In brief: A dual model for lease accounting: redrawing the lines (No. 2012-15)

DOWNLOAD

After more than a year of redeliberations, the FASB and IASB (the boards) took a big step forward this week in finalizing their revised proposals for lease accounting. They made significant decisions about how a lessee should recognize lease expense. In addition, they revisited some previous decisions concerning lessor accounting. This In brief article provides an overview of their decisions and what's next.

What's new?

After more than a year of redeliberations, the FASB and IASB (the boards) took a big step forward this week in finalizing their revised proposals for lease accounting. They made significant decisions about how a lessee should recognize lease expense. In addition, they revisited some previous decisions concerning lessor accounting.

All decisions noted in this In brief are tentative and therefore subject to change, as the boards have not yet concluded their deliberations.

Lessee accounting

The boards reconfirmed that lessees will recognize all leases with a maximum lease term of more than 12 months on balance sheet. Short term leases, with a maximum lease term of less than 12 months, will not be required to be put on balance sheet.

There will be two approaches to recognizing lease expense in the income statement:

1. Lessees will apply the approach proposed in the 2010 exposure draft for some leases, which results in a “front loading” of lease expense.
2. For other leases, lessees will apply a straight-line expense recognition pattern, similar to current operating lease accounting.

The boards agreed on a dividing line to determine when each approach should be applied. In principle, the dividing line will depend on whether a lessee acquires or "consumes" more than an insignificant portion of the underlying asset. The boards decided that, as a practical expedient, this principle will be applied based on the nature of underlying asset.

It is presumed that leases of property - defined as land and/or a building or part of a building - should be accounted for using a straight-line expense recognition pattern. This presumption is overcome if:

• The lease term is for the major part of the underlying asset’s economic life; or
• The present value of the fixed lease payments accounts for substantially all of the fair value of the underlying asset.

These criteria are similar to some of the criteria used today for capital lease classification under U.S. GAAP.

For leases of assets other than property - such as equipment – it is presumed that lessees should apply the approach proposed in the 2010 exposure draft, unless:

• The lease term is an insignificant portion of the underlying asset’s economic life; or
• The present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.

Lessor accounting

The boards decided that there should be symmetry between lessors and lessees in how they determine which approach to apply. They agreed that lessors should use the same dividing line and presumption as lessees (as outlined above). The boards previously decided that lessors of investment property should apply an approach similar to existing operating lease accounting. The boards’ latest decisions are expected to produce similar results in that most lessors of investment property will not apply the receivable and residual approach.

Where a lease gives a lessee the right to acquire or consume more than an insignificant portion of the underlying asset (typically presumed when the underlying asset is not property), the lessor will apply the receivable and residual approach. For a description of this approach, see In brief 2011-44, FASB and IASB make significant decisions related to lessor accounting and transition.

Conversely, where a lease gives a lessee the right to acquire or consume an insignificant portion of the underlying asset (typically presumed for leases of property), the lessor will apply an approach similar to today’s operating lease accounting. The underlying asset will remain on the lessor’s balance sheet and income will be recognized on a straight-line basis over the term of the lease.

While there are similarities in the criteria, there could be differences in the dividing line under the new model and existing U.S. GAAP. For example, real estate lessors may have to apply the receivable and residual approach for certain longer term real estate leases that are considered operating leases under current guidance.

What's next

The boards intend to meet again in July 2012 to address some final remaining issues, such as presentation and disclosure, before they prepare a revised exposure draft. The revised exposure draft is expected towards the end of this year.

Questions?

PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams that have questions should contact the Leasing team in the National Professional Services Group (1-973-236-7805).

Authored by:

Tom Wilkin
Partner
Phone: 1-973-236-4251
Email: tom.wilkin@us.pwc.com

David Humphreys
Partner
Phone: 1-973-236-4023
Email: david.humphreys@us.pwc.com

Krystyna Niemiec
Senior Manager
Phone: 1-973-236-5574
Email: krystyna.m.niemiec@us.pwc.com

Lou DeFalco
Senior Manager
Phone: 1-973-236-4141
Email: louis.defalco@us.pwc.com

In Brief is designed to provide a timely, high-level overview of significant financial reporting developments. It is issued by the National Professional Services Group of PricewaterhouseCoopers LLP. This publication has been prepared for general information on matters of interest only, and does not constitute professional advice on facts and circumstances specific to any person or entity. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication. The information contained in this material was not intended or written to be used, and cannot be used, for purposes of avoiding penalties or sanctions imposed by any government or other regulatory body. PricewaterhouseCoopers LLP, its members, employees and agents shall not be responsible for any loss sustained by any person or entity who relies on this publication.