Friday, January 28, 2011

Leases--Comments on IASB FASB Exposure Draft

Following is a summary of recent comments received by the IASB and FASB on the Leases Exposure Draft, courtesy of PWC

Scope exclusions
While there was general agreement that most arrangements accounted for as leases today should be governed by the standard, many have encouraged the boards to revisit the proposals on short-term leases and leases of intangibles.

Lessee accounting
Many respondents supported the right-of-use model for lessees, at least with respect to the balance sheet implications for simple leases. However, many disagreed with the measurement provisions for more complex leases. In addition, many expressed concern about the “deemed financing” premise and resultant accelerated expense recognition pattern in the ED.

Lessor accounting

Views on lessor accounting are more diverse. The ED proposes a “hybrid” model under which certain leases are accounted for under a performance obligation approach while others would be required to use a derecognition approach. Many believe that the case has not yet been made that the proposed hybrid model for lessor accounting represents a significant enough improvement from the current model to warrant a change. Some believe that a hybrid model is necessary to deal with different business models (e.g., financing models vs. contracts to use) while others believe a hybrid model is not consistent with concepts in the revenue recognition exposure draft and that only a derecognition approach is warranted.

Extension options
Almost all respondents disagreed with the definition of lease term as the longest possible term “more-likely-than-not” to occur. They believe this may result in recognition of amounts for extension periods that do not meet the definition of a liability. They also believe this approach would be highly subjective in application, result in significant volatility and be subject to manipulation in practice. While most respondents believe that some extension options should be included, there were differing views regarding the threshold at which respondents believe they should be recognized.

Contingent payments

The ED requires that contingent payments generally be included in the amounts recorded using a “probability-weighted” approach. Most respondents were critical of a probability-weighted approach and believe a “best estimate” approach is more appropriate. Some respondents also believe that certain types of contingencies (usage, performance, or index-based) should be treated differently—although there were differing views as to which types should be included and why.

Profit and loss recognition pattern
The ED includes an inherent financing element in the right-of-use model. This model results in a recognition pattern for the lessee that changes the expense recognition pattern of operating leases from rental expense to a combination of amortization and interest expense. It will also typically result in the acceleration of expenses compared to today's operating lease accounting and the timing of cash payments. Many respondents questioned the usefulness of this model.

Purchase options
The ED proposes that purchase options should be accounted for only when exercised. Many respondents believe they should be considered as part of the lease model.

Multiple-element contracts, executory costs and service arrangements
The ED includes guidance for distinguishing a lease from an in-substance sale/purchase and from a service contract. It also includes guidance for identifying the service components of an arrangement that contains a lease. Many respondents (both lessee and lessor) had concerns about accounting for an embedded lease in a multiple-element arrangement in which the vendor can replace the underlying asset or there is no specific asset identified in the contract. Multiple-element contracts that include a lease and a service arrangement represent a significant concern to many, especially for real estate leases. Many respondents believe the standard should specifically exclude service and executory costs from lease payments rather than try to link to the definition of a distinct service under the revenue recognition exposure draft. Many respondents have also raised concerns about the potential volume of “embedded leases” which now could have a significant accounting impact on multiple-element arrangements.

The ED provides for reassessment of significant assumptions if facts and circumstances indicate there would be a significant change in the amounts from a previous reporting period. Many respondents raised concerns about the operationality and cost/benefit of this approach. These respondents indicated that an annual reassessment may be appropriate while others suggested a “trigger-based” reassessment.

The ED provides for a “simplified retrospective” approach and does not allow for early adoption. While many respondents supported this approach for cost/benefit reasons, others observed that it creates an artificial and nonrecurring expense pattern. Many respondents also asked for more guidance on transition issues in general (e.g., use of hindsight) and for specific issues (e.g., sale leasebacks, leveraged leases and build-to-suit leases).

Most respondents supported the overall disclosure objectives, but believe that preparers should be allowed to exercise judgment in determining the volume of disclosures and financial statement presentation.

1 comment:

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