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Leases – initial measurement

Date recorded:

Initial direct costs

The purpose of this discussion was to discuss:

  • The definition of initial direct costs
  • The accounting by lessees and lessors for initial direct costs.

The staff recommended that initial direct costs should be defined consistent with the ED except for the removal of recoverable from the definition. The Staff noted that they believe the notion of recoverable is implicit in the definition and is therefore redundant. The proposed definition of initial direct costs is as follows:

Costs that are directly attributable to negotiating and arranging a lease that would not have been incurred had the lease transaction not been made.

The staff also recommended to retain the guidance in the Exposure Draft that lessees and lessors should capitalise initial direct costs by adding them to the carrying amount of the right-of-use asset and the right to receive lease payments, respectively.

The staff identified the following advantages to affirm the guidance in the Exposure Draft:

  1. It is consistent with the treatment of similar costs associated with acquiring other nonfinancial assets (for example, property, plant, and equipment and intangibles). Thus, this approach would create comparability with the measurement of other nonfinancial assets.
  2. It is consistent with the proposed amortised cost-based approach to the measurement of the lessee's right-of-use asset. In general, cost includes incremental costs directly attributable to the acquisition of the asset.
  3. Different treatment between leased assets and owned assets may provide structuring opportunities.

The Boards agreed almost unanimously in favour of the staff's recommendation.

Inception vs. commencement

The purpose of this discussion was to discuss:

  1. When should a lessee and lessor recognise and initially measure lease assets and liabilities
  2. When should the lessee determine their incremental borrowing rate
  3. How should a lessee account for costs incurred prior to date of commencement
  4. Should application guidance be provided on how to account for lease payments made before the date of commencement
  5. Should application guidance be provided on how to account for incentives provided by the lessor

The staff recommended the following:

  1. Require a lessee and lessor to recognise and initially measure lease assets and liabilities (and derecognise any corresponding assets and liabilities, e.g. derecognise a portion of the underlying asset if using the lessor derecognition approach) at the date of commencement of the lease
  2. Require a lessee to use its incremental borrowing rate calculated at the date of inception when using that rate to measure the liability to make lease payments
  3. State that costs incurred by the lessee before the date of commencement relating to the construction of the underlying asset are outside the scope of the leases standard (such contracts are usually build-to-suit leases – arrangements for the right to use an asset that is constructed to meet the needs of the lessee). The lessee would apply other applicable standards when accounting for such construction costs. Additionally there would not be requirements that apply only to build to suit lease contracts
  4. Include application guidance on how to account for lease payments made by the lessee before the date of commencement as set out in paragraphs 42-44 of Agenda Paper 11B
  5. Include application guidance on how to account for incentives provided by the lessor to the lessee as set out in paragraphs 48 and 49 of Agenda Paper 11B.

The Boards agreed with the staff's recommendation to initially measure the lease assets and liabilities at the date of lease commencement. This decision eliminates the concerns that potential gains and losses could develop between inception and commencement date and that any changes that occur between inception and commencement would be taken into account when initially measuring the assets and liabilities. A few Board members expressed concern over differences in impairment tests pre and post commencement. The Staff noted they intend to bring an impairment paper at a later date.

The Boards disagreed with the staff recommendation on when to set the incremental borrowing rate if that is being used. The tentative decision was to determine the incremental borrowing rate at commencement. Board members noted that determining the incremental borrowing rate at inception would add complexity and could cause entities to use hindsight in determining the rate.

The Boards agreed with the staff recommendation that costs incurred prior to commencement should be accounted for outside the scope of the leases standard. The staff will provide additional guidance on what other guidance will apply.

The boards agreed with the staff recommendation that lease payments made prior to lease commencement will be recognised as a prepayment and at the date the commencement the prepayments will be added to the right-of-use asset.

The staff recommended the following treatment for lease incentives:

  1. If the lessor reimburses the lessee for costs incurred and those costs meet the definition of initial direct costs (e.g. costs associated with a pre-existing lease commitment), those receipts from the lessor would be considered together with the associated costs incurred by the lessee and accounted for in accordance with the analysis in agenda paper 11A / memo 145 (i.e. the receipts from the lessor would offset the initial direct costs incurred by the lessee)
  2. If the lessor reimburses the lessee for costs that the lessee would expense when incurred (e.g. relocation costs), the lessee would recognise such payments from the lessor directly in profit or loss (i.e. those payments would offset the costs incurred by the lessee)
  3. Any other upfront cash received from the lessor would be considered to relate to the right to use the asset. Accordingly, we think that the lessee should treat the cash received as part of the overall lease payments for use of the asset to which a discount rate is applied when the lessee measures its lease liability at the date of commencement. As a consequence, such cash receipts are also included in the initial measurement of the right-of-use asset (those receipts from the lessor would reduce the right-of-use asset initially measured).

The Boards agreed with the recommendation for (a) and (c), however they did not agree with (b). Many Board members expressed concern that a lessee could change their expense recognition by changing what they determine is being reimbursed. Additionally it may be difficult to determine what costs are being reimbursed. Therefore the boards tentatively decided to eliminate (b) and agreed that all payments received from the lessor would be recognised as a reduction of the right of use asset.

Determination of the discount rate in a lease

The purpose of this discussion was to determine how lessees and lessors should determine the discount rate used to initially measure lease payments at present value.

The staff made the following recommendations:

  1. The staff recommends that a lessee establish its discount rate using either:
    1. Its incremental borrowing rate; or
    2. The rate that the lessor charges the lessee (the rate implicit in the lease), if readily determinable.
    Additionally, the staff recommended that the lessee guidance be clarified that if both rates are available, the lessee is required to use the rate the lessor charges the lessee.
  2. The staff recommended that the lessor should establish its discount rate as defined in the ED. That is, a lessor should use the rate that the lessor charges the lessee, which could be the lessee's incremental borrowing rate, the rate implicit in the lease, or, for property leases, the yield on the property.

    Additionally, the staff recommends that the definition of the rate that the lessor charges the lessee be clarified to state that when more than one indicator of the rate the lessor charges in the lease is available, the rate implicit in the lease should be used.

    The Boards discussed the recommendations and agreed with the staff's recommendations. Board members discussed if the rates would be different for the two categories of leases, finance or an other-than-finance. They noted it may be more likely in an other-than-financing lease to not know the implicit rate. A board member also clarified that he did not want a lessee to have to go to extreme measures to try to determine the implicit rate, and the staff clarified that is their intention and will try to clarify in drafting.

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