This update to the proposed changes in lease accounting is fairly detailed and covers a large scope of tentative decisions by the two boards. The decisions affirm some of the proposals in the original evaluation draft (ED) while other clarify or modify items in the original ED. The purpose of this update is to provide a flavor of what we expect to see in the revised ED.

During their July 2011 meetings the IASB and the FASB discussed re-exposure of the proposed standard, lessor accounting, the accounting for lease payments that depend on an index or a rate, the accounting for embedded derivatives in lease contracts, lessee presentation and disclosure, presentation: lessee statement of financial position and lessee statement of cash flows.

Re-exposure of the proposed standard

As I reported in Update #5, the boards agreed unanimously to re-expose their revised proposals for a common leasing standard. The boards made this decision to give interested parties some certainty about the project plan. The boards have still to consider some aspects of the leases project and expect to conclude their discussions in September. At that time the boards will confirm the comment period for the revised exposure draft and will be in a better position to provide more information about the timing of the project. The boards still hope to have revised standards published by the end of 2011.

Lessor accounting

The boards tentatively decided that a lessor should apply a 'receivable and residual' accounting approach as follows:

1.     The lessor would recognise a right to receive lease payments and a residual asset at the date of the commencement of the lease.

2.     The lessor would initially measure the right to receive lease payments at the sum of the present value of the lease payments, discounted using the rate that the lessor charges the lessee.

3.     The lessor would initially measure the residual asset as an allocation of the carrying amount of the underlying asset and would subsequently measure the residual asset by accreting it over the lease term using the rate that the lessor charges the lessee.

4.     If profit on the right-of-use asset transferred to the lessee is reasonably assured, the lessor would recognise that profit at the date of the commencement of the lease. The profit would be measured as the difference between (a) the carrying amount of the underlying asset and (b) the sum of the initial measurement of the right to receive lease payments and the residual asset.

5.     If profit on the right-of-use asset transferred to the lessee is not reasonably assured, the lessor would recognise that profit over the lease term. In that case, the lessor would initially measure the residual asset as the difference between the carrying amount of the underlying asset and the right to receive lease payments. The lessor would subsequently accrete the residual asset, using a constant rate of return, to an amount equivalent to the underlying asset's carrying amount at the end of the lease term as if the underlying asset had been subject to depreciation.

6.     If the right to receive lease payments is greater than the carrying amount of the underlying asset at the date of the commencement of the lease, the lessor would recognise, as a minimum, the difference between those two amounts as profit at that date.

The boards also tentatively decided that the following should be excluded from the scope of the 'receivable and residual' approach to lessor accounting:

 

1.     Leases of investment property measured at fair value

2.     Short-term leases. The boards previously decided that short term is a term of less than 12 months.

For those excluded leases, a lessor should (1) continue to recognise and depreciate the underlying asset and (2) recognise lease income over the lease term on a systematic basis.

Lease payments that depend on an index or a rate

The boards discussed the measurement of lease payments that depend on an index or on a rate that is included in the lessee's liability to make lease payments and the lessor's right to receive lease payments and tentatively decided that:

1.     Lease payments that depend on an index or a rate should be measured initially using the index or rate that exists at the date of commencement of the lease.

2.     Lease payments that depend on an index or a rate should be reassessed using the index or rate that exists at the end of each reporting period.

3.      Lessees should reflect changes in the measurement of lease payments that depend on an index or a rate (a) in net income to the extent that those changes relate to the current reporting period and (b) as an adjustment to the right-of-use asset to the extent that those changes relate to future reporting periods.

The boards will discuss at a future meeting how a lessor should reflect changes in the measurement of lease payments that depend on an index or a rate.

Embedded derivatives in lease contracts

The boards tentatively decided that an entity should assess whether a lease contract includes embedded derivatives that should be bifurcated and accounted for in accordance with applicable US GAAP and IFRS requirements on derivatives.

Lessee presentation and disclosure

The boards discussed lessee disclosures and tentatively decided that a lessee should disclose the following:

1.     A reconciliation of the opening and closing balance of right-of-use assets, disaggregated by class of underlying asset.

2.     A reconciliation of the opening and closing balance of the liability to make lease payments (unlike the proposal in the exposure draft, a lessee would not be required to disaggregate the reconciliation by class of underlying asset).

3.     A maturity analysis of the undiscounted cash flows that are included in the liability to make lease payments. The maturity analysis should show, at a minimum, the undiscounted cash flows to be paid in each of the first five years after the reporting date and a total of the amounts for the years thereafter. The analysis should reconcile to the liability to make lease payments.

4.     Information about the principal terms of any lease that has not yet commenced, if the lease creates significant rights and obligations for the lessee.

5.     Information required in paragraphs 73(a)(ii)-73(a)(iii) of the exposure draft (the boards will provide guidance, illustrations, or both about those requirements).

6.     All expenses relating to leases recognised in the reporting period, in a tabular format, disaggregated into (a) amortisation expense, (b) interest expense, (c) expense relating to variable lease payments not included in the liability to make lease payments, and (d) expense for those leases for which the short-term practical expedient is elected, to be followed by the principal and interest paid on the liability to make lease payments.

7.     Qualitative information to indicate whether circumstances or expectations about short-term lease arrangements are present that would result in a material change to the expense in the next reporting period as compared with the current reporting period.

The boards also tentatively decided that a lessee should:

1.     Present or disclose separately interest expense and interest paid relating to leases.

2.      Not combine interest expense and amortisation expense and present it as lease or rent expense.

 In addition, the boards tentatively decided that a lessee is not required to disclose the following:

1.     The discount rate used to calculate the liability to make lease payments.

2.     The range of discount rates used to calculate the liability to make lease payments.

3.     The fair value of the liability to make lease payments..

4.     The existence and principal terms of any options for the lessee to purchase the underlying asset, or initial direct costs incurred on a lease..

5.      Information about arrangements that are no longer determined to contain a lease.

With regard to future contractual commitments:

1.     The IASB tentatively decided that a lessee is not required to disclose the future contractual commitments associated with services and other non-lease components that are separated from a lease contract.

2.     The FASB tentatively decided that a lessee should disclose the future contractual commitments associated with services and other non-lease components that are separated from a lease contract.

 Obviously the boards currently do not agree on this point so we will be watching how they decide during an upcoming meeting.

Presentation: lessee statement of financial position

The boards discussed presentation in the lessee statement of financial position and tentatively decided that a lessee should:

1.     Separately present in the statement of financial position, or disclose in the notes to the financial statements, right-of-use assets and liabilities to make lease payments. If right-of-use assets and liabilities to make lease payments are not separately presented in the statement of financial position, the disclosures should indicate in which line item in the statement of financial position the right-of-use assets and liabilities to make lease payments are included..

2.     Present the right-of-use asset as if the underlying asset were owned. All IASB and FASB members agreed. The boards also decided that it is not necessary to clarify whether the right-of-use asset is a tangible or an intangible asset.

Presentation: lessee statement of cash flows

The boards discussed the lessee's statement of cash flows and tentatively decided that a lessee should:

1.     Classify cash paid for lease payments relating to the principal within financing activities..

2.     Classify or disclose cash paid for lease payments relating to interest in the statement of cash flows in accordance with applicable IFRSs or US GAAP..

3.     Classify as operating activities cash paid for variable lease payments that are not included in the measurement of the liability to make lease payments.

4.     Classify as operating activities cash paid for short-term leases that are not included in the liability to make lease payments.

The boards tentatively decided that a lessee should disclose:

1.     The expense recognised in the reporting period for variable lease payments that are not included in the liability to make lease payments..

2.     The acquisition of a right-of-use asset in exchange for a liability to make lease payments as a supplementary non cash transaction disclosure.

We can assist your company navigate the proposed changes. Our team consists of real estate asset managers, accountants and real estate lawyers to provide a 360 view of the new standards and how you may be affected. Call us today for more information at 213-840-9879.