Jan. 20 FASB/IASB meeting

The FASB and IASB met again on Jan. 20 to continue their review of the new lease accounting standard proposals.

Post-inception measurement of leases with options & contingent rentals
The boards decided that the discount rate for the lease (for both lessees and lessors) should remain the same if the lease term is subsequently changed.
If the contingent rentals change, the discount rate would only change if those rentals are contingent on variable reference interest rates (such as LIBOR).

Short-term leases
The boards decided to provide an optional simplified form of lease accounting for leases with a maximum possible lease term (including all options) of less than 12 months. Discussion noted that this is beyond standard materiality thresholds (such as expensing all purchases or leases below a specific value).
For lessees, the boards decided to permit recognizing the undiscounted remaining rent as the liability and asset. Therefore, no interest would need to be calculated. It will be noted, however, that this will result in a higher liability (and asset) appearing on the balance sheet, so this becomes a potentially costly choice for lessees. However, the interest for a single year would normally be pretty small, so the difference was presumed to be not highly significant.
For lessors, the boards decided to permit treating short-term leases as service contracts, which would not require any recognition of a performance obligation; the receivable would be a simple account receivable.

Investment properties
FAS 13 does not treat properties held for investment differently from other leased assets. IAS 40, however, overrides IAS 17 (the IASB regulation for leases), and permits very different accounting for such leases. The IASB decided to maintain IAS 40 for leased investment properties that are measured at fair value. The FASB asked its staff to prepare an agenda item to consider a similar standard for US GAAP.

Review of additional aspects of lease accounting will continue at a joint February meeting.

A return to classification?

At the January 5 joint meeting of the FASB and IASB, the boards agreed that leases that represent the purchase (by the lessee) or sale (by the lessor) of the underlying asset should be excluded from the scope of the standard and treated as sales. The key concept to be used is that the lease includes transfer of control of the asset, such as through an ownership transfer or bargain purchase option in the lease. While the intent is to parallel the revenue recognition project in this type of transaction, the boards weren’t happy with using the definition of control the staff provided (which comes from the revenue recognition project), considering it not well suited to the characteristics of leases; they directed the staffs to work on a more appropriate definition.

Some of the FASB/IASB staff suggested that leases whose term (including any bargain renewal options) covers the entire useful life should be treated as sale/purchase transactions. This is in essence putting a 100% level on FAS 13’s 7(c) test. There was substantial discussion about this, with no conclusion reached. Some board members felt this ignored the possibility of major costs or benefits associated with an asset even if it is at the end of its useful life (decommissioning costs or scrap values, for instance). But a number of other board members seemed in favor, depending on how things were defined. This will be revisited at a future meeting.

Dec. 18 meeting recap

The FASB & IASB held a joint meeting in London on Dec. 18. (I apologize for the delay in posting information; the end of the year is a hectic time at the office with providing year-end reports for clients.) The primary focus for discussion was contingent rentals and residual value guarantees, which were originally to be discussed in November but carried over when they ran out of time.

Contingent rentals

The boards recognized that this topic was one of the most controversial in the preliminary views document. Broadly, the boards reconfirmed their decision to include estimated future contingent rents in the obligation and asset capitalized for leases. To clarify certain aspects of the estimation process:

• An expected outcome technique is to be used, but the boards will specify that not every possible scenario must be taken into account in this calculation. (This means that the boards have decided to go with a probability-weighted outcome, rather than the “most likely” approach originally favored by the FASB.)
• Contingent rentals based on an index or rate would be measured using readily available forward rates. If none exist, the rates at inception of the lease would be used.
• For lessors, a receivable would be recognized for contingent rentals would be recognized only if the receivable could be measured “reliably,” in keeping with other tentative board decisions on revenue recognition (a project that is happening simultaneously).
• The obligation/receivable would be reassessed at each reporting date if there is a material change.

The boards could not decide whether the changes in the obligation/receivable should be matched by a change in the right-of-use asset or by a profit/loss entry, and directed the staffs to research the issue further, with plans to revisit the issue at a later date. The staff recommended that the matching entry depend on the type of contingent rent: those that result from the lessee buying more or less of the right of use (such as excess mileage charges on vehicles) would change the asset, while those based on an index or rate, or based on performance (such as percentage of sales) would be recognized in profit/loss.

Residual value guarantees

Guarantees of residual value are to be handled the same way as contingent rentals, as they are simply a specific form of a contingent payment (based on the value received by the lessor for the asset at the end of the lease term). Note that this is a significant difference from current accounting, which requires the entire guarantee to be recognized as a payment to be made; under the new regime, only an estimate of what the lessee is likely to actually pay will be counted.

Scope

The boards have decided to exclude from the scope of this standard leases of intangible assets (including software), leases to explore for or use natural resources, and leases of biological assets. “Non-core” assets will not be excluded.

The boards put the issue of excluding short-term leases back to the staff for further review and later decision.

The boards again ran out of discussion time, and so put off to Jan. 5 a discussion of excluding leases which are in-substance purchases/sales.