Summary: On May 16,
2013, the FASB and IASB issued a revised joint exposure draft (ED) on leases
that, if adopted, would pose significant changes for both lessees and
lessors. The proposal has been updated since it was originally published
in August 2010. Like the 2010 ED, the proposal would end “off-balance
sheet” accounting for almost all leases, likely impacting certain key performance
indicators and/or debt covenants across companies. Instead, both parties
to a lease would record assets and liabilities to reflect their respective
rights and obligations under the contract. The proposal is intended to
result in a more transparent representation of a lease’s economics by
eliminating the “bright lines” that distinguish different types of leases under
current accounting standards (e.g., operating vs. capital leases). The
revised exposure draft can be accessed here.
Comments are due by September 13, 2013.
The revised ED proposes a dual
approach to the recognition, measurement, and presentation of expenses and cash
flows arising from a lease, for both lessees and lessors, which is dependent
upon whether the lessee is expected to consume more than an insignificant
portion of the economic benefits embedded in the underlying asset. For most
property leases, a lessee would report a single, straight-line lease expense in
its income statement for its use of the underlying asset. For most other
leases, such as equipment or vehicles, a lessee would report amortization of
the asset separately from interest on the lease liability. The
combination of the asset amortization and financing cost associated with the
lease liability will generally result in a “front-loaded” expense recognition
pattern in the early years of a lease. The Boards are also proposing disclosures
that should enable investors and other users of financial statements to
understand the amount, timing, and uncertainty of cash flows arising from
leases.
Scope: The
proposed guidance would apply to all leases, except leases of intangible
assets, leases for the exploration or use of certain natural resources, and
leases of biological assets.
Transition and Effective Date: The
effective date of the proposal will be determined after the FASB and IASB
consider the feedback received on this and other current projects, but an
effective date prior to 2017 is not expected. The ED would apply to all
leases existing at “the beginning of the first comparative period” presented
upon adoption. That is, there would be no grandfathering of existing leases.
General: At commencement
of a lease, both the lessee and lessor would evaluate the amount of economic
benefits the lessee is expected to consume of the underlying asset. For
practical purposes, this assessment would often depend on the nature of the
underlying asset.
Type A leases would consist
of most leases of assets other than property (e.g., equipment, aircraft, cars,
trucks). More specifically, a non-property lease is considered Type A
unless the lease term is for an insignificant part of the total economic life
of the underlying asset or the present value of the lease payments is
insignificant relative to the fair value of the underlying asset at
commencement. If either condition is met, the lease is Type B.
Type B leases would consist
of most leases of property (e.g., land and/or a building or part of a
building). More specifically, a property lease is considered Type B
unless the lease term is for the major part of the remaining economic life of
the underlying asset or the present value of the lease payments accounts for
substantially all of the fair value of the underlying asset at
commencement. If either condition is met, the lease is Type A.
The accounting for Type A and B leases
is summarized below.
Lessees: At the
commencement date, a lessee would record a right-of-use asset and corresponding
liability for future rental payments for all leases, with an exception for
short-term leases, as noted below. The asset and liability would be
measured at the present value of the lease payments, discounted at the lessee’s
incremental borrowing rate, or the rate the lessor charges if it can be
determined. The right-of-use asset would also include any recoverable
initial direct costs incurred by lessee.
The present value of the lease
payments would be based upon two elements: lease term and rentals. The
term would be estimated as the noncancellable period of the lease, combined
with periods covered by an option to extend the lease if the lessee has a
significant economic incentive to exercise that option. Periods covered by an
option to terminate the lease would also be included if the lessee has a
significant economic incentive not to exercise that option.
The present value of rentals would
include fixed lease payments (less incentives to be paid by the lessor),
contingent rentals tied to an index (e.g., the Consumer Price index) or which
are in-substance fixed payments, and residual value guarantees. The
amount would also include the exercise price of a purchase option if the lessee
has a significant economic incentive to exercise that option, and termination
penalties if the lease term reflects the lessee exercising an option to
terminate the lease.
After commencement, the accounting for
Type A and Type B leases would differ.
Specifically,
lessees would do the following for Type A leases:
·
Amortize
the right-of-use asset on a straight-line basis, unless another systematic
basis is more representative of the pattern in which the lessee expects to
consume the right-of-use asset’s future economic benefits. The lessee would
amortize the asset over the estimated lease term or the underlying asset’s
useful life, whichever is shorter. If the lessee has a significant
economic incentive to exercise a purchase option, the lessee would amortize the
right-of-use asset to the end of the useful life of the underlying asset.
·
Separately
reflect the accretion of the lease liability as interest and the amortization
of the right-of-use asset in profit or loss, as well as variable lease payments
incurred after commencement.
Lessees would
do the following for Type B leases:
·
Determine
the amortization of the right-of-use asset for the period as the difference
between the periodic lease cost (as described in the next bullet) and the
interest on the lease liability (the amount that produces a constant
periodic discount rate on the remaining balance of the liability, taking into
consideration reassessment requirements). In other words, the amount of asset
amortization is a residual.
·
Reflect
a single lease cost, combining the effective interest on the lease liability
with the amortization of the right-of-use asset, calculated so that the
remaining cost of the lease is allocated over the remaining lease term on a
straight-line basis. However, the periodic lease cost cannot be less than the
effective interest charge associated with the lease liability. Variable
lease payments that were not included in the original lease liability would be
reflected in the period that they are incurred.
For both types of leases, the
right-of-use asset would also be assessed for impairment in accordance with
Topic 360.
Lessees would reassess the lease
liability for significant changes each period in the lease payments, term, or
discount rate; lessees would recognize the amount of the remeasurement of the
lease liability as an adjustment to the right-of-use asset with the following
exceptions: when related to a change in an index or a rate attributable to the
current period or when the carrying amount of the right-of-use asset has been
reduced to zero, the remeasurement should be reflected in profit or loss.
On the balance sheet, lessees would be
permitted to present right-of-use assets separately from other assets, and
lease liabilities separately from other financial liabilities or to combine
them with the appropriate classes of assets and liabilities while disclosing
which line items include them. In addition, if presenting separately on
the balance sheet, the right-of-use assets and lease liabilities arising from
Type A and Type B leases would not be commingled.
On the income statement, lessees would
display the interest on the lease liability separately from the amortization of
the right-of-use asset for Type A leases and the interest on the lease
liability together with the amortization of the right-of-use asset for Type B
leases.
Lastly, cash
payments would be classified within the statement of cash flows as follows:
·
principal
repayments on Type A leases within financing activities;
·
interest
on the lease liability arising from Type A leases within operating activities;
·
payments
arising from Type B leases within operating activities; and
·
variable
lease payments and short-term lease payments not included in the lease
liability within operating activities.
Lessors: A lessor would
apply one of two accounting models based on whether a lease is Type A or
Type B.
Lessors - Type A Leases: At the
commencement date, a lessor would recognize an asset for the right to receive
lease payments (plus any initial direct costs), with a corresponding credit to
lease income, and would derecognize a portion of the underlying leased asset,
with the corresponding charge to lease expense. The retained portion of the
rights in the leased property would be reclassified as a residual asset.
A lessor would initially measure the
lease receivable for a Type A lease in a manner consistent with how a lessee
would measure the lease liability (i.e., present value of the lease payments,
discounted at the lessee’s incremental borrowing rate, or the rate the lessor
charges if it can be determined). The lessor would initially measure the
residual asset as the sum of the present value of the amount the lessor expects
to derive from the underlying asset following the end of the lease term,
discounted using the rate the lessor charges the lessee (gross residual asset),
and the present value of expected variable lease payments, less any unearned
profit.
A lessor would subsequently measure
the lease receivable by increasing the carrying amount to reflect interest
accretion and reducing it to reflect the lease payments received during the
period. A lessor would determine the interest on the lease receivable in each
period during the lease term as the amount that produces a constant periodic
discount rate on the remaining balance of the receivable, adjusted for any
reassessment and impairment requirements.
Additionally, a lessor would
subsequently measure the residual asset at its initial carrying amount plus
accretion, adjusted for any reassessment and impairment requirements and for
variable lease payments.
After the commencement date, a lessor
would reassess the lease receivable for changes to the lease term, lease
payments, or discount rate, and remeasure the lease receivable and residual
asset accordingly. The lease receivable would also be assessed for impairment
in accordance with Topic 310, taking
into consideration the collateral relating to the receivable. Similarly, the
residual asset would be assessed for impairment in accordance with Topic 360,
taking into consideration any residual value guarantees relating to the
underlying asset.
On the balance sheet, the lessor would
present the lease assets (the sum of receivables and residual assets)
separately from other assets. However, lessors would be permitted to
present lease receivables and residual assets separately, or to disclose them
separately in the notes. On the income statement, all lessors would present
interest income on the receivable separately from other interest income, or
separately disclose which line items include the income. Profit or loss
recognized at lease inception may be presented on a gross or net basis,
depending on whether the lessor’s business purposes: if the lessor uses leases
as an alternative means of realizing value from the goods that it would
otherwise sell, revenue and cost of goods sold should be presented separately;
if the lessor uses leases for financing purposes, profit or loss may be
presented in a single line item. On the cash flow statement, all cash receipts
from lease payments would be part of operating activities.
Lessors – Type B Leases: A lessor would
continue to measure the underlying asset subject to a Type B lease, both at
lease inception and over the lease term, in accordance with other applicable
GAAP. This approach would be similar to existing lessor accounting for
operating leases. Presentation within the balance sheet and income
statement would be consistent with this approach, and all cash receipts from
lease payments would be part of operating activities.
Other
Provisions
·
Short-term
leases (contracts 12 months or less, including renewals, that do not contain a
purchase option): At inception, both lessees and lessors could elect not to
recognize assets or liabilities from a short-term lease, nor derecognize a
portion of the leased asset and simply recognize lease activity in earnings
over the lease term.
·
Sale-leasebacks:
A transferor would to assess whether the transferred asset has been sold using
the control principle in the 2011 Revenue Recognition Exposure Draft, and
account for transactions as either sales or financings accordingly.
·
Separate
components: Lessees and lessors would both be required to separately account
for lease and nonlease components. The ED provides separation and
allocation guidance for lessees; lessors would apply the allocation guidance in
the 2011 Revenue Recognition Exposure Draft.
Disclosures: The ED
proposes numerous new disclosures designed to explain amounts recognized in the
financial statements as a result of lease transactions, as well as to describe
the amount, timing and uncertainty of future cash flows. Such disclosures
would include many contractual details (lease term, contingent rentals,
options, etc.) and related accounting judgments. Lessees would disclose
reconciliations (i.e., rollforwards) of lease liabilities by class of underlying
asset. Lessors would provide similar reconciliations of their right to
receive lease payments and residual assets.
