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Leases

Date recorded:

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards discussed the potential inclusion of inventory within the scope of the leasing standard, the applicability of financial asset guidance to the right to receive lease payments, lessor subsequent measurement issues and lessor accounting for residual value guarantees.

Summary

The Boards made a number of tentative decisions during these discussions, as follows:

Scope - inventory

  • No scope exclusion would be provided in the leases standard for inventory.

 

Applicability of financial asset guidance to the right to receive lease payments

  • The lease receivable would be excluded from the scope of existing financial asset guidance for initial and subsequent measurement. However, financial asset guidance would apply to lease receivables in the context of impairment and derecognition
  • A fair value option of the lease receivables would be prohibited. However, the Boards instructed the staffs to analyse further whether there should be a requirement to measure the right to receive lease payments at fair value if that right were held for sale.

 

Lessor subsequent measurement issues

  • The lease receivable would be subsequently measured using the effective interest method and assessed for impairment in accordance with IFRS 9 Financial Instruments or IAS 39 Financial Instruments: Classification and Measurement (IFRSs) and Topic 310 Receivables in the FASB Accounting Standards Codification (US GAAP)
  • The residual asset would be assessed for impairment in accordance with IAS 36 Impairment of Assets (IFRSs) and Topic 360 Property, Plant and Equipment (US GAAP)
  • The lessor would recognise any changes relating to the reassessment of variable lease payments that depend on an index or a rate in profit or loss.
  • Revaluation of the residual asset would be prohibited (IASB only decision).

 

Lessor accounting: residual value guarantees

  • The lessor would not recognise residual value guarantees (RVGs) before they are due from the guarantor. However, the lessor would consider the existence of any RVGs when considering if the residual asset is impaired.

 

Scope - inventory

The Boards discussed whether a right-of-use asset under a lease arrangement could simultaneously also meet the definition of inventory and whether assets such as non-depreciating spare parts, operating materials and supplies associated with the leasing of another underlying asset (generally characterised as 'inventory' in existing practice) should be excluded from the scope of the leases standard.

The staffs provided their analysis indicating that, for lessors, they did not think that a lessor could have inventory out on a lease. Likewise, for lessees, the staffs did not think that a right-of-use asset subject to a lease agreement could also meet the definition of inventory. As such, the staffs, summarising examples and outreach activities with preparers and accounting firm constituents to discuss current arrangements marketed or labelled as 'leases of inventory', concluded that few, if any, transactions would meet the definition of a lease as tentatively defined at the April 2011 joint meeting (and would therefore not be subject to the final lease guidance). Further, those that do meet the definition of a lease would not be for an underlying asset that simultaneously meets the definition of inventory. Thus, the staffs concluded that an underlying asset subject to a lease arrangement could not simultaneously also meet the definition of inventory provided in IFRSs or US GAAP. As such, the staffs recommended that no scope exclusion for non-depreciating spare parts and other similar assets should be provided within the final lease standard given a lack of assessed need.

One IASB member provided an example of a lease of equipment in which the lessee receives spare parts with a right to return those parts if not used (i.e., a put option on spare parts). The IASB member noted that the revenue project would classify the put option as a lease. However, the above staff analysis would conclude that the put could not be a lease. Several Board members saw the revenue and leasing guidance to be asymmetrical, but expressed that the put option was effectively a purchase of the spare parts given control maintained by the lessee, and thus, did not object to the staffs' conclusion that an underlying asset subject to a lease arrangement could not simultaneously also meet the definition of inventory. The IASB member asked that specific guidance be placed in the standard for the put option example.

With few additional comments, the Boards tentatively decided that no scope exclusion would be provided for inventory given that no practical examples of lease arrangements that could simultaneously meet the definition of inventory were uncovered.

Applicability of financial asset guidance to the right to receive lease payments

The Boards discussed the potential application of existing financial asset guidance regarding initial and subsequent measurement (IFRS 9 and IAS 39 for IFRSs and Topic 825 Financial Instruments for US GAAP) to a lessor's right to receive lease payments.

The staffs recommended that the initial and subsequent measurement of the lease receivable should be excluded from the scope of IFRS 9 / IAS 39 and Topic 825, consistent with current guidance (i.e., no fair value option). In reaching this conclusion, the staffs noted that both the performance obligation and derecognition approaches included in the Leases ED proposed that the lease receivable be measured at amortised cost using the effective interest method, and few constituents expressed concern with this proposal.

Many Board members supported the staffs' recommendation. They noted that removing the scope exception for lease receivables from IFRS 9 and Topic 825 provided disadvantages such as: (a) fair value measurement would be inconsistent with the Boards' measurement of the lease receivable if the contract includes variable payments or options, (b) reassessment of the fair value each period would be complex and (c) fair value measurement could result in a Day 1 gain or loss.

However, two concerns were expressed with the staffs' recommendation. One Board member noted an inconsistency in the application model. Specifically, financial asset guidance was being used for impairment and derecognition; however, the staff recommendation was to exclude financial asset guidance for initial and subsequent measurement of the same assets. While he noted that this is consistent with treatment today, he expressed a desire to further consider the impairment of lease receivables as part of the impairment project for consistent application.

Another Board member, with support from many Board members, felt that a fair value option should exist in an environment in which lease receivables are held for sale at lease inception (e.g., securitised receivables). Given the nature of these receivables, fair valuing the receivables was seen to provide an appropriate measurement basis. However, the Board member was concerned with recognition of Day 1 gain or loss for the difference between the initial measurement of the lease receivable under the proposed guidance and the fair value of that receivable. The Board member preferred to adjust the residual asset to eliminate Day 1 gain or loss. A few Board members expressed concern with over-complicating the model in an environment in which the fair value option was not seen to be significant. However, the Board member noted that the current scope of the leases project could yield significant fair value differences given the exclusion of options from the recognised lease receivable which would be subject to fair value measurement. The Boards requested that the staffs perform further research on this issue.

With little deliberation on other staff proposals, the Boards tentatively decided that the lease receivable would be excluded from the scope of existing financial asset guidance for initial and subsequent measurement and a fair value option of general lease receivables would be prohibited.

Lessor subsequent measurement issues

Subsequent measurement, including impairment

The staffs presented feedback received from constituents regarding subsequent measurement of the right to receive lease payments and impairment (of the lease receivable and residual asset). The staffs noted that most respondents agreed with the proposals in the Leases ED (or did not comment). Those that did express concerns were generally US GAAP constituents who recommended clarification as to whether the impairment model for assessing the residual asset should be based on the impairment model for intangible assets or property, plant and equipment. Others recommended specific impairment guidance within the leases standard for the residual asset, rather than referring to existing guidance.

With little deliberation, the Boards tentatively decided that a lessor should subsequently measure the right to receive lease payments using the effective interest method, consistent with the proposals in the Leases ED and the measurement of other financial instruments.

In discussing impairment of the lease receivable and residual asset, one Board member expressed discomfort in concluding on the impairment model given that the impairment project is still being debated by both Boards. The staffs acknowledged this concern and expressed an intention to test the impairment model on leased assets once a tentative decision is reached on that project.

Other Board members considered possibilities for developing an impairment model for the residual asset, including referring to existing non-financial asset impairment guidance and developing unique impairment guidance for the residual asset in the leases standard. One FASB member, seeking a converged solution, proposed that US GAAP follow the IAS 36 Impairment of Assets model. However, other FASB members were concerned with this proposal since the IAS 36 model introduces concepts unique to US GAAP. Similarly, many FASB members were concerned with introducing a unique impairment model for leases.

While IASB members supported an IAS 36 model for impairment of the residual asset, FASB members were roughly split (4-3) on applying the property, plant and equipment impairment model or the intangible asset impairment model, with a slight majority preferring the property model given the nature of the residual asset appearing more akin to a tangible asset. Both Boards tentatively decided that the lease receivable would be assessed for impairment in accordance with IAS 39 and Topic 310, with little debate.

Variable lease payments

At the July 2011 meeting, the Boards tentatively decided that a lessor should reassess the measurement of lease payments that depend on an index or rate at the end of each reporting period. The Boards also tentatively decided that a lessee should recognise changes in those lease payments in profit or loss to the extent that those changes relate to the current reporting period and as an adjustment to the right-of-use asset to the extent that the changes relate to future reporting periods. However, the Boards did not decide how a lessor should reflect changes in the measurement of lease payments that depend on an index or a rate.

At this meeting, the Boards reversed their previous decision and tentatively decided that any changes relating to reassessment of variable lease payments that depend on an index or a rate be recognised immediately in profit or loss by a lessor. No specific discussion was provided in relation to the lessee model as part of this discussion.

Revaluation of the residual asset (IASB only)

With little debate, the IASB tentatively decided that revaluation of the residual asset would be prohibited. This was based on the fact that revaluation of the residual asset would be inconsistent with the IASB's decision regarding initial measurement and the decision against fair value measurement throughout the leases standard.

Lessor accounting: residual value guarantees

The Boards discussed how a lessor should account for RVGs provided by a lessee, a related party or a third party. As Board members recommended that the leases standard should provide guidance on the accounting by lessors for RVGs, discussions generally considered whether:

  • Approach A: the lessor would include RVGs in the initial measurement of the lease receivable measured at the amounts expected to be payable under the guarantee, or
  • Approach B: the lessor would not recognise RVGs before they are due from the guarantor (but considering the existence of RVGs when assessing the residual asset for impairment).

 

A few Board members supported Approach A as they felt it provided more transparency about the lessor's investment in the lease and results in recognition of the impact of the RVG at the time in which the gain economically occurs. However, many Board members supported Approach B since Approach A was seen as resulting in recognition of a larger gain on remeasuring the RVG than the amount of loss recognised on impairment of the residual asset. These Board members acknowledged that Approach B would generally result in deferring recognition of RVGs until the end of the lease as any impairment in the residual would be offset by a RVG, but supported Approach B given the mixed-measurement model being employed in lessor accounting. Thus, the Boards tentatively decided that the lessor would not recognise RVGs before they are due from the guarantor.