The FASB and IASB issued a revised Leases exposure draft on May 16, 2013 (the "revised ED"). The proposal would fundamentally change the accounting for lease transactions and have significant business implications. Under the revised ED, lessee’s must record substantially all leases on the balance sheet. A dual model is proposed for lessee and lessor income statement recognition.
Key developments in Lease accounting
- Lessees would account for the income statement impact using either a financing lease model (Type A lease) or a straight-line lease model (Type B lease). Classification would be based on the nature of the leased asset and its presumed consumption.
- Lessees would apply a straight-line lease model to leases of “property” (i.e., land, buildings, and part of a building) unless the lease term is for a major part of the asset’s economic life or the present value of the fixed lease payments represents substantially all of the asset’s fair value.
- For most leases of property, a lessor would account for the lease under the straight line model and apply an approach similar to today’s operating lease model. That is, a lessor would do the following:
– Continue to recognize the underlying asset
– Recognize lease income over the lease term, typically on a straight-line basis.
- Lessees would apply a financing lease model to leases of “non-property” (i.e., assets other than land and buildings) unless the lease term is for an insignificant portion of the asset's economic life or the present value of the fixed lease payments is insignificant relative to the asset’s fair value. Therefore, most non-property leases are expected to result in an expense recognition pattern that would be “front loaded”. Amortization of the right-of-use asset and interest expense on the lease liability would be reported separately in the income statement and cash flow statement.
- For most leases of assets considered other than property, a lessor would account for the lease under the financing lease model and would do the following:
– Derecognize the underlying asset and recognize a right to receive lease payments (the lease receivable) and a residual asset (representing the rights the lessor retains relating to the underlying asset)
– Recognize the effect of the discount on both the lease receivable and the residual asset as interest income over the lease term
– Recognize any profit relating to the lease at the commencement date.
- The lease term would include optional extensions only if the lessee has a significant economic incentive to exercise them. Variable lease payments would be included in measuring the right to use asset and lease liability based on a rate or index at the commencement date, payments that represent disguised minimum lease payments, and portions of residual value guarantees that are expected to be paid; a “probability-weighted” approach would not apply. Contingent rents relating to future performance (e.g., sales) and dependent on usage (e.g., miles driven) would not be included when measuring lease assets and liabilities.
What's next for Lease accounting?
- The Boards are in the process of their joint redeliberations of the May 2013 Exposure Draft. It is not clear how the boards will resolve their differences or how their current lack of consensus will impact the timing of a final standard..
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