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Leases – short-term leases

Date recorded:

The Boards continued their discussions from the previous day on the leases project. Today their discussions focused on short-term leases.

Accounting for short-term leases

The exposure draft proposed different accounting by a lessee and a lessor for short-term leases. Specifically, a lessee could elect to measure the liability at the undiscounted amount of the lease payments and measure the right of use asset as the undiscounted amount of lease payments plus initial direct costs while a lessor could elect on a lease-by-lease basis not to recognise assets or liabilities from the lease arrangement and instead retain the leased asset on the balance sheet while recognising lease payments over the lease term.

Comment letter respondents were generally supportive of providing simplified accounting for short-term leases; however, a majority of respondents disagreed with the proposals for lessees primarily because they felt the cost relief would not be significant enough.

The Boards considered three alternatives in considering the feedback received:

  • Alternative 1: Retain the exposure draft proposals for simplified accounting for short-term leases.
  • Alternative 2: Retain the exposure draft proposals for lessors but permit lessees to account for short-term leases in a manner similar to current operating leases (so that the accounting would be symmetrical between lessors and lessees).
  • Alternative 3: Eliminate the exception for short-term leases.

An IASB member began the discussions stating he supported alternative 2 so long as sufficient disclosures were provided (such as profit or loss information on short-term lease arrangements, the policy utilised and disclose payments due over the next twelve months). Several other IASB members supported this view as well.

However, other IASB members supported alternative 3, one because he believed introducing a third model for leases would result in additional complexity that would outweigh the benefit provided by the practical expedient while another felt that requiring the disclosures mentioned above would negate any benefit provided by allowing alternative 2. A third IASB member felt that structuring opportunities could also be created under alternative 2 in order to avoid balance sheet presentation, although other Board members mentioned that separate transactions would have to be entered into each period, each of which would be subject to the market risks at that point in time, which they felt would minimise the risk of structuring.

The FASB members were similarly split in views between alternatives 2 and 3. Ultimately, the Boards tentatively decided that the proposed guidance in the ED for the accounting for short-term leases by lessors would be retained and the requirements for lessees would be amended such that short-term leases would not be recognised on a lessee's statement of financial position (i.e., consistent with the current requirements for operating leases). As a result, both lessees and lessors would present the expense or income from short-term leases as lease income or lease expense which is consistent with current operating lease treatment.

Definition of short-term lease

The exposure draft defined a 'short-term lease' as "a lease that, at the date of commencement of the lease, has a maximum possible lease term, including options to renew or extend, of 12 months or less." However, based on the definition of 'lease term' from the Boards' subsequent deliberations, the staff believed the definition of 'short-term lease' should be revisited.

The staff recommended a definition of 'short-term lease' as "a lease that, at the date of commencement of the lease, has a maximum possible term, including any options to renew, of approximately 12 months or less." One IASB member expressed concern with the inclusion of 'approximately' in the definition and questioned the staff on its inclusion. The staff responded that this was added in order to be consistent with some of the terminology in the insurance project but that the staff did not have a strong view on it being part of the definition.

The Boards tentatively decided that the definition of short-term lease should be "a lease that, at the date of commencement of the lease, has a maximum possible lease term, including any options to renew or extend, of 12 months or less". Therefore, in determining whether a lease that includes a renewal option is short-term, a lessee and lessor would not evaluate whether there is a significant economic incentive for the lessee to exercise the option because it is assumed the renewal option would be exercised.

Application of short-term lease guidance

The Boards also discussed how an entity would apply the practical expedient provided for short-term leases (alternative 2 above). The Boards considered three approaches: (1) applying on a lease-by-lease basis, (2) permitting application enterprise wide through an accounting policy election, or (3) requiring application of the practical expedient for all short-term leases.

An IASB and FASB member each proposed a combination of the first two alternatives where an entity would be permitted to apply the practical expedient as an accounting policy election for specific asset classes. This approach was raised in part because of concerns that an entity may have smaller short-term leases for certain asset classes (e.g., photocopier leases) but may have another short-term lease that is more significant and does not wish to apply the practical expedient (e.g., equipment critical to production efforts). This combination received support from both Boards, however, the Board members (both IASB and FASB) representing financial statement users tended to prefer consistency above all else and supported requiring application of the practical expedient to all short-term leases.

Ultimately, the Boards tentatively decided that an entity would apply the short-term lease guidance as an accounting policy election by asset class.

Pattern of profit or loss recognition

Based on the decision to provide the practical expedient so that short-term leases would be accounted for similar to current operating leases, the staff suggested the Boards clarify the pattern over which profit or loss would be recognised. The Boards tentatively decided that lease payments on short-term leases would be recognised on a straight-line basis over the lease term unless another systematic and rational basis is more representative of the time pattern in which use is derived from the underlying asset.

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