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Leases

Date recorded:

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards discussed: (1) disclosure requirements for lessors, (2) transition accounting for both lessees and lessors and (3) transition accounting for sale and leaseback transactions.

Summary

The Boards made a number of tentative decisions, including the following:

Lessor accounting: Disclosures

A lessor should disclose:

  • lease income generated from the entity's leasing activities (in tabular form) disaggregated by (a) profit recognised at lease commencement, (b) interest income on the lease receivable, (c) accretion of the residual asset, (d) variable lease income for amounts not initially recorded in the lease receivable and (e) short-term lease income.
  • fixed-price purchase options which exist on underlying leases.
  • information about variable lease payments and lease term options included in paragraph 73(a)(ii) – 73(a)(iii) of the Leases ED (i.e., disclosing the basis and terms on which contingent rentals are determined and the existence and terms of options, including renewal and termination options).
  • a reconciliation between the beginning and ending balances of the lease receivable and residual asset.
  • a maturity analysis of undiscounted cash flows that are included in the lease receivable, with reconciliation to the amounts reported in the statement of financial position for the lease receivable. Time bands for the maturity analysis should, at a minimum, include each of the first five years following the reporting date and the total of the amounts for the remaining years.
  • how it manages its exposure to the underlying asset, including:
    • its risk management strategy;
    • the carrying amount of the residual asset that is covered by residual value guarantees and the unguaranteed portion of the carrying amount of the residual asset; and
    • whether the lessor has any other means of reducing its exposure to residual asset risk (e.g., buyback agreements with the manufacturer from whom the lessor purchased the underlying asset or options to put the underlying asset to the manufacturer).

However, disclosure would not be required for:

  • initial direct costs incurred in the reporting period and included in the lease receivable.
  • the fair value of the lease receivable or the residual asset.
  • the range or the weighted average of discount rates used to calculate the lease receivable.

Transition: Other considerations

  • The transition exception in FASB Accounting Standards Codification (ASC) Topic 840-10-25 Leases (formerly Emerging Issues Task Force (EITF) Issue 01-8 Determining Whether an Arrangement Contains a Lease) would not be retained in the final standard (FASB only).
  • No transition guidance would be provided in the final leases standard for short-term leases, investment property measured at fair value, subleases, useful lives of leasehold improvements, build-to-suit leases and in-substance purchases and sales. The Boards will consider transition guidance related to secured borrowings at a future meeting.

Transition: Sale and leaseback transactions

  • Transition requirements for sale and leaseback transactions would be aligned with decisions reached in transitioning for lessees and lessors.

 

Lessor accounting: Disclosures

The Boards discussed disclosure requirements for lessors. The IASB and FASB staffs presented disclosure recommendations in the following areas: lessor disclosure implications based on decisions reached to date on lessee disclosures, initial direct costs, roll-forward disclosures, maturity analyses and fair value disclosures of a lessor's exposure to residual asset risk. However, the staffs noted that certain of the disclosures proposed in the Leases ED were not being brought back to the Boards because the disclosures were either (a) no longer needed because of the Boards' decisions about recognition and measurement or (b) the disclosures did not give rise to significant issues in the comment letters or outreach following the issuance of the Leases ED. A summary of those requirements retained but not discussed during the meeting can be found in Appendix C to IASB Agenda Paper 2D / FASB Agenda Paper 208 on the public website.

Recommendations based on lessee disclosure decisions:

For comparability to decisions previously reached as part of lessee disclosure deliberations, the staffs presented a number of lessor disclosure recommendations, including recommending that a lessor should disclose:

  • in tabular form, the total amount of lease income generated from the entity's leasing activities. For example, a lessor would disclose profit recognised at lease commencement which separately identifies profit recognised in revenue and profit recognised in cost of sales, interest income on the lease receivable, accretion of the residual asset, variable lease income for amounts not initially recorded in the lease receivable but earned during the period and short-term lease income.
  • information about variable lease payments and the lease term options, including the basis and terms on which contingent rentals are determined and the existence and terms of options, including for renewal and termination.

However, a lessor would not be required to disclose the existence and principal terms of any options for the lessee to purchase the underlying asset.

While the Boards agreed with the staffs' recommendations for required tabular disclosure of lease income and information about variable lease payments and the lease term options (of which, it is expected that the Boards will provide examples of ‘illustrative disclosures' in the final leases standard), many Board members expressed significant reservations about the staffs' recommendation not to require disclosure of purchase options. These Board members believe understanding a lessor's residual asset exposure is useful information to financial statement users. However, concerns were raised by many Board members as to an appropriate presentation of this information (e.g., qualitative or quantitative disclosure, aggregation of leases in a portfolio or considering lease contracts individually, etc.). Other Board members expressed concern that requiring this disclosure is an example of ‘disclosure overload'. These Board members saw the disclosure as being insignificant to most reporting entities. While the Boards initially split on requiring disclosure of purchase options (i.e., the FASB preferred disclosure of purchase options and the IASB preferred no requirement to disclose purchase options), the Boards tentative decided on disclosure of the existence of fixed-price purchase options so that a financial statement user would understand that the value being reported is subject to another contract (i.e., this disclosure would provide information to assess residual asset exposure).

The decision to disclose information about leases subject to purchase options contradicts decisions reached regarding lessee disclosure. Consequently, many Board members requested that the tentative decision on lessee disclosure of purchase options be revisited.

Initial direct costs:

Paragraph 73(a)(vii) of the Leases ED required an entity to disclose the nature of its arrangements, including initial direct costs incurred during the reporting period and included in the right to receive lease payments. In a previous Board meeting, the Boards tentatively decided to eliminate the disclosure of initial direct costs incurred in the period for lessees on the basis of these costs likely being immaterial to the lessee. In applying consistent disclosures, the staffs recommended the removal of the required disclosure of initial direct costs incurred and included in the lease receivable. The basis of this removal was that these costs would be reflected in the return generated by the lessor, and thus, separate disclosure was not necessary. With little debate, the Boards agreed with the staffs' recommendation.

Roll-forward of disclosures:

Paragraph 80 of the Leases ED required an entity to disclose a reconciliation of opening and closing balances of the rights to receive lease payments, lease liabilities arising from leases to which it applies the performance obligation approach and residual assets arising from leases to which it applies the derecognition approach. In the conduct of constituent outreach, many preparers cited cost / benefit concerns with disclosure of roll-forward reconciliations of the right to receive lease payments and the residual asset. However, users saw the reconciliation as providing information which was not available otherwise and provided for information in one location in the financials. The staffs recommended the retention of roll-forward disclosures for lease receivables and the residual asset for consistency with the revenue recognition and insurance contract projects. With little debate, the Boards tentatively agreed with the staffs' recommendation. One Board member questioned whether the disclosure would be required for both interim and annual periods. The staffs noted that they would consider interim disclosures at a later date. Thus, relevant tentative decisions were limited to annual disclosures at this stage.

Maturity analysis:

Paragraph 86 of the Leases ED required a lessor to disclose a maturity analysis of the right to receive lease payments. Citing outreach feedback and previous decisions of the Boards as part of lessee disclosures, the staffs recommended a maturity analysis of undiscounted cash flows that are included in the lease receivable, with reconciliation to the amounts reported in the statement of financial position for the lease receivable. Time bands for the maturity analysis would be, at a minimum, each of the first five years following the reporting date and the total of the remaining years.

Many Board members wished to confirm that any disclosure considerations were consistent (and not redundant) with other projects the Boards were currently working on. Specifically, Board members noted that certain of the disclosures appeared redundant with the liquidity proposals in the accounting for financial instruments. The majority of the Boards agreed with this assessment. Thus, the Boards agreed that any tentative disclosure decisions would be based on an overarching review of guidance across other projects to ensure they are not redundant.

A few Board members requested the addition of a disclosure requirement for the range or the weighted average of discount rates used to calculate the lease receivable. These Board members noted this as valuable information to allow analysts to project forward while also understanding current values in the statement of financial position. Others argued that this information could effectively be reached from the information recommended for disclosure by the staffs.

The Boards tentatively confirmed the staffs' recommendations, including the recommendation not to require disclosure of the range or the weighted average of discount rates used to calculate the lease receivable.

Fair value and disclosures of a lessor's exposure to residual asset risk:

The staffs considered potential disclosure of fair value of the lease receivable and residual asset. Citing the cost and complexity (e.g., the tax effects of leases) for preparers of the financial statements, as well as the contradiction of such a disclosure requirement given other decisions by the Boards regarding recognition and measurement, the staffs recommended that the Boards not require disclosure of the fair value of the lease receivable or the residual asset. However, the staffs noted the need for information about a lessor's exposure to residual asset risk, and thus, recommended disclosure of certain additional information to highlight this exposure.

With little deliberation, the Boards tentatively decided not to require the disclosure of the fair value of the lease receivable or the residual asset. However, the Boards tentatively decided to require disclosure about the lessor's exposure to residual asset risk by disclosing how it manages its exposure to the underlying asset, including disclosure of (i) its risk management strategy, (ii) the carrying amount of the residual asset that is covered by residual value guarantees and the unguaranteed portion of the carrying amount of the residual asset and (iii) whether the lessor has any other means of reducing its exposure to residual asset risk.

Transition: Other considerations

EITF 01-8 exception (FASB only decision):

The FASB discussed whether to provide the transition exception in Topic 840-10-25 (formerly EITF Issue 01-8) in the final leases standard. This transition guidance allowed for certain transactions to be grandfathered and not evaluated under the EITF 01-8 framework unless they were subsequently modified. Thus, if the transition exception in EITF 01-8 is not retained, then an entity with an arrangement that contains a lease that was in effect before May 2003 and continued to be in effect as of the effective date would be required to account for the lease even if it previously was not accounting for the lease due to the transition exception in EITF 01-8.

With little debate, the FASB tentatively decided that the EITF 01-8 exception would not be retained in the final leases standard in order to increase comparability in applying the new standard.

Other considerations:

The staffs considered whether transition guidance was necessary for the following considerations: short-term leases, investment property measured at fair value, subleases, useful lives of leasehold improvements, secured borrowings, build-to-suit leases and in-substance purchases and sales.

The staffs recommended that guidance was not necessary in these areas (absent secured borrowings, in which the staffs are performing further research based on discussions by the Boards during the October 2011 joint Board meeting) because the accounting should be apparent based on the new leases standard, the accounting is addressed in other IFRSs or US GAAP or other associated reasons.

The Boards tentatively agreed with the staffs' recommendations. However, the Boards asked that the staffs bring back the staffs' analysis for transition guidance related to secured borrowings based on outreach currently being performed by the staffs.

Transition: Sale and leaseback

The Boards discussed transition accounting for sale and leaseback transactions. The staffs presented three approaches to transition accounting for sale and leaseback transactions. These approaches sought to balance a desire for comparability in the accounting for both the sale portion and the lease portion of the transaction over time with the costs and complexity of a transition approach.

Many Board members cited a desire to align sale and leaseback transition requirements with the decisions already reached to date on transition. This decision was quickly supported by both Boards. Thus, the Boards tentatively decided that for capital / finance leases existing at the beginning of the earliest comparative period presented, prospective application of the new lease requirements would be permitted. However, for operating leases existing at the beginning of the earliest comparative period presented, entities would be permitted to apply either a full-retrospective approach or a modified retrospective approach.

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