Wednesday, July 8, 2009

Additional decisions on lessee accounting

At meetings held June 17 and June 18, the FASB and IASB (respectively) discussed additional lease accounting issues that were not covered in the Preliminary Views discussion paper. The following topics were discussed and conclusions reached:

Sale and leaseback transactions

An asset (most commonly real estate) may be sold and immediately leased back. FAS 98 has an extensive set of tests to determine whether the continuing involvement of both seller/lessee and buyer/lessor are such that the transaction should be recognized as a sale and a lease, or as a financing that doesn’t meaningfully transfer the asset, so that it would remain on the books of the putative seller/lessee. Sale/leasebacks are sometimes done for cash flow purposes; at other times, a major purpose under current accounting may be off-balance sheet financing. With the end of operating lease accounting under the new rules, the latter purpose would disappear.

The boards decided that in a sale/leaseback, the entire asset should be derecognized and replaced with a right-to-use asset (rather than keeping a portion of the original asset on the seller/lessee’s books). The IASB concluded that a gain should be recognized immediately; the FASB’s meeting summary doesn’t indicate their decision. The FASB thinks there may be a need for additional guidance when the sale price or rental payments aren’t at market rates.


Existing general accounting standards for impairments should also be used for lease right-to-use assets. This means that US lessees would use FAS 144, while IFRS users would use IAS 36, consistent with their treatment of impairments of other assets.


The FASB holds that revaluation of the right-to-use asset would reflect amortization and impairment. Adjusting based on fair value would generally not be permitted. The IASB refers to revaluation models in IAS 16 for property, plant, & equipment, and IAS 38 for intangible assets, which do permit revaluing based on fair value.

Initial direct costs

Initial direct costs for negotiating and arranging leases are to be expensed as incurred.


This was a big hole in the preliminary views document. Both boards agreed that leases should be set up using the remaining rents as of the date of application of the new standard, valuing the obligation at the present value of the rents (using the current incremental borrowing rate), and setting the asset to the same value (the IASB notes that there could be an impairment adjustment).

Nothing, however, is said about how to handle the existing deferred liabilities on existing operating leases with scheduled rent increases, or the difference between asset and liability on existing capital leases. Will this be taken directly to retained earnings, or recognized as a gain or loss in the income statement? Most lessees would probably prefer to recognize the change in the income statement, because almost all leases (leveled operating and capital) would show a gain on removal. The argument would be that they have in effect over-expensed these leases, so they should be able to recover that excess expense as part of the changeover.

Next steps

The discussion paper comment period closes a week from Friday, July 17. The boards plan to discuss the comments at meetings in September. In July there will be another meeting to discuss additional matters related to lessor accounting (following up their May meeting); I haven’t seen a specific date yet. The two boards will be holding joint meetings on July 23 & 24, but I don’t see any indication whether they will take that time to discuss leases, or will continue their more typical practice of meeting separately to discuss the issues.

Sources for board information:
IASB meeting summary:
IASB meeting audio:
IASB meeting agenda papers:

FASB meeting summary:
Meeting handout:

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