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Journal entry — Leases — FASB and IASB continue redeliberations

Published on: Apr 25, 2014

At their April 23, 2014, joint meeting, the FASB and IASB continued redeliberating their revisions to lease accounting. The boards discussed (1) lease modifications, (2) contract combination, (3) variable lease payments (including in-substance fixed lease payments), and (4) the discount rate to be used in the calculation of lease assets and lease liabilities. 

The following table summarizes the tentative decisions reached at the meeting:



Lease modifications

The boards tentatively agreed to define a lease modification as “any change to the contractual terms and conditions of a lease that was not part of the original terms and conditions of the lease.” In making that determination, an entity would “consider the substance of the entire modified contract . . . and not just the written changes.”

  • A lessee/lessor would account for a lease modification as a new lease, separately from the original lease, when the modification (1) “grants the lessee an additional [right-of-use (ROU)]” asset and (2) prices the additional ROU asset “commensurate with its standalone price (in the context of that particular contract).”
  • A lessee would account for a lease modification that does not represent a new lease as follows:
    • For a modification that either (1) expands the scope of the original lease or (2) results in a change to the lease consideration only, the lessee would use the updated lease payments and discount rate to revise the lease liability and would recognize any difference between the new lease liability and the old lease liability as an adjustment to the ROU asset.
    • For a modification that reduces the scope of the original lease contract, the lessee would adjust the lease liability by using the revised lease payments and an updated discount rate, derecognize a proportionate amount of the ROU asset, and recognize any difference as a gain/loss through earnings.
  • A lessor would account for a lease modification that does not represent a new lease as follows:
    • For the modification of a Type B lease, the lessor would account for the modified lease as a new lease. Any prepaid or accrued rent associated with the original lease would be considered lease payments under the new lease.
    • For the modification of a Type A lease, the lessor would use the guidance in IFRS 91 under IFRSs or ASC 3102 under U.S. GAAP to determine how to account for changes in the lease receivable.

Contract combinations

The boards tentatively agreed that “two or more contracts entered into at or near the same time with the same counterparty” would be combined under the new leases standard if either of the following conditions is met: (1) “the contracts are negotiated as a package with a single commercial objective” or (2) “the amount of consideration to be paid in one contract depends on the price or performance of the other contract.” This guidance is consistent with the requirements in the forthcoming revenue recognition standard.3

Variable lease payments

The boards reaffirmed the requirement in the May 2013 ED that only variable lease payments that depend on an index or a rate should be included in the initial measurement of the lease assets and lease liabilities (by using the level of the index or rate at lease commencement). In addition, the boards reaffirmed that variable lease payments based on usage or performance of the asset should not be included in the measurement of the lease liability (lessee’s perspective) or receivable (lessor’s perspective) but should be recognized in the income statement in the period in which they are incurred.

While the boards concurred that variable lease payments based on an index or rate should be included in the initial measurement of the lease payments, they did not agree on how such payments should be subsequently measured. The FASB supported the staffs’ recommendation (described as Approach 3 in Agenda Paper 278), which would result in the reassessment of variable payments only when the lease liability is reassessed for other reasons (e.g., when the lease term is reassessed or when it is reasonably certain that the lessee will exercise a purchase option). In contrast, the IASB supported Approach 2 in the agenda paper, which would also require that the lease payments be remeasured when there is a change in the contractual cash flows as a result of a change in an index or rate.

The boards tentatively agreed that lessors should not remeasure variable lease payments based on an index or rate. 

In-substance fixed payments

The boards tentatively agreed to:

  • Retain the principle that in-substance fixed payments should be considered lease payments and included in the calculation of lease assets and lease liabilities.
  • Include in the Basis for Conclusions language indicating that the fact that some variable lease payments are considered in-substance fixed lease payments under the new standard is consistent with current practice.

The boards did not reach a consensus on whether to include in the final standard additional examples illustrating the concept of in-substance fixed lease payments. Some board members wanted to include more application guidance and limit the examples, while others preferred (1) a combination of illustrative examples and application guidance or (2) only additional illustrative examples.

Discount rate

The boards tentatively agreed to make limited changes to the definition of discount rate in the 2013 ED. These changes include:

  • Describing the rate the lessor charges the lessee (as used in the ED) as the rate implicit in the lease.
  • Requiring that the initial direct costs of the lessor be included in the calculation of the rate implicit in the lease.
  • Clarifying that the boards’ use of the term “value” in the definition of “incremental borrowing rate” refers to the cost of the ROU asset.

In addition, the boards agreed that a lessor is not required to subsequently reassess the discount rate used. A lessee is only required to reassess the discount rate upon a lease modification or when there is a change in the (1) lease term or (2) assessment of whether the lessee is reasonably certain to exercise its option to purchase the underlying asset.

At their May 2014 joint meeting, the boards plan to discuss the following items related to the leases project:

  • Definition of a lease.
  • Separating lease and nonlease components.
  • Initial direct costs.
  • Lease incentives.


1  IFRS 9, Financial Instruments.

2  FASB Accounting Standards Codification Topic 310, Receivables.

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