Tuesday, April 28, 2009

DP Chapter 9: Other lessee issues

Continuing with the review of the FASB & IASB Discussion Paper on revising lease accounting. Today’s installment covers chapter 9.


The boards have not yet discussed, but plan to make decisions on, the following topics:

• Timing of initial recognition
• Sale and leaseback transactions
• Initial direct costs
• Leases that include service arrangements
• Disclosure

Detailed review:

This is only one of a large number of accounting standards projects that are taking place simultaneously (the FASB project web page lists at least 37 different projects currently underway), and so even though the boards started this project in July 2006, they have not had enough time to discuss everything that will need to be resolved to produce a new standard. The following are issues that they recognize they need to work on:

Timing of initial recognition

There is often a gap of time between when a lease is signed and when it starts (the lessee takes possession of the asset and starts paying rent). Currently, a capital lease doesn’t hit the balance sheet until the lease starts. However, it could be argued that signing a lease results in rights and obligations that meet the standard definition of assets and liabilities. In rebuttal, some argue that before delivery, the lease agreement is an executory contract, which is not normally recognized on the balance sheet.

Therefore, the boards much decide if the assets and liabilities should be recognized at signing. If recognition is required, an appropriate measurement of value is needed, as it may not be the same as the asset/liability at the start of the lease. In addition, if construction is required during the period between signing and occupancy, there may be additional measurement issues, as rent may be subject to adjustment for construction costs, and so the exact amount is not known at signing.

Sale and leaseback transactions

A popular recent method of financing has been a sale/leaseback transaction, wherein an owner of an asset (most often real estate) sells the asset and leases it back. In some cases, FAS 98 prohibits the transaction from being recognized as a sale and a lease; instead, it must be treated as a deposit or financing, with the asset remaining on the books of the original owner and no lease shown. The continuing involvement can result in valuations that aren’t consistent with market values (there might be a below-market sales price in exchange for a below-market rent, for instance).

The boards will consider several options for sale/leaseback transactions:
  1. Treating all sale/leasebacks as financings—the sale and lease would be ignored, and sales proceeds would be treated as a liability, repaid by the “lease” payments like any other loan. If this option is chosen, the boards need to decide if there are circumstances under which a gain or loss could result from the sale.
  2. Treating all sale/leasebacks as sales—the asset would be sold and taken off the balance sheet, and a regular lease recognized with asset and obligation. If this option is chosen, the boards need to decide in what, if any, situations a gain on the sale would be deferred.
  3. A hybrid approach, treating some transactions as financings and others as sales, depending on whether the transaction meets certain criteria (perhaps using those in current standards). This, of course, raises the potential for structuring.
Initial direct costs

IAS 17 currently calls for costs incurred in negotiating & arranging a lease (such as commissions, legal fees, and internal costs) to be added to the asset value of a capital lease and amortized over its life. FAS 13 has no such requirement; such costs are immediately expensed. IAS 17 is consistent with the treatment of costs associated with purchasing assets; FAS 13 is consistent with the treatment of costs in business combinations and for the acquisition of some financial instruments. The boards must decide which direction to take.

Leases that include service arrangements

Currently, costs for services associated with leases are considered executory costs, which are excluded from capitalization. Some leases clearly define the costs that are for services vs. the rent for the asset. Others, however, do not; with all leases capitalized, it becomes more important to properly separate service costs from asset costs. The boards will consider providing additional guidance.


The boards have not discussed disclosures; the primary current disclosure is the footnote report of future minimum lease payments. The boards will consider whether disclosures should provide additional information regarding the presence of options and contingencies.

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