Wednesday, April 29, 2009

DP Chapter 10: Lessor accounting

Continuing with the review of the FASB & IASB Discussion Paper on revising lease accounting. Today’s installment covers chapter 10.


The boards list some of the issues that need to be resolved to set up lessor accounting in a right-to-use model, as well as to properly handle subleases. Subleases must be addressed with the lessee standard, but the boards have yet to discuss the alternatives available, such as using existing sublease rules with the new lessee standard, keeping leases with subleases under the existing standards, or defining a new right-to-use methodology for subleases before doing so for lessor leases.

Detailed review:

Lessor leases

In July 2008, the boards decided that rewriting lessor accounting would slow their project too much, and that the more crucial need was for a revised lessee standard. Therefore, they decided to postpone making any changes to lessor accounting, so as not to delay further the lessee standard (which has already been delayed two years from the original schedule).

This chapter describes in general how a right-to-use model might apply to lessors. The first option would convert the original asset into two assets: a receivable (a financial asset) for the rents due, plus a residual value (non-financial) asset for the remainder of the asset’s value after the end of the lease. (Alternatively, the lessor might derecognize only the portion of the original asset that matches the receivable, leaving the remaining asset portion on the books.) No obligation would be recognized.

The second possible approach to lessor accounting would create a liability to recognize the lease (the performance obligation to provide the asset to the lessee), while leaving the original asset on the lessor’s books and creating a new asset for the receivable (equal to the obligation).

The boards would need to decide when, if ever, profit (or loss) could be recognized on the lease, particularly keeping in mind that many manufacturers lease equipment as a method of sales. For such transactions, recognizing profit on the “sale” would seem more appropriate, more consistent with similar transactions, than recognizing just interest income. (This is currently done with sales-type lessor leases under FAS 13.) On the other hand, if a bank is providing the financing on the lease, one would normally expect all the income to come through interest.


After the decision to defer lessor accounting, the boards were reminded that subleases raise many of the same issues as lessor leases. Leaving sublease accounting alone while changing lessee accounting raises issues, because current sublease accounting uses a different methodology that results in different measurements and inconsistencies in treatment. At the least, the boards would probably offer additional guidance on how to apply the current standards to subleases in the new regime. They suggest that they could also require additional disclosures.

Alternatively, the boards could exclude a head lease from the scope of the new standard, so that a lease with a sublease would continue to be accounted for as under the current standard (FAS 13/IAS 17). However, this reduces comparability because leases with subleases would be accounted for differently than other leases. It leaves those leases out of the head lessee’s balance sheet, understating its assets and obligations. And no one knows what to do if a sublease is entered into after the start of the head lease.

A third option is to develop a lessor right-to-use model for subleases only. This would be more consistent through the whole series of transactions. But it would be inconsistent with the current lessor accounting model, which means that a lessor that buys some of its assets to lease out and leases others (resulting in some lessor leases and some subleases) would account for the transactions differently, some under FAS 13/IAS 17 and others under the new standard. And the boards would have to work through many of the issues of lessor accounting, even though they wanted to defer that.

The boards note the following additional issues which need to be dealt with for lessor accounting:

(a) investment property
(b) initial and subsequent measurement
(c) leases with options
(d) contingent rentals and residual value guarantees
(e) leveraged leases (for US GAAP)
(f) presentation
(g) disclosure

Investment property is the only issue discussed in detail; the others are simply named. Investment property is treated different by US GAAP (FASB standards) and IFRSs (IASB standards); international standards exclude investment property from IAS 17 lease accounting, instead using IAS 40, Investment Property, which among other things includes an option for carrying the property at fair value rather than cost. It remains to be decided whether investment property would continue to be excluded from lease accounting, or otherwise treated differently from other lessor leases. (US GAAP does not differentiate investment property and accounts for it under FAS 13 as any other lease.)

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