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Leases

Date recorded:

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED) the boards discussed several lessor and lessee related topics including:

 

The Boards made a number of tentative decisions, including the following:

Receivable and residual approach

Decisions

  • Initially measure the residual asset as an allocation of the carrying amount of the underlying asset. The initial measurement of the residual asset comprises two amounts: (a) the gross residual asset, measured at the present value of the estimated residual value at the end of the lease term discounted using the rate the lessor charges the lessee, and (b) the deferred profit, measured as the difference between the gross residual asset and the allocation of the carrying amount of the underlying asset.
  • Subsequently measure the gross residual asset by accreting to the estimated residual value at the end of the lease term using the rate the lessor charges the lessee. The lessor would not recognise any of the deferred profit in profit or loss until the residual asset is sold or re-leased.
  • Present the gross residual asset and the deferred profit together as a net residual asset.
  • The Boards also tentatively decided that there should be no distinction between when profit is or is not reasonably assured in accounting for a lease contract by a lessor.
  • The FASB and the IASB tentatively decided that a lessor's lease of investment property would not be within the scope of the receivable and residual approach. Instead, for such leases the lessor should continue to recognise the underlying asset and recognise lease income over the lease term.

 

Discussion

The boards had tentatively decided on the receivable and residual approach ("R&R") at prior meetings. The staff has received input on these decisions from outreach they performed. The staff summarised the outreach which reflected concern regarding the reasonably assured/not reasonably assured criteria, including difference between leases and revenue recognition, auditability of the criteria, and the perceived option to elect a model. Based on the outreach the staff recommended certain modifications to the R&R approach.

The boards discussion first focused on how to measure the residual asset and how to subsequently accrete the residual asset. The staff presented 4 options:

  • Approach A - Initially measure the residual asset by determining what the future depreciated carrying amount would be at the end of the lease term as if it were not subject to lease accounting and then discount this based on the rate the lessor charges the lessee. The residual asset is subsequently accreted.
  • Approach B - initially measure the residual asset as the present value of the estimated fair value at the end of the lease term. The residual asset is subsequently accreted.
  • Approach C - Initially measure the residual asset at an allocation of the carrying amount. The residual asset would not be subsequently accreted.
  • Approach D - Initially measure the residual asset at the present value of the estimated fair value at the end of the lease term. Additionally the manufacturing profit of the underlying asset is allocated between the receivable and the residual asset. The profit associated with the residual asset is deferred until the underlying asset is sold or re-leased.
The boards were split between approach A & D or retaining the previous decisions. Several board members preferred approach D because it would result in consistent interest income recognition between a manufacturer and a financial institution and a consistent balance of the residual asset at the end of the lease term. Other board members were concerned that there needed to be a constraint on profit recognition. After a lengthy discussion a majority of board members voted for approach D.

 

The other significant decision was regarding the staff's recommendation to provide a scope exception from the proposed lessor accounting for a lessor's lease of multiple leases of physically distinct portions. These lessors would apply current operating lease accounting. The Boards agreed that the proposed R&R approach would result in many operational challenges for these lessors. Additionally other board members believed that there were different economics with these arrangements. However, the boards were concerned with trying to define multi-tenant properties. Therefore they tentatively decided to provide the scope exception for investment properties as defined in IAS 40 and the proposed FASB's Investment property entity project.

Variable lease payments and the measurement of the residual asset

Decisions

  • If the rate the lessor charges the lessee does not reflect an expectation of variable lease payments, the lessor would not make any adjustments to the residual asset with respect to variable lease payments.
  • If the rate the lessor charges the lessee reflects an expectation of variable lease payments, the lessor would adjust the residual asset on the basis of its expectation of variable lease payments by recognising a portion of the cost of the residual asset as an expense when variable lease payments are recognised in profit or loss. Any difference between actual and expected variable lease payments would not result in any further adjustment to the residual asset with respect to variable lease payments.

 

The boards had concerns about the staff's recommended approach to account for variable lease payments and the subsequent measurement of the residual asset. The biggest concern was the complexity of the proposal. Other board members were concerned with the inconsistency this would create with the lessee model. The boards were initially split in their votes (IASB in favour of the staff's recommendation and the FASB opposing). However the FASB board members changed their vote so that there would be convergence in this decision.

Presentation statement of comprehensive income

Decisions

  • The accretion of the residual asset as interest income
  • The amortisation of initial direct costs as an offset to interest income
  • Lease income and lease expense (for example, revenue and cost of sales) in the statement of comprehensive income either in separate line items (gross) or in a single line item (net), on the basis of which presentation best reflects the lessor's business model
  • A lessor should separately identify income and expenses arising from leases by either separate presentation in the statement of comprehensive income or disclosure in the notes to the financial statements. If disclosed, the notes should reference the line item in which the income is presented.

 

Fair value requirement for lease receivables held for sale

Decisions

  • Should not measure a lease receivable at fair value, even if part or all of that receivable is held for the purpose of sale
  • Should apply existing derecognition requirements (in IFRS 9 Financial Instruments, or FASB Accounting Standards Codification Topic 860, Transfers and Servicing) to lease receivables, but allocate the carrying amount of a lease receivable on the basis of its fair value excluding any option elements and variable lease payments that are not transferred
  • Should apply the disclosure requirements in IFRS 7 Financial Instruments: Disclosures, and Topic 860 for transferred lease receivables.

 

Lessee transition

Decisions

  • The Boards tentatively decided that for capital/finance leases existing at the beginning of the earliest comparative period presented, a lessee would not be required to make any adjustments to the carrying amount of lease assets and lease liabilities and should reclassify those lease assets and lease liabilities as right-of-use assets and liabilities to make lease payments.

 

The Boards tentatively decided that for operating leases existing at the beginning of the earliest comparative period presented, a lessee should:

  • Recognise liabilities to make lease payments at transition measured at the present value of the remaining lease payments, discounted using the lessee's incremental borrowing rate as of the effective date for each portfolio of leases with reasonably similar characteristics. The incremental borrowing rate for each portfolio of leases should consider the lessee's total leverage, including leases in other portfolios.
  • Recognise right-of-use assets equal to the proportion of the liability to make lease payments at lease commencement calculated on the basis of the remaining lease payments.
  • Record to retained earnings any difference between the liabilities to make lease payments and the right-of-use assets at transition.
  • A lessee could also choose to apply the requirements in the proposed lease standard retrospectively in accordance with IAS 8 or ASC 250.

 

The boards also tentatively decided to provide the following reliefs when adopting the lease standard:

  • An entity is not required to evaluate initial direct costs for contracts that began before the effective date
  • An entity may use hindsight in comparative reporting periods including the determination of whether or not a contract is or contains a lease.

 

Lessor transition

Decisions

  • The Boards tentatively decided that for finance/sales-type and direct finance leases existing at the beginning of the earliest comparative period presented, a lessor would not be required to make adjustments to the carrying amount of the assets associated with those leases.

 

For operating leases existing at the beginning of the earliest comparative period presented, the Boards tentatively decided that a lessor should:

  • Recognise a right to receive lease payments, measured at the present value of the remaining lease payments, discounted using the rate charged in the lease determined at the date of commencement of the lease, subject to any adjustments required to reflect impairment.
  • Recognise a residual asset consistent with the initial measurement of the residual asset under the receivable and residual approach, using information available at the beginning of the earliest comparative period presented.
  • Derecognise the underlying asset.
  • A lessor could also choose to apply the requirements in the proposed lease standard retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors or ASC 250.

 

Several board members favoured full retrospective approach to adopt the proposed lease standard. However, there was concern about the cost of this approach therefore the boards tentatively decided on providing an option between the modified approach and full retrospective.

The FASB board also noted that these decisions did not change the previous decisions relating to leverage leases.

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