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Leases

Date recorded:

Definition of a lease

The FASB's Lead Project Manager introduced the agenda paper on the definition of a lease. He said that in October 2014, the Boards had reached a number of decisions with respect to the definition of a lease. In that session the Boards had tentatively decided that:

  • a lease would be defined as a contract that conveyed the right to use an asset for a period of time in exchange for consideration;
  • an asset was identified either explicitly or implicitly in the contract and the supplier had no substantive rights to substitute that asset;
  • the customer controlled the right of an identified asset if the customer had the right to both (i) direct the use of the identified asset and (ii) obtain substantially all the economic benefits from directing the use of the identified asset during the applicable period; and
  • a supplier’s protective rights would not in isolation prevent the customer from having the right to direct the use of the asset.

He pointed out that the Boards had not reached a decision on whether a customer must have the ability to derive the benefits from directing the use of an identified asset on its own or together with other resources that were sold separately. He said that the Boards would be presented with three alternatives to decide on the topic.

He introduced alternative 1 by saying that under this approach, in order to meet the definition of a lease, a customer must have the ability to derive the benefits from directing the use of an identified asset on its own or together with other resources (e.g. a good or service) that were sold separately (by the supplier or any other supplier) or can otherwise be sourced in a reasonable period of time (e.g. by hiring an employee or an independent contractor). He then presented alternative 3 which he said that it did not include the ability to derive the benefits requirement. He said that alternative 3 would conclude that a lease existed when a customer had the right to both (a) direct the use of an identified asset; and (b) obtain substantially all the benefits from directing the use of the identified asset even if the customer cannot realise those economic benefits independently from the supplier. Finally, he presented alternative 2 which he said that it represented some middle ground between alternatives 1 and 3. He said that conceptually alternative 2 was closer to alternative 1 but with some changes to address possible unintended consequences, it would apply the ability to derive the benefits requirement only to those contracts in which the asset was incidental to the delivery of services. The identified asset would be considered incidental only when the asset component was substantially lower that the service or services component in the arrangement.

He concluded that the staff recommended the Boards to adopt alternative 3 because it would retain a simpler, less complex definition of a lease with less application issues and best information for users and would avoid unintended consequences.  He said that since their last meeting in October the staff had spoken with large practitioners, and they had concluded that alternative 1 would not result in significant differences as compared to alternative 3 in most leases because most services were available or sold separately. He also said that the staff did not recommend alternative 2 because it would be more complex to apply and would require more guidance. He then moved the discussion to the Boards.

Several FASB Board members indicated that they believed that alternative 1 was conceptually the best answer but, in case it were necessary to reach a converge decision, they could also accept alternative 3 because it would be easier to apply.

The FASB Chairman said that he believed that alternative 1 was the best answer conceptually but alternative 3 was easier. He said that he agreed with the staff analysis that the differences between alternative 1 and 3 would be applicable to limited cases.

One FASB member pointed out that there would not be many leases to which alternative 1 would be applicable. If there was a lease that met the criteria in alternative 1, it would not qualify as a lease, and for that reason he would support alternative 1. He could also support alternative 3.

Another FASB member said that he agreed with prior comments and he would support alternative 3 on cost benefits considerations.

Another FASB member said that he believed that the staff did a better job of articulating alternative 1. He said that he would accept alternative 3 as his first choice, but he could also accept alternative 1 if necessary to reach a converge decision.  

One FASB member asked how alternative 3 would work in a contract that did not specify the asset but where the contractor only owned one asset. He asked whether it would be assumed that the asset was implicitly specified because the supplier could not use any other asset. The FASB Lead Project Manager said that there would not be a different answer between alternatives 1 or 3. Further, he indicated that it would be concluded that the asset was implicitly specified and that the same conclusion would be reached under the current or in the future standard. He pointed out that just because of one single aspect it would not mean that there was a lease. The case would be similar to the T-shirt factory [the example discussed in October]. He said that just because there was a specified plant it would not mean that there was control of the use of the identified asset; it would also be necessary to direct its use and to have the ability to derive its benefits.

Another FASB member said that he believed there would be differences in alternatives 1 and 3 for example in the drilling industry. He said that it would not be the same if a customer requested a provider some drilling rigs to drill some holes vs requesting a provider to drill the holes. He pointed out that alternative 1 would capture the differences better because it required to derive the economic benefits from the use of the asset. The FASB Lead Project Manager responded that the differences in those scenarios would not be captured by alternatives 1 or 3; it would be captured by the control criteria. He said that for example if a customer asked a provider to drill 10 holes at an specified location, generally, that would not be a lease; however, if a customer instead had a contract stating that in the next 3 years the customer would direct where to drill and when (meaning that the customer would be setting for and what purpose the asset would be used), then it would have to pass the control criteria. Assuming that it would pass, in order to differentiate between alternative 1 vs alternative 3, it would be necessary to analyse whether the customer could obtain other resources that were sold separately to provide the services. He said that they had found in their discussions that for most large classes of assets they were being sold separately.

Another FASB member said that there was fine line between the notions of controlling the use of asset vs the ability to derive benefits from it. He said that for example if a customer hired a provider for construction and the provider had only one bulldozer and hired the provider to move something from point A to point B, that scenario would not be a lease because the customer did not control the use of the asset; on the other hand, if a customer hired the provider with his equipment for a particular period of time (more than one year) to provide the service, then it would be a lease. In both cases the customer was hiring a vendor to move something from point A to point B. He acknowledged that his concern was not related to apply alternative 1 vs alternative 3; instead, it was a general question to understand how the model apply. The FASB Lead Project manager responded that the ability to change how and for what purpose an asset was used was the key question to apply in that scenario. He said that in that scenario the customer could not decide on whether to move the bulldozer to another project and it would be different from a scenario where a customer locked a provider for a year and decide during that period what the bulldozer was going to do. He said that the objective of the lease definition was to capture assets for which during a period of time the customer could decide about how to use the asset. Further, he provided another example for IT services: He said that if the customer could not decide how to use the servers even though the assets were explicitly specified in the contract, this would not mean that there was a lease. He pointed out that the customer had to be able to decide how the asset would be used throughout the lease term.

One FASB member asked whether there would have to be a "magic" period of time or multiple tasks. The FASB Lead Project manager responded that it would not be necessary. Further, he provided another example by which if a customer leased a car, the customer would decide where to drive and what to hold in the card during the period of the lease, the notion that a customer could decide what purpose the asset was used was not different from contracting a vendor to use a specific bulldozer for a three year period and the customer deciding how and when to use the bulldozer. However, that would be different from hiring a vendor to build a building and the vendor could decide how to use the bulldozer, which bulldozer use etc. because the customer would not have the ability to control the use of the asset. He pointed out that the control analysis was a requirement to consider before analysing alternative 1 vs alternative 3.

Another FASB member said that although he would conceptually prefer alternative 1vs alternative 3, he could accept alternative 3, because, for example, in a scenario where a provider was a rig supplier and had a specialised rig patented that only his employees could operate, also that no-one else could supply because of the unique knowledge required, that would not be a lease because the customer did not have the ability to operate it. The FASB Lead Project manager said that in that particular scenario it showed where alternative 1 and 3 would differ. Further, he said that the facts that the asset was highly specialised and that nobody else could supply it, would lead to a different answer; however, he pointed out that it would be applicable to a very small population. The FASB member said that for that reason he would support alternative 1 because he would not want to capture those contracts as leases.

The discussion then moved to the IASB Board. The majority of the IASB members expressed support for alternative 3 because they were still concerns about unintended consequences. On the other hand, some members expressed support for alternative 1 because they believed it was better articulated than the one discussed in the October meeting.

The IASB Chairman said that he found alternative 2 difficult to apply although safer; he said that he would prefer alternative 1 because it was better reformulated since it removed the concept of 'readily available'. He also said that alternative 1 would not add much complexity because it would not be applicable for most cases and it would show that the Boards had listened to concerns expressed by many users that they were trying to capture too many leases.

Another IASB member expressed support for alternative 2 because it would cover only a narrow population and would scope out some obvious service contracts. He provided an example in which a customer entered into a home security contract which would require alarm equipment and he said that the majority of the contract was for service, and with alternative 2 that contract could be easily scoped out. He also said that alternative 3 could be appropriate although he preferred alternative 2.

Another IASB member said that in the example of the specialised drilling rig discussed before, the customer still could decide many fundamental questions about the asset, for example where the rig would go, how deep to drill, and how to address environmental concerns. However, she said that under alternative 1 the contract would not be a lease because the provider was the only one able to operate the asset. The IASB's Technical Principal confirmed her assessment although she stressed that the population would be very narrow (that particular provider was the only one able to operate the asset and the provider did not sell the asset separately). The IASB member responded that she found it very difficult to accept alternative 1. Further, she said that if a customer bought the rig and hired a provider to operate it, there would be no doubt that the customer had control of the asset.

Several IASB members agreed with those concerns. One IASB member indicated that he had discussions with oil and gas operators in his jurisdictions and found the same concerns. He believed that alternative 3 was the best answer. Another IASB member said that he agreed with the concerns expressed before and he would prefer alternative 3 because it was the appropriate answer, he said that he did not think that alternative 1 provided the right answer even in those limited number of circumstances discussed. One IASB member also expressed support for alternative 3, although he was concerned about the scope. He said that most countries had different kind of licences; he did not believe that just because there was a licence requirement that only the vendor could operate the asset, then it would not be a lease.

The Vice Chairman indicated that he would prefer alternatives 1 or 3. Another IASB member expressed the same opinion and he indicated that if alternative 1 were adopted, then they would have to address too many questions, interpretations etc. in the future, and alternative 3 was much easier to apply. The Chairman pointed out that the issue came out to them many times and would prefer the Board to keep that in mind.

The FASB Vice Chairman called a tentative vote and four members voted for alternative 1 and three members voted for alternative 3. Then the IASB Chairman called a vote and two members voted for alternative 1 while eleven members voted for alternative 3. In order to reach a converged solution, the FASB Vice Chairman called a second vote to ask the members whether they could accept alternative 3; six FASB members said they could.

 

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