The boards redeliberated but could not reach consensus on certain key issues with respect to the joint leasing project.
On March 18 and 19, 2014, the FASB and IASB (the boards) re-deliberated aspects of the joint leasing project, including the lessee and lessor accounting models, lease term, and exemptions and simplifications. The boards voted on a number of items but were unable to reach consensus on certain key issues.
Lessee accounting model
The boards agree that lessees would need to reflect all leases, other than those eligible for exemption, as a right-of-use asset (reflecting the control conveyed over the asset acquired during the lease term) and a liability (reflecting the obligation to pay rent) on the balance sheet.
The boards could not come to agreement, however, on the income statement impact. The FASB members support a dual model, with income statement treatment determined in a manner similar to current leasing literature, but without the bright lines. Under this approach, most existing capital leases would be accounted for in a fashion similar to current GAAP (Type A leases). Amortization of the right-of-use asset would be recognized separate from interest on the lease liability. This would produce a front-loaded expense recognition pattern characteristic of financed purchases. Most operating leases under current GAAP would be recorded on the balance sheet, but would retain a straight-line expense recognition pattern (Type B leases). Expense would be recognized in a single line in the income statement.
The IASB members, on the other hand, support the Type A approach for most leases, resulting in a financial reporting model similar to finance leases today. Their reasoning is based on their belief in the conceptual merit of this approach and that all leases contain an inherent financing element.
Lessor accounting model
For lessors, the IASB members support a model that produces a result similar to current leasing literature, i.e., the need to determine if a lease is effectively a financing/sale (Type A) or not. A lessor would determine the lease classification by assessing if the lease transfers substantially all of the risks and rewards of ownership incidental to the underlying leased asset, and would recognize profit similar to the principle in current literature (IAS 17 Leases).
The FASB members support a similar model, except that for Type A leases, they would permit a lessor to recognize a sale at lease commencement only if control of the underlying asset was transferred to the lessee. This model would look to the concept of control as established in the forthcoming revenue recognition standard.
The boards agreed that both a lessee and a lessor would include extension options in the lease term if a lessee had a significant economic incentive to exercise such options. “Significant economic incentive” is meant to be a high hurdle consistent with the concept of “reasonably certain” under current IFRS.
The boards also agreed that a lessee would reassess the lease term only upon the occurrence of triggering events (significant events or changes in circumstances) that were under the lessee’s control. A lessor would not reassess the lease term.
Exemptions and simplifications
The boards affirmed that there would be an exemption for short-term leases, which would be accounted for in the same manner as today’s operating leases. “Short-term” would mean 12 months or less, using the same definition of the term as used elsewhere in the standard.
Also discussed was the IASB’s support for explicitly permitting lessees and lessors to apply the lease guidance at a portfolio level. While the FASB did not want such guidance in the main standard, they indicated that they would consider a reference in the basis for conclusions.
Although the IASB supported a recognition and measurement exemption for small assets, the FASB asked its staff to do more research on the magnitude of leases of small ticket items to get a sense of the possible impact. The boards were in agreement that there should not be specific materiality guidance as to what would qualify as a “small ticket” lease.
The proposed lease accounting guidance will affect almost every company and for some, the proposed changes may be significant. Metrics such as EBITDA, net income and operating cash flows will be affected. These in turn will likely affect loan covenants, credit ratings, and other external measures of financial strength. Lessees will need to consider business process changes in multiple areas, including finance and accounting, IT, procurement, tax, treasury, legal, operations, corporate real estate and HR.
Deliberations are expected to continue in the coming months. 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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