The IASB and FASB discussed:
- Application guidance on when to use the performance obligation or derecognition approaches
- Revisited: Scope - Purchases/sales of the underlying asset
- Accounting for arrangements with service and lease components
- Business combinations
- Additional disclosures.
The Boards discussed the application guidance on when to use the two approaches for lessor accounting.
First, the Boards discussed the timing of the assessment which approach to use. The majority of both Boards agreed that a lessor should be required to determine at inception of the lease whether the lease exposes the lessor to significant risks and benefits associated with the underlying asset and that determination should not be subsequently reassessed. One FASB member suggested that one of the exceptions to the principle should be business combinations. The Boards agreed. Nonetheless, several Board members suggested that reassessment should be performed also in case of significant change in the economics of the contract. The staff clarified that the change in the economics would be accompanied by the change of the lease contract that would automatically trigger reassessment.
Subsequently, the Boards discussed clarification of the terms underlying asset in the context of the assessment. The Boards agreed that the term underlying asset in this context should refer to the asset itself and not to the credit risk. One Board member also noted that the risks and benefits associated with the underlying asset shall be determined at the inception of the lease but assessed over the life of the lease not just at the end of the lease.
Several Board members expressed their concerns over the articulation of the principle and expressed their preference to formulation of the principle based on transfer or retention of the risk rather than creation of exposure (as lessor is already exposed to the risks of the underlying asset).
The discussion focussed on the general criteria of the usage of performance obligation and derecognition approaches. Several Board members questioned the business model criterion and suggested that it could be expressed in a better way as it could lead to structuring opportunities. They also questioned whether risks and rewards were used as a proxy for existence of performance obligation. Some suggested that over the time of the lease performance obligation aspect could be dominant and at the end of the lease the transfer notion is dominant.
The Boards also noted that in the assessment of the risks and rewards the present value of the residual value at the end of the lease period should be considered.
The Boards will continue the discussion on this issue later this week.
After a short discussion, the Boards agreed that residual value guarantees provided by parties other than the lessee should be considered in determining whether a lessor is exposed to significant risks and benefits associated with the underlying asset. The Boards noted that such approach focuses on economics of the lease rather than legal form of the contract.
The Boards also agreed not to provide any additional guidance for the long-term leases of land and noted that the general principles should be applied for all type of contracts (based on significant risks and benefits).
Finally, the Boards considered the set of factors to be considered in determining whether a lessor is exposed to significant risks and benefits associated with the underlying asset. Some Board members expressed their concerns how operational the factors will be as interaction between the criteria to distinguish between the two approaches, short and long term leases and factors to determine between leases and sales/purchases of underlying assets. In addition some Board members expressed their concerns over the complexity of the hybrid approach for lessor and its inconsistency with the proposed guidance for lessees. Even though the Boards agreed in principle with majority of the factors suggested (business model, exposure to risks and benefits associated with the underlying asset at the end of the lease - i.e. lease terms and residual value guarantee, significance of contingent rentals, nature of the underlying asset, relation of fair value of lease payments and fair value of underlying asset and material non-distinct services), the Boards asked the staff to re-consider these factors and articulate them more clearly. The Boards will discuss these conditions later this week.
The Boards re-discussed the criteria for scoping the contracts that meet the criteria for classification as a purchase or sale of an underlying asset out of the new leases standard. Some Board members expressed their concerns that given the decisions taken on the hybrid approach, some criteria for classification as a purchase or sale and related to derecognition approach for lessor would overlap. Some Board members noted that the rationale for scoping of these contracts have been substantially narrowed by the decision to pursue the hybrid approach. Nonetheless, other Board members considered the two set of criteria necessary. In their view, the scope analysis related always to the whole asset and as such would better depict the lending nature of the transaction in some circumstances.
The Boards noted that the economic distinction between derecognition approach and purchase and sale is very small, but could have practical significance. Consequently, the Boards decided to retain the separate criteria for determining whether the contract should be classified as a purchase or sale of the underlying asset. Nonetheless, the Boards decided to retain only the criteria related to title transfer and bargain purchase option, as all other criteria would be already covered by the derecognition approach.
One IASB member asked whether the bargain rental option should not represent a separate criterion as it economically can equal to the bargain purchase option. The staff clarified that this condition would be already covered by the other proposed criteria.
The Boards considered accounting for arrangements that contain both service components and lease components.
After a short discussion, in which several Board members expressed their concerns with the appropriate revenue and profit recognition, the IASB agreed that lessor under the derecognition approach to lessor accounting should be required to bifurcate service and lease components in a lease arrangements for both distinct and non-distinct service components. Nonetheless, this proposal was narrowly defeated in the FASB, as three FASB members expressed their concerns over separation of non-distinct services based on practicability concerns and margin considerations. The IASB agreed to do the allocation based on the relative standalone selling prices of the service for both distinct and non-distinct services.
The Boards discussed the allocation of revenue for lessors between the various components. For many Board members it was contradictory to use the relative selling prices of the non-distinct services (as these are usually not separable) and noted that a kind of allocation based on cost-plus-margin approach might be necessary.
Some Board members questioned why the bifurcation is not required for lessees as well if it is possible to require it for lessor accounting. These Board members were concerned by the possible revenue recognition patterns of these contracts. The staff responded that such bifurcation would be too onerous for the lessees due to informational asymmetry.
The Boards continued to consider the accounting for the service component of a lease arrangement under the derecognition approach to lessor accounting, considering two possible approaches: accounting based on proposed revenue recognition requirements or by recognising a separate performance obligation for the service components. The second approach would lead to slightly earlier revenue recognition as well as grossing-up of the statement of financial position. The Boards remained split on the issue, with the IASB preferring to recognise a separate performance obligation, and the FASB preferring to refer to the proposed revenue recognition guidance.
As the Boards were split on the accounting, the Boards decided to ask questions to constituents in the forthcoming exposure draft on these issues (on bifurcation as well as on accounting treatment).
The Boards discussed the recognition and measurement of the lease assets and liabilities in a business combination. After a short discussion, the Boards agreed that all lease assets and liabilities in business combinations should be measured in accordance with the proposed leases requirements and that an acquirer would measure those assets and liabilities as if the lease arrangement was a new lease arrangement. Based on that decision, the lessee would measure the right of use asset at the present value of remaining lease payments reflecting the acquirer's discount rate (that would equal the initial measurement of lease obligation) and any adjustment for the off-market rate. The lessor, under the performance obligation approach would adjust the initial measurement of the performance obligation (that would equal the initial measurement of lease receivable) for the off-market rate. Under derecognition approach, any adjustment for off market rate would adjust the lease receivable (that would be initially measured at the present value of the remaining lease payments reflecting the acquirer's discount rate).
The Boards agreed to add following proposed disclosures relating to the hybrid lessor model to the disclosure section of the forthcoming exposure draft:
- details on the accounting policy on which model(s) that the lessor applies,
- the types of risks/benefits of the underlying asset that the lessor considered when deciding which approach to apply, and
- separately for each type of lessor approach any impairment that occurred.
The Boards also agreed that an entity should disclose the existence and principal terms of any purchase options for the lessee to purchase the underlying asset.
The Boards will continue to discuss leases later in the week.