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Leases

Date recorded:

It was noted that the Board had previously discussed the foundations for a model for lease accounting based on the analysis of contractual rights and obligations and the identification of resulting changes to assets and liabilities.

The Board continued by considering accounting for cancellation and renewal options in leases applying this model where the options are under the control of the lessee.

The Board considered the following examples using a ten year lease with an option to cancel after three years.

Example A: Lessee has an option to renew at a market rent at year 3.

The staff proposed that in the first three years the lessee and lessor had unconditional rights to use the equipment, receive payment, and have the equipment returned at the end of the lease and corresponding obligations.

In years four to ten they had a conditional right and obligation to receive and make payment. In addition there is an unconditional right to make use of the equipment and an unconditional obligation to 'stand ready' to provide the equipment.

The Board agreed with the staff's analysis.

Example B: Lessee has an option to renew at year 3 at a rent that is predetermined at the beginning of the lease.

The staff proposed the same analysis as for example A but noted that the call option may have an initial value.

In addition the staff noted an alternative view to recognise the entire 10 year lease term on delivery of the equipment if it is considered probable that the Lessee will keep the equipment for the full term.

The Board indicated a level of discomfort with the alternative view.

Example C: Lessee has an option to cancel at year 3; a cancellation payment is required.

The staff proposed the same analysis as for example B but that the cancellation payment is accrued over the first three years and deducted evenly from the payments in years four to ten if the lease is not cancelled.

Example D: Lessee has an option to cancel after a minimum period of 12 months; no cancellation payment is required.

The staff proposed a similar analysis to example A. The staff noted that the lessor may expect renewals and this may indicate the existence of an intangible asset.

Example E: Lessee has an option to renew at year 3 at a rent that is predetermined at the beginning of the lease and below the expected market rent (this type of arrangement is sometimes referred to as a 'bargain renewal').

The staff proposed the same analysis as for example B.

The staff noted the following example related to rentals contingent on the lessee's usage:

A lessee enters a three-year lease on a motor vehicle at an annual rental of CU 10,000. In addition, an extra CU 1 per mile is payable if the lessee exceeds 60,000 miles. The excess mileage charge reflects fair compensation for the additional wear and tear of the vehicle.

The staff proposed the following analysis:

  • The lessee has an unconditional right to use the vehicle for 3 years or 60,000 miles and an unconditional obligation to pay CU 30,000 to the lessor.
  • The lessee does not have an obligation to pay more than CU 30,000. The lessee has an unconditional right to obtain use of the vehicle for more than 60,000 miles. However, the lessee's actual right to use the car for more than 60,000 miles is conditional on the lessee assuming another liability.
  • The lessor has an unconditional right to receive CU 30,000 and to have the vehicle returned when the lease comes to an end.
  • The lessor has a conditional right to receive consideration for excess mileage. The lessor also has an unconditional obligation to stand ready to make the excess mileage available to the lessee at a predetermined price.

The staff believes that the call option over additional use represents a present unconditional right of the lessee (so may be an asset) and a present unconditional obligation of the lessor (so may be a liability). However the option may have little value at inception of the lease.

In addition the staff noted an alternative view will be considered of accounting for the expected value of the contingent rent payments at inception of the lease.

The Board expressed concerns as to both of the above views.

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