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Leases

Date recorded:

The Boards held a joint meeting to discuss the topics which were initially considered by the IASB in an IASB only session on Tuesday, 13 December 2011 - that being:

 

Summary

In its joint meeting, the Boards made a number of tentative decisions, including the following:

  • Leases in which both the lessee and lessor each have a right to cancel the lease at any point in the future without termination penalties which effectively trigger a minimum lease term of more than 12 months would meet the definition of short-term leases when the notice period / cancellation penalty, together with any initial non-cancellable period, is 12 months or less.
  • Lessors of investment property would recognise rental income on a straight-line basis, or another systematic basis if that basis is more representative of the time pattern in which rentals are earned from the investment property (IFRSs only). Lessors of investment property that are not investment property entities or investment companies would recognise rental income on a straight-line basis, or another systematic basis if that basis is more representative of the time pattern in which rentals are earned from the investment property (US GAAP only).
  • A lessor of investment property would recognise only the underlying investment property (as well as any accrued or prepaid rental income) instead of recognising a lease receivable and corresponding lease liability.
  • Certain disclosures (outlined below) would be required for lessors with leases excluded from the scope of the receivable and residual approach.

Cancellable leases

The Boards discussed the accounting for a lease in which both the lessee and the lessor each have a right to cancel the lease at any point in the future without any termination penalty, subject to a short notice period (such as one month) (referred to as a 'cancellable lease').

Considering previous decisions taken by the Boards regarding the definition of 'lease term' and short-term leases', the staff presented its interpretation of the accounting for cancellable leases. The staff noted that the lease term for a lease would be limited to the non-cancellable period together with any termination or notice period. Entities would be able to apply short-term lease accounting to these leases if the non-cancellable period, together with the termination or notice period, is less than 12 months. In contrast, if option periods are not enforceable (e.g., the lessee does not have the unilateral right to extend the lease term beyond any non-cancellable period), entities would apply previous Board decisions (e.g., the lessee would not have the right to use the underlying asset beyond the non-cancellable period and would not include such options in the lease term).

Many Board members were supportive of the staff's interpretation. However, other Board members expressed concern with:

  • uncertainty as to whether leases which include “penalties” for failing to renew or terminating a lease qualify as 'cancellable leases' for purposes of the above interpretation. Two specific concerns were raised:
  • One Board member questioned whether the existence of a 'termination penalty' in a lease should inherently scope the lessee or lessor out of the cancellable lease interpretation. His concern was that a 'termination penalty' may be insignificant to the short-term lease assessment. For example, in a month-to-month lease with no notice period, where a 1-month termination penalty exists in exiting the lease, the staff's proposal was seen to scope out this lease from the cancellable lease interpretation. Therefore, the lessee and lessor would assess the lease term applying the significant economic incentive criteria. This Board member noted that a 'termination penalty' which would not 'economically' disqualify lessees or lessors from applying the short-term lease exception should be subject to the cancellable lease provision.
  • Another Board member questioned whether termination penalties were limited to cash consideration on termination or failure to renew a lease. He noted a lack of distinction between a lease which requires cash consideration at termination of a lease and a lease in which the lessor charges off-market terms on initiation of the lease but reimburses the lessee if the lease is extended beyond the initial term. Therefore, he wanted cancellable leases to consider off-market terms in their scope.
  • the inconsistency in applying the significant economic incentive threshold in recognition of the lease term but not applying a similar methodology in the recognition of short-term leases. These Board members cited application difficulties in applying two unique definitions, as well as possible structuring opportunities that may ensue. Thus, they preferred that lessees and lessors apply the significant economic incentive threshold outlined in recognition of the lease term before deciding if a lease is short term (i.e., recognised lease term is 12 months or less).

Given these concerns, many Board members expressed a desire for the staff to bring back the issue of defining a short-term lease to a future meeting. However, other Board members felt that a tentative decision could be reached if the scope of the matter was appropriately defined. Therefore, the FASB chair proposed to amend the scope of cancellable leases, whereby cancellable leases would include a lease in which both the lessee and the lessor each have a right to cancel the lease at any point in the future without a termination penalty which would effectively trigger a minimum lease term of more than 12 months. Using this scope, both Boards tentatively agreed that cancellable leases would meet the definition of short-term leases when the notice period, together with any initial non-cancellable period, is 12 months or less.

Rental income recognition for investment properties

The Boards discussed how a lessor should account for rental income arising from investment property that is outside the scope of the lessor receivable and residual approach. For purposes of the discussion, it was assumed that the definition of investment property would be an asset-based definition as opposed to an entity-based definition. However, the staff acknowledged that the definition of investment property would need to be addressed in a future meeting.

In light of current requirements in IFRSs and US GAAP, the IASB was asked to consider necessary guidance for all investment properties (both investment properties measured at fair value and investment properties measured at cost) under IFRSs. The FASB was asked to consider only investment properties that are not held by investment property entities or investment properties under US GAAP as the FASB's Investment Property Entities and Investment Companies exposure drafts provide rental income recognition guidance for investment properties held by investment property entities and investment companies in which the exposure drafts propose that rental income should be recognised on a contractual basis (i.e., when lease payments are received or become receivable in accordance with the lease contract).

Citing current requirements in IFRSs and US GAAP, as well as feedback received on the Leases ED's proposals about rental income recognition for investment property and as part of the FASB's Investment Property Entities and Investment Companies projects, the staff communicated two approaches to rental income recognition for investment properties: recognise rental income on a contractual basis (Approach 1) or recognise rental income on a straight-line basis, or another systematic basis if that basis is more representative of the time pattern in which rentals are earned from the investment property (Approach 2). The staff recommended Approach 2 (for all lessors of investment property in IFRSs and lessors of investment property that are not classified as investment property entities or investment companies in US GAAP).

Noting that the staff's recommendation would result in divergence between IFRSs and US GAAP for lessors of investment property that are classified as investment property entities or investment companies in US GAAP, one FASB member requested that the FASB consider feedback from constituents on its Investment Property Entities and Investment Companies projects to determine if a converged solution could be achieved. The FASB staff noted that feedback to date suggested that constituents believed that recognising rental income on a contractual basis (for investment property entities or investment companies) was more aligned with the fair value measurement basis proposed in the Investment Property Entities and Investment Companies projects, but the staff would consider further feedback from its constituents during the proposal period. With little additional debate, the Boards tentatively agreed with the staff's recommendation.

The Boards were also asked to consider the recognition of lease assets and lease liabilities for lessors of investment property. While some constituent outreach suggested that in order to be consistent with the lessee right-of-use model, a lessor of investment property should not only continue to recognise the underlying asset, but also recognise a lease receivable and corresponding lease liability, the staff recommended that a lessor of investment property should recognise only the underlying investment property on its statement of financial position (as well as any accrued or prepaid rental income). With little debate, both Boards tentatively agreed with the staff recommendation consistent with previous decisions taken by the Boards.

Disclosures for leases excluded from the receivable and residual approach

The Boards considered disclosure requirements for lessors that have leases of investment property that are excluded from the scope of the receivable and residual approach. The staff recommended, considering current disclosure requirements in IFRSs and US GAAP, previous Board decisions regarding disclosure as part of the leases project and general feedback from outreach activities, that the following disclosures be included in the leases guidance for leases of investment property that are excluded from the scope of the receivable and residual approach:

  1. A maturity analysis of the undiscounted future non-cancellable lease payments for a lessor's lease of investment property excluded from the scope of the receivable and residual approach. The maturity analysis should show, at a minimum, the undiscounted cash flows to be received in each of the first five years after the reporting date and a total of the amounts in the years thereafter. That maturity analysis would be separate from the maturity analysis of the payments related to the right to receive lease payments under the receivable and residual approach.
  2. Both minimum contractual lease income and variable lease payment income within the table of lease income.
  3. The cost and carrying amount of property on lease or held for leasing by major classes of property according to nature or function, and the amount of accumulated depreciation in total.
  4. Information about leases that are scoped out of the receivable and residual approach consistent with paragraph 73 of the Leases ED, updated for decisions the Boards have reached to date. That information would include:
    1. A general description of those lease arrangements
    2. Information about the basis and terms on which variable lease payments are determined
    3. Information about the existence and terms of options, including for renewal and termination
    4. A qualitative description of purchase options, including information about the percentage of assets subject to such agreements
    5. Any restrictions imposed by lease arrangements.

One Board member expressed a desire to amend a) such that the maturity analysis would include the present value of future minimum lease payments as opposed to undiscounted payments. He felt that that present value information was more useful to users of the financial statements regarding balances held in the financial statements. However, others felt that undiscounted payments provided important information regarding liquidity. Further, discounted payments were seen to pose application difficulties such as defining an appropriate rate when the implicit rate in a lease may be based on payments beyond the minimum lease payments. Another Board member requested the disclosure of fair value information which was seen as more valuable information to financial statement users. However, many expressed concerns with application of a fair value model from a practical perspective.

When put to a vote, the Boards tentatively agreed with the staff's recommended disclosures without amendment.

Future meeting topics

The staff noted that in future Board meetings, it would bring back certain additional topics for deliberation, including:

  • the definition of investment property as applied in the above tentative decisions.
  • the lessee accounting model given feedback and concerns raised by constituents over the last several months.
  • additional disclosure matters.
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