Lease accounting, particularly for lessees, was criticised in the financial crisis for not recognising contractual commitments under lease contracts in a way that was transparent and useful to users. As a result, lease accounting was revisited and at the same time lessor accounting was evaluated in an attempt to achieve symmetry between lessee and lessor accounting.
Feedback on the 2010 ED indicated that the profit or loss impact of the lessee model did not reflect useful information as a result of so-called “front-loading” to profit or loss. Front-loading is caused by the combination of a decreasing interest charge over time as the lease liability is repaid and the straight line amortisation of the right-of-use asset. The re-exposed ED includes proposals to mitigate the front-loading of profit or loss for specific types of leases.
For lessors, feedback indicated that the current model does reflect decision useful information to users which has resulted in a reassessment of the symmetrical approach in the 2010 ED.
Objective. The ED establishes the principles that lessees and lessors shall apply to report the amount, timing and uncertainty of cash flows arising from a lease.
Scope. The ED will not apply to leases of intangible assets, biological assets, exploration rights, and service concessions within the scope of IFRIC 12 Service Concession Arrangements.
IFRIC 4 Determining Whether an Arrangement Contains a Lease contains guidance for the assessment of contracts that do not take the legal form of a lease but conveys a right to use an asset, for example take-or-pay arrangements. The ED has incorporated this guidance into the proposed standard, but has re-written the criteria which may lead to some changes in the application of the guidance in practice.
Separating components of a contract. The lessor will be required to split a contract into its respective components, for example a lease including a maintenance contract, using the principles for the allocation of transaction price to performance obligations outlined in the revenue recognition exposure draft ED/2011/6 Revenue from Contracts with Customers.
Lease term. The lease term is the non-cancellable lease term together with renewal option periods where there is significant economic incentive to extend the lease. The application of economic incentive may require judgment especially where the lease is in a strategic location.
Classification of a lease. At the commencement date the entity has to classify a lease as either Type A or Type B, where Type A leases normally mean that the underlying asset is not property while Type B leases normally mean the underlying asset is property.
However, the entity will classify a lease other than a property lease as Type B if:
- the lease term is for an insignificant part of the total economic life of the underlying asset; or
- the present value of the lease payments is insignificant relative to the fair value of the underlying asset at the commencement date of the lease.
Conversely, the entity will classify a property lease as Type A if:
- the lease term is for the major part of the remaining economic life of the underlying asset; or
- the present value of the lease payments accounts for substantially all of the fair value of the underlying asset at the commencement date.
Contract modifications. A contract modification will result in a reassessment of lease assets and liabilities. The difference between the carrying amounts of assets and liabilities under the old lease and the new lease is recognised immediately in profit or loss.
Lessee accounting. At the commencement date of the lease, the lessee shall discount the lease payments using the rate the lessor charges the lessee, or if that rate is unavailable, the lessee’s incremental borrowing rate. The lease payments include:
- fixed payments, less any lease incentives receivable from the lessor;
- variable lease payments that depend on an index or a rate are initially measured using the index or rate as at the commencement date;
- variable lease payments that are in-substance fixed payments;
- amounts expected to be payable by the lessee under residual value guarantees;
- the exercise price of a purchase option if the lessee has a significant economic incentive to exercise that option; and
- payments for penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.
The lessee recognises the present value of lease payments as a liability. At the same time it recognises a right-of-use asset equal to the lease liability plus:
- any lease payments made to the lessor at or before the commencement date, less any lease incentives received from the lessor; and
- any initial direct costs incurred by the lessee.
After commencement date, the liability is increased by the unwinding of interest and reduced by lease payments made to the lessor. The lease liability is reassessed when there is a change in the expected amount of lease payments. If the remeasurement relates to the current period, the adjustment is reflected directly in profit or loss. Alternatively, the adjustment is recognised to the right-of-use asset provided the adjustment does not result in the right-of-use asset being negative. The right-of-use asset will be subject to impairment.
A lessee will recognise in profit or loss, unless the costs are included in the carrying amount of another asset:
- for Type A leases, the unwinding of the discount on the lease liability as interest and the amortisation of the right-of-use asset.
- for Type B leases, the lease payments will be recognised in profit or loss on a straight line basis over the lease term and reflected in profit or loss as a single lease cost. The single lease cost will be allocated to the actual unwinding of interest on the liability and any remaining lease cost is allocated to the amortisation of the right-of-use asset. However, the periodic lease cost shall not be less than the periodic unwinding of the discount on the lease liability.
- variable lease payments not included in the lease liability in the period in which the obligation for those payments is incurred.
The ED proposes disclosure to enable the user to differentiate the financial impacts of owned and leased assets in the financial statements.
Lessor accounting. The lessor model in the ED is similar to current lease accounting.
For Type A leases:
- The lessor will discount the lease payments, as outlined for lessees, using the rate the lessor charges the lessee and recognise this amount as the lease receivable;
- Recognise a residual asset being the sum of the present value of any unguaranteed residual, variable lease payments not included in the lease receivable and an allocation of profit relating to the residual asset;
- Recognise the profit on the portion of the asset leased immediately in profit or loss;
- Recognise the unwinding of interest on the lease receivable and residual asset in profit or loss over the lease term.
A reassessment in the expected lease payments, excluding the impact of credit risk, will be reflected immediately in profit or loss. The interest rate in the lease may be amended during the lease term if certain criteria are met. The lease receivable and residual asset will be subject to impairment.
Income from Type B leases will be recognised in profit or loss on a straight line or other systematic basis over the lease term, similar to current operating lease accounting for lessors. The leased asset will not be derecognised or reclassified but will be depreciated using the principles for owned property, plant and equipment.
The ED proposes disclosure to enable the user to determine the financial impacts of leases in the financial statements.
Effective date. The IASB will decide on the effective date only upon completion of its redeliberations.
As this is one of the convergence projects, the FASB has issued a corresponding ED. Comments on both proposals close on 13 September 2013.