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Leases — Boards Discuss the Lease Expense Recognition Pattern

Published on: 31 May 2012

At their joint board meeting last week, the FASB and IASB continued discussing the lease expense recognition pattern that would result from the lease accounting model proposed in their respective exposure drafts (EDs) (i.e., front-end loaded expense pattern). For over a year, constituents have been consistently indicating to the boards that the accounting proposed in the EDs does not reflect the economics of all types of leases.

The boards’ staffs presented a summary of feedback received from outreach conducted with constituents on four approaches for lessees to measure their right-of-use (ROU) assets after initial recognition and the effect of amortizing those assets on the lease expense recognition pattern.1 On the basis of the summary, the boards directed the staffs to prepare recommendations for discussion at their June meeting that focus on approaches A, D, and a combination of the two (see discussion below).

Summary of Approaches

All four approaches are consistent with earlier decisions about initial measurement of the ROU asset and the lease liability. In addition, under all the approaches, entities would subsequently measure the lease liability by using the effective interest method. The approaches differ, however, in how entities would amortize the right-of-use asset and present lease expense in the income statement.


Approach A (Financing)

Approach A reflects the accounting model proposed in the boards’ 2010 EDs. Under this approach, the ROU asset is treated as though it is purchased, and amortization is consistent with other nonfinancial assets. Thus, total expense (amortization and interest) would typically be higher in the earlier years of a contract. The lessee would present the interest expense related to the lease liability and the amortization expense related to the ROU asset separately in the income statement.


Approach B (Interest-Based Amortization)

Under Approach B, entities would amortize the ROU asset by using the interest-based amortization method (i.e., the carrying value of the ROU asset would be calculated each period at the present value of the future lease payments). This is unlike typical amortization methods used for nonfinancial assets. Because the amortization expense on the ROU asset would generally be lower in the early years, total expense may be closer to straight-line when combined with the interest expense. The lessee would present the amortization expense and the interest expense together in the income statement as total lease expense.


Approach C (Underlying Asset)

The ROU asset is viewed as two different components under Approach C: (1) a portion of the underlying asset the lessee acquires and consumes and (2) the residual asset the lessee borrows over the lease term. Entities would amortize the ROU asset on the basis of their estimate of the consumption of the underlying leased asset over the lease term. The higher the consumption of the underlying asset, the more the agreement would resemble a purchase and thus be accounted for as such. The lower the consumption, the more the agreement would resemble a service that would be accounted for as a straight-line total lease expense. The lessee would present the interest expense related to the lease liability and the amortization expense related to the ROU asset separately in the income statement.


Approach D (Whole Contract)

Under Approach D, the ROU asset and the lease liability would be one unit of account (“inextricably linked” at lease commencement and throughout the lease term). The lessee would calculate the lease expense by taking into account the total lease payments divided by the lease term. The difference between the lease expense and the interest expense related to the lease liability would be allocated to the ROU asset. This approach would always result in a straight-line expense pattern, even if lease payments are not equal throughout the lease term. The lessee would present the total expense as one line item.

Summary of Feedback Received

All participants in the outreach process (users, preparers, and auditors) supported the proposal that all leases be on the balance sheet, which is consistent with the broad objective of the lease project. In addition, the majority of participants supported some variation of approaches A and D or a combination of the two. Very few supported approaches B and C, mainly because of concerns about cost and complexity. Views varied on whether there should be just one model for
all leases.

Editor’s Note: During their redeliberations in 2011, the boards discussed an approach similar to one that combines approaches A and D. The boards noted concerns about such an approach, including how to determine which types of leases should apply Approach A and which should apply Approach D.

Boards’ Discussions

The boards discussed (but did not vote on) how a combination of approaches A and D might work. Some members suggested using the criteria under IAS 17, Leases, to categorize leases. Others suggested outright exemptions for certain types of leases (e.g., real estate leases). Still others suggested using “reverse IAS 17 criteria” to distinguish between the two types of leases but noted that such approach would result in more leases being accounted for as “finance” leases than under current accounting requirements.


[1] The boards initially discussed these approaches at their February 2012 joint meeting. Since then, the staffs have been conducting outreach with approximately 100 users, preparers, and auditors to assess the potential cost and benefits of the approaches.

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