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Journal entry — Leases — FASB and IASB continue redeliberations

Published on: May 23, 2014

At their joint meeting yesterday, the FASB and IASB continued redeliberating their revisions to lease accounting. The boards discussed (1) the definition of a lease, (2) separating lease and nonlease components, and (3) initial direct costs. 

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



Definition of a lease

The boards tentatively reconfirmed their decision from the May 2013 ED that a lease possesses both of the following characteristics:

  • The fulfillment of the contract depends on the use of an identified asset.
  • The contract conveys the right to control the use of the identified asset for a certain period in exchange for consideration.

Use of an Identified Asset

The boards agreed to provide additional guidance on when a lessor’s substitution rights are considered substantive in the evaluation of whether an identified asset exists. Specifically, the boards decided that for a substitution right to be considered substantive, a lessor would need to have the “practical ability” to substitute the identified asset and must economically benefit from the substitution. In addition, the boards tentatively decided that a lessee can presume that a substitution right is not substantive when it is impractical to prove otherwise.

Right to Control the Use of an Identified Asset

The boards agreed to provide additional guidance on evaluating whether a customer has the right to control the use of the underlying asset. Specifically, the boards decided to clarify that the control analysis should focus on the customer’s ability to affect the economic benefits derived from using the underlying asset.

The boards also tentatively agreed to provide a more robust framework and examples related to determining which decisions on directing the use of the asset would have the greatest impact on the economic benefits derived from use of the asset.  

Separating lease and nonlease components

The boards tentatively reconfirmed the guidance in their May 2013 ED on when multiple lease components in a contract should be combined or separated from one another.

The boards also reconfirmed that both lessees and lessors would be required to separate lease components and nonlease components (e.g., any services provided) in an arrangement and allocate the total transaction price to the individual components. Lessors would perform the allocation in accordance with the guidance in the forthcoming revenue recognition standard, and lessees would do so on a relative stand-alone price basis (by using observable stand-alone prices or, if the prices are not observable, estimated stand-alone prices). However, lessees would be permitted “to elect, as an accounting policy by class of underlying asset, to not separate lease components from nonlease components, and instead account for the entire contract . . . as a single lease component.”1

In addition, the boards concluded that both lessees and lessors would be required to “reallocate the consideration in a contract when the contract is modified and the modification is not a separate, new contract.”2 Lessees would also be required to reallocate the consideration in the contract upon a reassessment of the lease term or a change in the likelihood that a purchase option will be exercised.

Initial direct costs

The boards tentatively decided that the definition of initial direct costs for both lessees and lessors should include only those costs that are incremental to the arrangement and that the entity would not have incurred if the lease had not been obtained. This definition would be consistent with the notion of incremental cost in the impending revenue recognition standard. Under this definition, costs such as commissions and payments made to existing tenants to obtain the lease would be considered initial direct costs. In contrast, costs such as allocated internal costs and costs to negotiate and arrange the lease agreement (e.g., professional fees such as those paid for legal and tax advice) would be excluded from this definition.

In addition, the boards tentatively agreed that a lessee would include all initial direct costs in its initial measurement of the right-of-use asset.

For Type A leases, with the exception of leases that result in the recognition of manufacturers’ profit, lessors would include all initial direct costs in the initial measurement of the lease receivable. Lessors entering into arrangements that result in the recognition of sales profit would recognize initial direct costs as expenses at lease commencement. For Type B leases, lessors would defer the initial direct costs and amortize them as expenses over the term of the lease.

The boards plan to discuss the following items related to the leases project at future meetings:

  • Subleases.
  • Sale-and-leaseback transactions.
  • Leases of “small” assets.
  • Presentation and disclosure.
  • Cost-benefit concerns, transition, and effective date.
  • FASB only: (1) leveraged leases and (2) private-company and not-for-profit issues.
  • Other (e.g., related-party leases).


1 See Agenda Paper 3B/283.

2 The evaluation for determining whether a modification would result in a new contract is based on the boards’ tentative decisions on lease modifications made at their April 2014 joint meeting. See Deloitte’s April 25, 2014, journal entry for more information.

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