More decisions, summarization so far

The FASB and IASB met again last week to further deliberate on leases. Among the decisions reached:

Start of accounting: A lease may be signed well in advance of when the lessee takes possession of the property (particularly with property, which may need extensive construction before occupancy). The boards have affirmed that the lease does not hit the books until the "commencement" of the lease, which is normally when possession is granted. Payments made between the "inception" (signing) and "commencement" will be accounted for as prepayments (an asset that is then folded into the ROU asset at commencement). If the lease meets the definition of an "onerous contract," it is to be accounted for during the inception to commencement period according to the Contingencies accounting standards: IAS 37 and FASB Topic 450.

Tenant incentives: Lessees are to subtract these from the right-of-use asset.

Sale & leaseback: Rather than a series of tests in the Exposure Draft to determine whether a transaction qualifies for sale and leaseback accounting, the boards have now decided that as long as the sale part of the transaction meets the existing accounting requirements (under the Revenue Recognition standard) to recognize a sale, it qualifies for SLB treatment. In general, if control of the asset has passed to the buyer/lessor, it qualifies. One change from current SLB accounting is that if the seller/lessee has a gain or loss on sale, that is to be recognized immediately, rather than amortized over the life of the lease.

Leases with service components: When the service component is not clearly identified separately in the agreement, the FASB in the ED called for capitalizing the entire contract as a lease (the IASB favored split recognition). Both boards have now decided that if the purchase price of one component (lease or service) is "observable," you can calculate the split based on that.

Discount rate: FAS 13 calls for the interest rate on lessee capital leases to be based on the lease's implicit interest rate, if known, or the lessee's incremental borrowing rate (IBR). In many cases, the lessee doesn't know the lessor's implicit rate, because the expected value of the asset at lease expiration (the "unguaranteed residual") is not stated, so the IBR tends to be used. (The rate may be higher if the present value of the rents using these rates is more than the fair market value; in that case, a rate is calculated to make the PV of the rents equal to the FMV.)

The ED introduced a new term: "the rate the lessor charges the lessee." This is to be used when available, a decision now confirmed. Finally, though, the boards have defined what they meant; this can be (from the observer summary) "the lessee's incremental borrowing rate, the rate implicit in the lease, or, for property leases, the yield on the property. When more than one indicator of the rate that the lessor charges the lessee is available, the rate implicit in the lease should be used." The lessor always by definition knows this rate. If the lessee does not, the IBR is to be used.

Initial direct costs: The boards defined this as "Costs that are directly attributable to negotiating and arranging a lease that would not have been incurred had the lease transaction not been made." The intent is to have a consistent definition for a series of standards (including insurance and revenue recognition, which are at similar stages of development), though there may be slight modifications to meet specific needs of the different standards. Any such differences are intended to be explained by the boards, to maintain the overall consistency.

IDCs are to be capitalized by both lessees and lessors, by adding them to the right-of-use asset and right to receive lease payments, respectively.

Summarization: The IASB staff has prepared a detailed description of the impact on the ED of the new decisions by the boards. This describes both the confirmed decisions and the changes, with links to IASB observer notes for each.

Thanks to the IASB for their podcast and to Asset Finance International for their summary.

Ownership transfer leases, update

In my March 17 post, I said that it wasn't clear how the scope change affected leases with an ownership transfer. Based on the IASB Update just released regarding last week's meeting, it seems clear that they are also to be considered leases. The boards have decided to simply eliminate the language that took leases with bargain purchase options and ownership transfers out of scope of the leasing standard.

Purchase options and short-term leases

The FASB & IASB met this week for continuing discussions, on leases as well as other topics. In their meetings on March 14 & 15, they reached the following conclusions for the new lease accounting standard:

• The ED had scoped out (excluded) leases with bargain purchase options and ownership transfers (also called "in-substance purchases") from the new lease accounting standard, stating that they should be treated as a sale & purchase and handled according to the revenue recognition standard (which is also at the ED stage). However, this decision was left over from when the boards had briefly planned to treat all lessor leases according to the "performance obligation" model, which would have been inappropriate for these transactions. With a derecognition model for lessors now in place, the need to separate out these types of leases is less evident. The boards agreed that leases with a bargain purchase option should be returned to the scope of the leases standard. It's not yet clear if leases with ownership transfer will be considered leases or sales.
• Relatedly, the boards are adjusting the treatment of purchase options. In the ED, these did not need to be accounted for until exercised. Now, they must be accounted for if there is a "significant economic incentive" to exercise them. It remains to be determined how the accounting will work if the conclusion of a significant economic incentive changes in the middle of the life of the lease (in either direction), though the boards concluded that they would not permit a switch between the "finance" and "other than finance" categories they set up last month.
• Short-term leases: The boards have decided that leases with a maximum lease term of 12 months or less, including renewal options, can be treated like current operating leases. They will not be shown on the balance sheet for lessees; income and expense will be shown on the income statement as currently (with rent leveling as needed). This will be an option; lessees & lessors can choose to treat short-term leases like other leases. However, the option must be chosen for all leases in an asset class, rather than lease by lease.

Thanks to Deloitte's IAS Plus and Asset Finance International for their reviews of the meetings, which were the basis for this entry.

2015 implementation?

The new leasing standard is one of several major standard revision projects the FASB & IASB have underway. Others include revenue recognition and insurance contracts, which are considered heavily interrelated with the leases, and other comprehensive income, fair value measurements, financial instruments with characteristics of equity, and financial statement presentation, which are considered more independent of other standards.

The boards put out a separate Exposure Draft asking for comments on implementation dates. While the volume of comments wasn't nearly as high as for the leases ED, the consensus response was that the impending changes are major, and financial statement preparers need substantial time to update their systems. At the boards' combined March 2 meeting, the boards didn't decide whether to implement the three linked standards (leases, revenue recognition, and insurance contracts) at the same time or in staggered order, but stated that they "will provide adequate time for stakeholders to apply the new requirements." Several members of the IASB stated a preference for 1/1/2015 as the implementation date, while most FASB members didn't want to make a commitment to a date at this time, and several expressed a preference for a staggered implementation.

Note that since U.S. companies typically report two years of comparables, and the leases ED says those comparable years will need to be restated on implementation, that means that effectively companies would need to apply the standard effective 1/1/2013, even though they wouldn't be reporting the results accordingly until later. It's not clear yet whether earlier implementation will be encouraged or permitted.