss as there is no direct correlation between the value of the residual asset and the amounts receivable under contingent rentals.
The Boards then considered how changes in usage-based contingent rentals should be treated. Some Board members were of the opinion that additional usage of the leased asset would lead to a reduction in the residual asset, whereas other Board members did not agree that this will always be the case. It was suggested that a lessor should be able to determine at the commencement of the lease which additional usage would lead to a decrease in the residual asset and which would lead to increase servicing costs. Based on this, only additional usage that does not result in a decrease in the residual asset should be recognised in profit or loss.
Several Board members had sympathy with this view but did not think it was practical to imply in practice. After a short discussion on the matter, the Boards were asked to vote on the following 3 alternatives:
- all usage adjustments are recognised in profit or loss and possible impairment test on the residual asset;
- all usage adjustments are recognised as an adjustment to the residual asset; or
- additional usage that does not result in a decrease in residual asset, is recognised in profit or loss and other usage adjustments are adjusted against the residual asset.
The majority of the FASB members voted in favour of all usage adjustments being recognised in profit or loss, whereas the IASB was evenly split between the 3 alternatives (5 votes each). The IASB members supporting the latter two alternatives then indicated that they don't object to the first alternative. The Boards therefore tentatively agreed that all usage adjustments should be recognised in profit or loss.
The Boards were also asked how changes in the receivable arising from residual value guarantees should be accounted for. The Boards acknowledged that the link between the residual value guarantee and the value of the residual asset is closer than with contingent rentals and usage adjustments. However, the Boards agreed that in the light of their previous decision to freeze the residual asset at initial measurement, changes in the receivable arising from residual value guarantees need to be recognised in profit or loss.
Lessor accounting - Derecognition approach: Accounting for Subleases
The Boards considered how to account for subleases under the derecognition approach. Without much deliberation, the Boards tentatively agreed not to provide different measurement guidance for assets and liabilities under a sublease and that intermediate lessors should present all assets and liabilities arising from a sublease gross on the statement of financial position.
Lessor accounting - Derecognition approach: Presentation
The Boards then deliberated how a lessor's assets, liabilities, revenue and expenses arising from a lease contract should be presented in the financial statements. With regards to presentation in the statement of financial position, the Boards tentatively agreed that, subject to the general presentation and materiality requirements in IAS 1, the lease receivable should be presented separately from other receivables and the residual asset with property, plant and equipment but separately from owned assets on the face and disclosed separately by class of asset.
When discussing the presentation in the statement of comprehensive income, the Boards considered whether to require:
- gross presentation of revenue and cost of sales by all lessors;
- net presentation by all lessors; or
- gross presentation by some lessors (i.e. manufacturers and dealers) and net presentation by others (i.e. financing entities).
Some Board members supported gross presentation by manufacturer and dealer lessors as that would appropriately present the economic reality of the transaction, whereas net presentation by financing entities would be more appropriate especially as they don't have a gross margin to present. The Boards had a short discussion on what the appropriate criteria would be to make the distinction. One Board member suggested allowing management to apply judgement in a way that is similar to how management present financial statements based on the business activities of the entity. Several Board members supported this view subject to the requirement to provide information that is meaningful to the users. The majority of Board members voted for this alternative.
The Boards requested the staff to consider the disclosure requirements for the derecognition of financial assets when formulating the disclosure requirements for lessors under the derecognition approach and provide sufficient explanations if some requirements are considered not appropriate to lessor accounting.
In concluding the session, the Chairman asked the respective Boards to indicate their preference for the performance obligation or derecognition approach in order to provide the staff with some idea on where to focus their efforts. By a large majority the FASB indicate a preference for the performance obligation approach for all lessors, while a majority of the IASB members preferred a hybrid model, where some lessors apply the derecognition approach and others the performance obligation approach. However, the IASB has not yet had time to consider whether the distinction should be drawn between manufacturer and dealer lessors vs. other lessors or the characteristics of the leasing arrangements. The IASB will meet within the next couple of days to define the distinguishing factors.