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Leases (IASB and FASB)

Date recorded:

The Boards were asked to consider some questions that have been raised during the drafting process about the identification of lease components and the unit of account when applying the lease classification guidance. More specifically, those questions include:

  • When a contract conveys the right to use more than one asset, how would an entity determine whether there is one or multiple lease components that should be accounted for separately?
  • How would an entity apply the classification guidance if the lessee obtains the right to use an asset or assets that incorporate both property and non-property elements?
  • If the lease is a property lease that incorporates land and building elements, is an entity required to apply the classification guidance separately to the land element and the building element, as is required in existing leases standards?

Lease components

The Boards previously tentatively decided that an entity should allocate the consideration in a contract to each lease component. However, the Boards have not discussed how an entity would determine whether there is one or multiple lease components that should be accounted for separately when a contract conveys the right to use more than one asset. Therefore, the staff brought to the Boards a recommendation to apply the proposals in the revenue recognition project regarding the identification of separate performance obligations for the purpose of identifying separate lease components (i.e., the guidance in the revenue recognition proposals identifying when a good or service is distinct - paragraph 28 in the revenue recognition proposals). Specifically, the staff proposed the inclusion of the following guidance in the revised exposure draft (as adapted from paragraph 28 in the revenue recognition proposals):

An entity would consider the right to use an identified (underlying) asset to be a separate lease component if the lessee can benefit from the use of the identified asset either on its own or together with other resources that are readily available to the lessee. Readily available resources are goods or services that are sold or leased separately (by the lessor or other suppliers) or resources that the lessee has already obtained (from the lessor or from other transactions or events).

An entity would account for each separate lease component as a separate lease, subject to the guidance on the allocation of consideration in a contract within the leases ED.

In discussing this recommendation, many Board members expressed support for the staff recommendation. However, most noted that paragraph 28 in the revenue recognition proposals is to be analysed in conjunction with paragraph 29 of those same proposals. As such, Board members preferred that the leases proposals incorporate the equivalent of both paragraphs 28 and 29 of the revenue recognition proposals as opposed to only paragraph 28.

Another Board member questioned whether the proposal created unnecessary complexity and requested confirmation as to the practical impact of identifying separate lease components particularly when all the ‘component’ elements are classified consistently. One Board member rebutted the claim that separating lease components was unnecessary, particularly on the lessor side, where he noted that residual asset valuations may vary depending on whether lease components are separated or combined.

Another Board member questioned how this proposal would interact with the asset componentisation in IAS 16 Property, Plant and Equipment. The staff noted that componentisation requirements in IAS 16 would be retained, and thus, lessees would have to consider those requirements as part of the broader leasing proposals.

When put to a vote, the Board tentatively supported the recommendation of the staff, subject to incorporating the equivalent of both paragraphs 28 and 29 of the revenue recognition proposals into the leases revised exposure draft.

Classification of leases

The Boards previously decided that the recognition of lease-related expenses by a lessee and the accounting applied by a lessor would depend on whether a lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. The Boards proposed that this classification principle is applied differently depending on whether the underlying asset is a lease of property or a lease of an asset other than property. Because the lease classification guidance is different depending on whether the underlying asset is property, some have questioned how an entity would determine whether the underlying asset is property when the underlying asset within one component contains both property and non-property elements. The staff highlighted two possible ways to address this issue. The first would be to include guidance stating that an entity would determine the nature of the underlying asset on the basis of the nature of the primary asset in the component. The primary asset would be the predominant asset for which the lessee has contracted for the right to use. The second approach to addressing the issue would be to include guidance stating that a lease component is regarded as a property lease for classification purposes if that component includes any property element. The staff recommended the first approach; believing it to be relatively straight-forward to apply and should result in conclusions that follow the nature of most leases.

Board members expressed general support with the staff recommendation. However, a couple of Board member did express reservations regarding an example included in the staff paper. In that example, pertaining to a lease of space on a telecommunications tower, the staff concluded the lease was a non-property lease in applying the first approach above. These Board members saw the lease of space on a telecommunications tower as a property lease (not unlike the lease of a floor of a building). A similar issue is currently being considered by the IFRS Interpretations Committee. The staff noted their assessment was based on assumptions regarding the useful life of the asset – leading to a conclusion that the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset during the lease term. However, this assumption was not specifically discussed in the staff paper. The staff acknowledged that the inclusion of illustrative examples in the revised exposure draft would require additional details regarding assumptions applied.

With little additional feedback, the Boards tentatively supported the recommendation of the staff.

The Boards also discussed whether there should be a requirement to allocate lease payments between the land and building elements of a property lease when classifying that property lease. The staff recommended excluding a requirement in the revised exposure draft to allocate lease payments (i.e., there would be no requirement to split one lease component into land and building elements for classification or accounting purposes). The reasons for this recommendation were simplicity and a belief that there is little benefit from including a requirement to allocate lease payments (since both the land and building elements of most property leases will be classified consistently).

Board members expressed general support with the staff recommendation. However, one IASB member, fearing unintended consequences in treating land and building elements of a property lease as a single property lease, preferred that IFRSs retain the requirement to allocate lease payments between the land and building elements of a property lease when applying the classification requirements. He did propose an exception to this requirement (which is currently present in US GAAP) – that being, a preparer would not be required to allocate lease payments between the land and building elements of a property lease when the fair value of the land is insignificant when compared to the total fair value of the leased property. Little support was expressed by other Board members to this proposal.

With little additional feedback, the Boards tentatively supported the recommendation of the staff.

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