Subleases, balance sheet, cash flow

The FASB/IASB joint meeting for June was held June 17-19, 2014. The boards discussed subleases, lessee balance sheet presentation, and cash flow statement presentation. Discussions were made in the context of  the FASB's tentative decision to permit two different types of lessee presentation (Type A leases, essentially the same as current capital leases, and Type B leases, similar to current operating leases but with an asset and liability on the balance sheet) and the IASB's tentative decision to treat all lessee leases as Type A capital leases.

Subleases

Both boards agreed that the intermediate lessor (who leases the underlying asset from its owner, and subleases it out to the sublessee) should account for the head lease and the sublease as two separate contracts, unless the contracts meet contract combinations guidance that the boards adopted in April. (This guidance indicated that they should be combined "if either of the following criteria are met: (a) The contracts are negotiated as a package with a single commercial objective; or (b) The amount of consideration to be paid in one contract depends on the price or performance of the other contract.")

In keeping with this, the assets and liabilities of the two contracts should not be offset (unless them meet financial instruments requirements for offsetting). Likewise, lease income and lease expense should not be offset unless the intermediate lessor meets the "principal-agent" guidance in the newly released revenue recognition standard (ASC 606, IFRS 15).

The FASB held that a sublease should be classified with reference to the underlying asset, while the IASB calls for classifying it with reference to the right-of-use (ROU) asset arising from the head lease.

Since the IASB has decided to have a single lessee accounting model, while maintaining the existing capital vs. operating separation for lessors, subleases will end up with accounting that is not in sync between the two sides of the transaction.

Balance sheet presentation

Both boards agreed that Type A lessee lease assets should either be presented as a separate line item, or combined with the same type of assets as the underlying leased assets and then disclosed separately in the notes (the latter treatment is not permitted if the amounts are material). The FASB concluded that Type B assets should be treated likewise, and should be separated from Type A assets. This will facilitate analysis that depends on distinguishing lease types, such as bankruptcy analysis, bank regulatory capital tests, and possibly loan covenants.

Likewise, liabilities can be reported as a separate line item or disclosed in the footnotes, with Type A and Type B liabilities reported separately. If liabilities are combined in the primary statement, the footnote should indicate which line item contains the lease liabilities.

Cash flow presentation

Lessors: Confirming the 2013 Revised Exposure Draft (RED), lease cash receipts are classified within operating activities.
Lessees: Confirming the RED, cash payments for the principal portion of a Type A lease are financing; cash payments for the interest portion of a Type A lease are operating (FASB), or either operating or financing based on a lessee's accounting policy choice (IASB); cash payments for a Type B lease are operating.

The IASB also decided to require a separate presentation of total lease payments, so that statement users can find a single number for the cash outflow.

Catching up on June results

June 13 meeting results:

Short-term Lessee Leases

The boards agreed to operating lease accounting for lessee leases with a maximum lease term (including renewal options) of 12 months or less. No asset or liability need be placed on the balance sheet, and rent expense is recognized on a straight-line basis over the lease term. (Lessees may choose to do full finance lease accounting if they wish. How likely is that?) Disclosure of current rent and how representative that's likely to be of the future was discussed.

Subleases

A head lease and sublease are to be accounted for as separate transactions, using normal lessee accounting for the head lease and lessor accounting for the sublease (using the right-of-use asset as the fundamental asset for the transaction, not the original underlying asset).

June 1 meeting results:

Foreign Exchange Differences and Impairment

Both of these are to be recognized in accordance with existing guidance, which is somewhat different between FASB and IASB.

Residual Value Guarantees

The new standard calls for recognizing only the portion of any residual value guarantee that is expected to be payable, rather than the maximum amount. If there is a significant change in the expected RVG payable, an adjustment is required; the portion that applies to current or prior periods is recognized in profit or loss, while the right-of-use asset is adjusted for the portion applying to future periods.